Bringing diversification benefits & reliable cashflows

Interest in timber investments is strong; at a time when interest rates are low and there is uncertainty over the eventual end of quantitative easing (QE) institutional investors are keen to diversify portfolios and enhance them with alternatives.

Timber investments - classic real assets

Timber investments are ‘classic’ real assets in the sense that  they generate income while at the same time offering a degree of protection against inflation. The low correlation between timber investments and equity markets is another important factor – particularly at the moment.

Two sources of income

An investment in forest areas offers two potential earnings sources: from the sale of timber as a renewable commodity and from the increase in the value of the land. The growing demand and shortage of supply are enhancing  value, as every day forests are being cleared to make way for agricultural land or building space. In the USA, in particular, forest investments have risen in value - in some cases noticeably - in response to this.

Limitation for foreign investors

However, it is not always possible to acquire title in forested areas. In Brazil, for example, this has inhibited the involvement of foreign investors. An alternative is to lease forest areas for timber cultivation. Demand for timber as a commodity is strong throughout the world as it is profiting from macro trends such as global population growth and greater prosperity in the emerging markets – most notably in Asia. Of course, demand for timber is subject to fluctuations – in the financial crisis, demand receded and this led to a drop in timber prices. However, a positive trend is still clear over the long term, partly due to the fact that the supply of timber cannot simply be raised at the drop of a hat.

Good prospects for America

We see promising possibilities for investment in the forests of the Americas. Countries such as Uruguay and Brazil offer the prospect of above-average returns. North America has a long tradition of timber cultivation and, thanks to its close proximity to the timber-processing factories and sales markets, is an exceptionally interesting investment target. In the emerging markets, significantly higher returns can be generated, albeit at a higher investment risk. Aquila Capital is currently examining projects in the USA and South America. A share interest was also recently acquired in Australia.

Manageable risks

Although there are risks associated with forest investments, in our view they are manageable. Losses due to forest fire, storm damage or bark beetle are statistically low in cultivated forest areas and these risks can also be insured against. Other uncertainties include the timber price as well as in harvest costs, the weather and any currency developments. Political risks can be mitigated by careful asset selection. With diversification benefits and on-going cashflow generation, we anticipate growing interest in timber investments as part of a wider, real asset allocation.