Seeing the value of the woods – and the trees

Hugh Humfrey of Timberland Investment Resources Europe, tells Will Jackson about the value of timber.

Q. Is it fair to say that timber is a more popular asset class among American investors than Europeans?

A. If you go to Germany, families have owned forestry for hundreds of years – they appreciate the long-term nature of the asset class. So it is not a new asset class to European investors. What is happening is that European institutional investors are paying more attention to it because of the attributes it has. We see plenty of interest out there, which in due course we hope to convert into funds under management.

Q. What are the benefits of allocating to forestry?

A. At the top of the list – attractive returns over a long period. If you take a 20-year view, timberland has performed well against equities, bonds, commercial property and other commodities. To put that into perspective, what you don’t get from timber is plus-30% years as you can in equities. But you don’t get minus-30% returns either. So not only have the returns been robust, they’ve also been with less volatility than other more traditional financial assets. Portfolio diversification comes into it.

When you look at the return components of timber, long-term returns are primarily driven by the biological growth of the tree, and significantly less so by timber and land prices. If you know where you are in the world, you know what type of tree you’ve got, and you do a bit of soil analysis, then you know how that tree is going to grow and you can model it over a long time with a high degree of predictability. That’s very attractive – particularly to pension funds. (article continues below)

Q. There are risks involved with this sort of investment – your forest could be hit by disease or fire. How do you mitigate those sorts of risks?

A. First of all is diversification. That’s a combination of geographic and species diversification. So you stay away from Hurricane Alley in the south-east US, and you diversify your species so you avoid a calamity from disease. Good forest management is particularly important. In the main we’re talking about plantations here, so you control the undergrowth because the trees grow better, so it’s less prone to fire. You build access roads because you need to get into your property – they act as firebreaks.

Last year, you would have thought the whole of the west coast [of America] was on fire. That wasn’t commercial timberland. A lot of that fire was either happening in national parks, which aren’t managed intensively so there is undergrowth, or it was happening in scrubland. One of the issues with national parks is that because it’s public land, you have people in there hiking, camping and throwing cigarette ends out of cars. In a plantation the risks of fire exist but they’re mitigated.

Q. What sort of returns can you expect from timber?

A. They vary. If you accept that the US is the most developed, mature, and liquid market, then you should look for an IRR [internal rate of return] of 7% or 8%, perhaps a bit more. If you venture into South America, which in forestry terms is considered pretty developed, you want low double-digit returns. Then you can move significantly up the risk curve – I was listening to someone who had investments in East Africa and they were talking about 20% returns. For us, that’s too far up the risk curve.

Q. Your fund is subject to Financial Services Authority approval. When it has been launched, where will you invest?

A. It will be circa 40% in the US, 20% in Brazil, and 20% in central Europe. The balance could be anywhere – it might be the UK, Australia or New Zealand, so the lower end of the risk curve.

Q. What assets will the fund own?

A. Fundamentally we want to buy timberland – a combination of trees and land. In the main we’ll try to do that via freehold. Sometimes that’s not possible and a lease on the timber itself might satisfy our return criteria.

Q. Investors are already able to access several products investing in timber. Should they be careful about what assets each fund is holding?

A. You want to be clear what asset it is that you’re acquiring, and to understand the drivers of those assets. If you invest in Brazil, your strategy is all about timber, its growth and its use. If you’re investing in the US, you’re looking at timber, its growth, its use, land and all sorts of other income streams that can come off it. The other thing is that in some parts of the world you can’t own freeholds – you have to get involved in some sort of lease. It might almost be a lease in perpetuity, but it’s still a lease.