Why We Use Timber in Investment Portfolios

If you’ll recall, in previous discussions we talked about Real Estate as an asset class, and then we discussed the merits of Commodities as a broad asset class for your portfolio. Timber is an asset class that is not well-represented in the broad Commodities indexes, and (at least as of this writing) there is no index fund tracking what is considered the benchmark for the US-based timber industry, the National Council of Real Estate Investment Fiduciaries (NCREIF) Timber Index.

Timber as an Asset Class

Timber is typically not well-represented in other Commodities indexes. The nature of timber as an asset doesn’t lead it to treatment the same as most other commodities, due to its unique 3-part return generating process. Returns are generated by:

1) cutting and selling the timber itself;

2) increases in demand for timber, which tends to follow the growth of the GDP; and

3) inflation in the cost of timber, which over time has tended to slightly out-pace inflation in the general economy.

Capital appreciation in the timber asset class is generated by the increases in the value of the underlying land, plus the natural growth rate of the trees.

The risks associated with the asset class include primarily demand-side risks. Since supply-side inputs are primarily “free”: sun, soil, and water; risks in generation of the product are relatively small. In the management of the product there are costs and minor risks – that of land management, lease and/or other acquisition costs and taxes, and the risks of climate change, fire damage, and other biological damage. These management risks are deemed to be relatively small (much less than 1%).

On the other hand, the demand-side risks are many: demand for lumber can vary dramatically with the economic cycles, but some demand is always present. In addition, if the volume of available finished product is too great for the demand, price volatility can be present to erode returns.

Over the past 40 years, depending upon the benchmark in use (I used the Hancock Global Timber Index), the yield on timber as an asset class was in excess of 9%, with a standard deviation of roughly 12.5%. Recent calculations of future returns for timber indicate anywhere from a 6% to a 7.5% return for the near term. Longer term calculations quickly become invalid due to the dependency upon the global GDP estimations.

And lastly, given the compelling return predictions, one of the critical factors that we look for when choosing additional asset classes to invest in is low correlation to the remainder of our portfolio. In this case, timber fits the bill quite well – when compared to fixed income, equities, foreign equities, other commodities, and foreign-currency bonds, the correlation falls well below .25. This means that, for example, any movement (positive or negative) in the underlying value of our timber proxy has historically reflected other asset class movements at less than a 25% rate. In other words, if the domestic equities asset class experienced a 10% correction, historically speaking, you would expect less than a 2.5% “reflective” correction in the timber asset class.

So, all in all, it seems to make a great deal of sense to have a small exposure in our portfolios to Timber as an asset class when seeking additional non-correlated returns beyond the more common asset classes. Timber is not always present in the portfolios that I develop, but it is quite often included, for the reasons stated above.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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