Timber is coming out of the woodwork

Few British retail investors look to timber as a commodity and it is a complex market. But with tropical timber offering both consistent prices and stable growth, it may be worth considering.

Many asset classes have fallen over the tough market environment of the past few years. Most investors have therefore found it difficult to find new investment opportunities that can give portfolios true diversification and potential for capital growth. However, timber is one such opportunity that more investors should analyse.

It is a difficult area to write about in such a short article, owing to the depth of the market, the specialist and subjective nature of it, and its attributes as an asset class. Unfortunately, there is no handbook about the history of timber as a commodity and how to invest in it, but enough research is out there to build up a positive outlook for the asset class as an investment.

Few British retail investors look to timber as a commodity, especially relative to mainstream commodities like oil, gold, or softs. However, it has gained interest in recent years. With institutional investors it is more common, especially in America. For example, Harvard Management, which manages endowment and pension money for Harvard University, allocated 10% of its $27 billion to timber in 2005.

A big problem many investors face is establishing what “timber” constitutes. To the man on the street it could mean any common variety of wood. “Tropical timber” is a more specific classification and its underlying constituents are some of the most common forms of timber/wood traded internationally. World Bank provides statistics on various traded commodities, including a section on raw materials, which incorporates timber. This raw materials section includes the following forms of timber: logs, plywood, sawnwood and woodpulp. There is a large number of underlying species and processed products.

Under the “logs” category, species include teak, meranti, sapelli, niagon and samba. In 1945 only 19 species were widely known and traded. This has grown to about 150, with most of the trade in the form of logs.

Since the late 1960s, trade volumes for selected tropical timber products have been on a general uptrend. This is also true for prices of tropical timber products since the 1950s. Interestingly, teak sourced from Thailand has not suffered as big price falls relative to the other forms of timber. The graph above shows more recent price data from World Bank for timber (sawnwood and logs) from Malaysia.

There is an obvious uptrend in both products’ prices over recent years. More fascinating, logs (the meranti and sarawak species) showed lower price growth but more stability – a potentially useful trait for portfolios. Sawnwood, used more in construction, has suffered because of the global recession, especially the fall-out in the American housing market.

Demand for timber used in construction will potentially remain affected by the uncertain global economic climate. However, more specialist hardwoods and top-end products such as teak are less affected and prices should be resilient.

So how do you invest in timber? Well, it depends on the type of exposure an investor wants. It is possible to buy shares in a company whose activities include the planting and harvesting of timber. Some examples available for British investors are listed on the Alternative Investment Market (Aim). There are also a few timber real estate investment trusts (Reits) available in America. However, some researchers have serious doubts about their underlying exposure to physical timber.

There are also various collective investment funds that provide a diversified portfolio of timber companies. The growth in exchange-traded funds (ETFs) has resulted in the launch of a few timber-related products in America. One contains exposure to 27 companies from 11 countries, while the other is comprised of 25 of the largest publicly-traded firms engaged in the ownership, management or upstream supply chain of forests and timberlands. Both of these ETFs fell by over 40% in 2008, so they give investors stockmarket risk. They also mainly give exposure to forestry/ paper stocks, which lack most of the benefits of timber investing, and there is little correlation between these funds and a suitable and well-established timber market benchmark.

The options mentioned above provide a broader level of exposure and therefore spread risk. However, they subject an investor to stockmarket risk and potential volatility.

Although investors may be gaining some indirect exposure to physical timber and its investment characteristics, the actual share price performance of the timber companies may negate any positive results from the asset.

Another option that could potentially offer true portfolio diversification is to participate in buying the physical trees/land of timber plantations. Investors can then benefit from the actual growth of the plantations over their lifetime and the potential increase in the price of the type of wood being grown. Several investments are available in Britain, specifically in Scotland. Others are further afield, including one offering exposure to plantations of a variety of hardwoods in Costa Rica.

Investors pick the types of wood they wish to grow and then receive title documents for the land and global positioning system (GPS) co-ordinates of their trees. However, this is a “hands-on” approach with relatively high charges, and is too specialist for the average investor.

Also available are collective investments that pool investors’ money to buy sustainable teak plantations in Brazil, which are managed directly by an established forestry management company. This provides a greater spread of plantation exposure to the underlying asset. However, investors must be confident with the relationship between the fund promoter and forestry management company.

Investors must research and understand the structures, dealing and redemption status of each of these options as many are illiquid.

In summary, there is a long-established commodity market in timber which is relatively unknown to retail investors. The market and its prices have generally seen consistent and more stable growth than other commodities over many decades. Investors should research the market thoroughly and decide what kind of exposure, if any, they feel comfortable with.