Dozens of mythologies and religions around the world consider trees sacred. Buddha, after achieving enlightenment, sat under a banyan tree for seven days. In the Garden of Eden, the two most important plants were the tree of life, and the tree of knowledge of good and evil. In Celtic mythology, trees were of vital importance to Druids, for whom the oak was one of the most sacred objects.
Nowadays, trees have largely lost their spiritual value, gaining a financial one instead. Apart from their long-established importance to several industries, trees and farmlands have emerged as an interesting way for institutional investors to tap uncorrelated returns.
Richard Davidson, who is the lead fund manager of the Gresham House Forestry fund, as well as the chair of the investment committee of its forestry management subsidiary, Aitchesse, found the Sitka spruce species especially interesting, just like the Native American tribe Hopi, for whom spruce is still a holy tree.
Aitchesse has around £200 million of assets under management invested in the Sitka spruce forests in the UK on behalf of endowments and other institutions.
‘If you’re investing in a forestry fund, it’s actually not that dissimilar from a lot of other, real estate-type assets,’ Davidson explains.
‘You would use a DCF approach to value the assets: look at the cash flows, which come when you sell the timber; look at the costs, which include buying a land and establishing the forest; and you look at the liquidity that is available on the market to buy and sell forests.’
The Sitka spruce grows quickly compared with other trees: a full-cycle takes 35-40 years. Its financial appeal is now so large that today one out of every two trees that grow in the UK are the Alaskan-native conifers. 200 years ago, there were none.
Choosing the best approach
Investors can access forestry assets through various investment vehicles, usually choosing private equity funds or partnerships, such as the Gresham’s fund (which utilises a Scottish Limited Partnership structure).
Among the pension funds which have invested in forestry, the majority chose private equity funds. Flintshire, a UK Local authority pension fund, has £27.5 million invested across several timber funds, including £4.5 million with BTG Pactual Select Timberland Resources Fund II and £5.7 million with Stafford International Timberland IV Fund. Also Essex, another Local Government Pension Scheme (LGPS) invested with Stafford, putting £77 million into two of Stafford’s timber funds.
Suffolk LGPS invested £6.9 billion with Brookfield Timberlands Fund V L.P., which is a US$1 billion PE fund investing primarily in timberlands in the US, Brazil and Australia.
However, London Pension Fund Authority has taken a different approach to the asset class: the LGPS invested more than £7 million with Phaunos Timber fund, which is a fund of funds listed on the London Stock Exchange.
Outside the UK, Australia’s Care Superannuation fund also invested in Stafford, with its International Timberland VI fund, whereas €36 billion Ilmarinen, which is Finland’s oldest pension and insurance group, has exposure to several forestry strategies, including two Dasos Timberland funds.
However, there are also other opportunities. Swiss asset manager Pictet runs the thematic equity fund, which invests in listed securities exposed to forestry and timber. Gabriel Micheli, one of the co-managers of the €1.2 billion Pictet-Timber fund, argues that this approach is in some regard better than private equity.
‘Investing in forest-related listed equities means you can get better forests for a cheaper price because listed companies still have a discount to private equity values. On top of that, you usually have a better forest because these companies own forests that have been managed for decades and usually they have only kept the best ones. I believe that the diversification is also stronger in this case.’
However, investing in the thematic equity fund also means there is an equity risk premium as well as volatility.
Pathways to returns
Micheli points out that there are specific factors that influence his thematic fund.
‘Of course we tend to follow the equity market but we have very specific drivers: the first one is the housing market, mainly in the US, the second is the consumption growth in emerging markets, especially China (hygiene products), and the third one is the overall economic environment, which impacts industries such as packaging.’
In the case of private equity forestry strategies, income and risk are driven by different factors. In the case of Gresham’s fund, these might be: increase in land values, pulp and chip wood production or bar production for panel products. However, by far the largest chunk of income comes from selling sawlogs for timber, which in the case of Sitka spruce, is responsible for 65% of returns.
‘There are financial risks and biological risks. Timber prices might go down, the cost of operations can go up, such as building roads, buying young trees, building fences. The third risk would be if the favourable tax treatment, which we have now in forestry in the UK, were to change.’
However, Richard Davidson, who is also chairman of the University of Edinburgh Endowment fund, says that the volatility of timber prices can be managed within his fund.
‘The good thing about timber is that it’s not like wheat or barley or any other agricultural crop, meaning you don’t have to harvest it at a certain time. The tree just continues to grow for up to 200 years. So if you don’t like the price today, and you’ve got enough cash to pay the bills, then you can leave the trees to grow for another year or two.
‘And when you do come to harvest, there’s more timber there. Because the trees just get taller and broader every year.’