21 March, 2022 / Comment
Five reasons to invest in timberland
By Martin Davies, global head, Nuveen Natural Capital
Low carbon intensity and potential to generate verified carbon credits help investors achieve climate targets
Timberland, and the wood fibre it generates, is vital to the global economy. It provides a renewable resource for housing, furniture, packaging, tissue, heat and energy. What’s more, we depend on forests for essential environmental services like air and water purification.
For many decades, timberland was owned primarily by governments, wealthy families and corporations. However in the 1980s, rising demand for timberland corresponded with the restructuring of the forest products industry in the US, resulting in a shift in timberland ownership from operating companies to financial investors.
In the decades since, timberland has proven itself a compelling asset class offering strong market fundamentals, attractive returns, limited correlation with traditional asset classes and a reliable hedge against inflation. Now within a backdrop of rising inflation and market volatility intensified by the ongoing Russia-Ukraine conflict, investors are becoming increasingly conscious of the quantifiable climate and investment benefits that timberland offers.
Driven by trees’ natural ability to sequester and store carbon, those benefits are increasingly valued as climate action ramps up (through voluntary commitments or regulations) and as markets for forest carbon expand.
For today’s International Day of Forests, here are the five key principles that provide a fundamental case for investing in timberland.
- Strong market fundamentals
Investing in timberland and primary production is the best way to benefit from growing worldwide demand for wood. As populations expand and become wealthier and renewable alternatives to steel and concrete in construction are sought growing wood demand provides attractive opportunities for timberland investors.
In emerging market countries such as India and China, increases in per capita income are expected to be greatest, with demand for forest products for both domestic consumption and exportation expected to rise. In developed markets such as the EU and the US, economic growth is also expected to increase demand for wood, particularly as a low-carbon alternative for production.
- Attractive returns with a stable cash yield
Timberland returns, particularly over the past three decades, have been highly competitive with traditional asset classes. For instance during the period between 1992-2020, timberland outperformed US and non-US fixed income and non-US equities by between 177 and 377 basis points. Timberland also proved to be far less volatile than equities.
As a store of value, timberland has been resilient throughout recent recessions. This long-term resilience is the result of the dual sources of return (capital appreciation and cash yield) and the fact that tree growth is not affected by market volatility or business cycles.
- Portfolio diversification
Timberland returns can exhibit low or negative correlations to equities and fixed income. A key driver of this lack of correlation is that a portion of the investment return is generated through biological growth, which is independent of market movements.
Payments for ecosystem services, like carbon credits, provide an additional source of uncorrelated return and have the potential to enhance diversification benefits from timberland investment.
- Hedge against inflation
Timberland continues to provide investors with a reliable hedge against inflation.
For example between 1992 and 2020, the correlation between US CPI and timberland was positive and exceeded the correlation between inflation and traditional asset classes. One reason for this is that timberland assets produce the raw materials for many products in the CPI basket of goods, such as building materials, furniture, tissue, paper and packaging.
The correlation between timberland returns and inflation has remained reliably positive for many decades, suggesting that as inflation increases, timberland performance should keep pace with or even outpace inflation.
- Quantifiable climate and environmental benefits
Timberland represents a direct investment in biological carbon removal. Trees’ natural ability to sequester and store carbon, alongside agricultural crops are currently the only proven and scalable means to remove greenhouse gas emissions from the atmosphere. As demand for low-carbon building materials and sustainable inputs to production increase, demand for timber from sustainably managed forests is expected to grow.
Approximately 2.6 billion tons of carbon dioxide, a third of the CO2 released from burning fossil fuels, is absorbed by forests every year. Trees not only remove CO2, but can actually store it for a century or more.
As an asset class, timberland has the lowest average carbon intensity — or net CO2 emissions per euro invested — amongst both alternatives and traditional asset classes. An allocation to timberland, with a net negative carbon profile, can balance more emissions-intensive sectors within an institutional portfolio, helping it to achieve climate targets efficiently and without having to unnecessarily sacrifice returns.
Timberland’s potential to generate verified carbon credits creates additional value. Credits can be monetised to boost financial returns, retained by the landowner to offset their emissions or simply retired. Already, major corporations such as Apple, Microsoft, Amazon and Google have announced ambitious carbon neutrality goals.
Corporate demand for forest carbon credits to meet climate targets from companies like these could fundamentally alter production forest management, the size of the investable universe and the timberland ownership framework.
Alongside the climate benefits, sustainably managed forests can improve biodiversity and preserve and protect environmental features and valuable habitats.
Timberland’s low carbon intensity and potential to generate verified carbon credits can help investors efficiently achieve their climate targets. As price pressures return to global markets, timberland’s traditionally high correlation with inflation – combined with the other enduring principles described here – make the fundamental case for timberland investing as strong as ever.
Part of the Bonhill Group.