Alternative Investment: Forestry (4 of 8)

Alternative Investment: Forestry (4 of 8)

alternative-investment

There are a significant number of drivers behind forestry investment, including a desire to invest in green projects, growing timber prices and relatively consistent returns

Risk Level

'Forestry' is Risk Level 4 of 8 in Alternative Investments.

Investment Case

Diversification And Performance

Returns from forestry have outperformed stock markets and traditional investments in the long term with returns averaging 6.5% a year over the last century - compared to 5.2% a year for the UK stock market. In addition, forestry historically performs well when markets fall – and has a low correlation to traditional asset classes. Forestry is a classic hedge against high inflation. Not only is forestry a tangible commodity, but as trees grow their value should increase in line with inflation. Biological tree growth tends to offset any depreciation in timber prices.

Supply And Demand

The global timber trade is valued at more than £372 billion a year, with estimates that demand for timber will increase 60% by 2030, according to the United Nations Food and Agriculture Organization. This growth will partly be driven by economic and population growth in India, China and the rest of Asia.

However, there are new constraints upon supply. Governments and international Non-Governmental Organisations (NGOs) are legislating to prevent illegal and unsustainable logging, which together account for as much as 70% of all timber sold.

Other Considerations

Investing in forestry in the UK can offer significant tax breaks, including being an ideal shelter for those wishing to avoid inheritance tax.

Forestry only pays income intermittently and harvest dates can be far into the future.

Findings

There has been a surge of interest in the forestry sector since 2008 as investors have sought out alternative investment opportunities away from the stock market. Just over half of investments in this sector were launched in 2011 and 2012. The majority of forestry-related products are genuine businesses looking for alternative sources of capital, but a small minority are opportunistic - set up in locations where land is cheap, in a sector where it is easy to make outlandish claims for levels of return achieved many years in the future - and without any upper limit or time-frame for closing their fundraising.

Returns, time-horizons, minimum levels of investment and the timing of income payments vary widely.

Projects based on fast growing crops such as bamboo (technically a species of grass) can pay regular income and have shorter investment horizons. Projects based on slow growing hardwoods such as teak have much longer periods between income distributions. The vast majority of investors’ returns are paid at the end of the project life-cycle – which can be over 20 years away. Long-term projects tend to offer the highest potential returns, but the locations and long time-frames involved add risks investors must consider.

Ownership structures vary from sub-leases to alternative finance investment bonds, and more esoteric ideas such as advanced purchase orders. All of the structures must be looked at carefully in the light of the Financial Conduct Authority’s consultation paper CP12/19 on UCIS and “close substitutes”.

Geographically, Forestry projects are located across the world, with investments in emerging and frontier markets offering higher returns that reflect perceived higher levels of risk and the lower cost of land.

Transaction costs are typically high as these are land purchases that require ongoing management – especially at harvest and thinning times. Costs can be as high as 40% of the gross income though they are typically lower.

The quality of the product provider and the operating companies are crucial in this sector. Investors must be confident they can do a good job over a long period of time. Certification by the Forestry Stewardship Council (or similar) can also provide a benchmark for quality.

It’s also worth noting that as governments clamp down on illegal logging this may well reduce supply and favour commercial plantations such as these kind of projects.

Summary

Forestry appeals as a sector that provides uncorrelated returns, genuine diversification and a hedge against inflation. The direct investment products offer a wide range of interesting opportunities in a number of locations – but investing over long time frames requires a high degree of confidence in the project.

Investment Fundamentals

  • High investment returns
  • Long term
  • Returns weighted towards the end of the project
  • High reliance on operating/management company
  • Located in developing markets with very low cost land

Investor Conclusions

For investors and their agents, directly owned forestry investments should be considered for capital protection and diversification benefits. The opportunity to access forestry at low levels may not last for much longer – but investors need to develop a high level of understanding of the project to feel confident about their purchase.

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