Growth, protection, income and diversification

With equity markets faltering and inflation soaring, timber and forestry ETFs provide investors with exposure to a physical asset that can offer steady growth, downside protection, regular income and increased portfolio diversification.

Timber and forestry ETFs offer growth, income, downside protection and diversification.

It is no surprise, therefore, that institutional investors such as insurance companies, pension funds and hedge funds have long viewed woodland as a useful portfolio tool.

Timber’s defensive growth quality comes from an inherent fundamental characteristic: trees grow regardless of economic conditions. It is this natural process of tree growth that delivers timber’s consistent and attractive return profile.

Indeed, according to Investment Property Databank, an investment performance data provider, the annualised rate of return over the past decade for forestry in the UK has been 10.4 per cent. This compares to 3.7 per cent for equities, 5.9 per cent for gilts and 6.8 per cent for commercial property.

Defensive characteristics

Natural growth increases both the volume and value of the timber – as trees increase in diameter they are utilised for more valuable end products. This growth is predictable at the time of investment and, assuming relatively stable timber prices, provides investors with an assured return.

With regard to timber prices, these have generally risen ahead of inflation, providing investors with long-term stable real returns. With assured growth in volume this combination provides investors with a mechanism to preserve capital.

Cash flow largely arises from harvesting of the timber. However, unlike agricultural crops, forestry owners can time their harvest in response to favourable movements in the price of timber, thereby enhancing returns.

This ability to effectively warehouse the asset by delaying harvesting – known in the trade as ‘storing on the stump’ – during times of weaker prices, allows value to accrue by leaving the trees to continue to grow.

Strong demand

The supply and demand fundamentals backing timber are strong. Timber has wide-ranging traditional uses from paper and packaging, through to pallets and fencing, to high value construction and joinery.

The uses of timber are also being extended to include biomass for electricity generation and bioethanol as a substitute for oil derived fuels, both from a non-polluting source. These new markets are creating significant new demand for timber – demand which is forecast to grow.

Infrastructure and housing projects in emerging market economies are driving demand for timber and, as per capita incomes in these countries rise, consumers are buying items we in the West take for granted, such as lavatory paper and paper towels.

What is interesting, though, is that timber is yet to experience the price hike seen in other commodities over the past two to three years as a result of the emerging markets boom. But as the fundamentals are similar, timber prices may yet follow a similar upward path.

Of course, like any investment, there are risks. These include natural disasters, such as fires and hurricanes, along with the risk of pest infestation and disease. A well structured and diversified timberland portfolio, however, as well as insurance in certain cases, can help significantly and mitigate against potential losses.

Timber and forestry ETFs

ETFs by their very nature are well structured and diversified. The iShares S&P Global Timber & Forestry ETF, for example, holds equity stakes in 26 different companies operating in the timber and forestry industry around the world, while the Guggenheim Timber ETF offers exposure to 27 companies.

iShares S&P Global Timber & Forestry ETF
Listed in London, the iShares S&P Global Timber & Forestry ETF aims to track the performance of the S&P Global Timber & Forestry Index. This offers exposure to the 26 largest and most liquid listed companies globally that are involved in the ownership, management or the upstream supply chain of forests and timberlands.

Guggenheim Timber ETF
The Guggenheim Timber ETF aims to track a specialist equity index called the Beacon Global Timber Index. This index is designed to track the performance of common stocks of global timber companies that own or lease forested land and harvest the timber for commercial use and sale of wood-based products, including lumber, pulp or other processed or finished goods such as paper and packaging.