Reducing Timberland Portfolio Risk
Through Strategic Diversification
SOFEW Conference
Renaissance Charlotte Suites Hotel, Charlotte, NC
March 20, 2012
Chung-Hong Fu
Timberland Investment Resources, LLC
Agenda
Managing timberland portfolio risk through strategic diversification
1. Timberland Investment Risk Factors
2. Timberland Portfolio Diversification Methods
3. Summary and Recommendations
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Timberland Investment Risk Factors
Timberland investments have three primary types of risk – Market Risk,
Manager Risk and Biological/Natural Risk
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Timberland Investment Risk Factors
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Timberland Portfolio Diversification Methods
Four approaches to diversifying a timberland portfolio and mitigating risk
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Areas of Diversification:
1) Spatial Diversification – By Country
The broadest and most direct way to achieve portfolio diversification is to acquire
forests in different countries – but,, recognize
g
that systemic
y
market risk still exists
because of global trade flows of wood and wood products.
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Areas of Diversification:
1) Spatial Diversification – By Country
There are effectively four inter-linked global market zones for timber and timber
products. For diversification purposes,
p
p p
, the gains
g
begin
g to diminish after four or five
countries are represented in a portfolio.
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Areas of Diversification:
1) Spatial Diversification – By Region or Local Market
For a country with a sufficiently large forest products sector, it is possible to
diversify across different regional and local markets.
markets
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Areas of Diversification:
1) Spatial Diversification – By Property Footprint
Shape and size of forest properties can serve as a diversification tool
 The size, shape and distribution
characteristics of a single timberland
investment, or a portfolio of timberland
assets, increases or decreases exposure
to…
 Biological risks such as variations in
climate and soils
 Catastrophic risks, such as storms, fire,
disease, pests and theft
 Local market risks, such as the strength or
weakness of the regional mill base or the
rural real estate market
 The downside of having varied and
dispersed forest assets is that it can be
more challenging or more costly to
manage
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Areas of Diversification:
2) Temporal Diversification – By Maturity of Timber
Different maturities may reduce exposure to price cycles in the market
 Holding timberland stocked with timber of varying maturities or ages can
provide temporal market diversification
 When a stand of trees is ready to be harvested there is no guarantee that the market will be
sstrong
o g for
o the
eg
grade
ade o
of timber
be that
a is
s be
being
g so
sold.
d
 If an investment is stocked with timber of varying ages, there is less exposure to the risks
associated with down cycles for particular grades.
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Areas of Diversification:
3) Income Diversification – By species and product
Holding assets stocked with different tree species and managed to produce
different end
end-use
use log products reduces exposure to market shocks
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Areas of Diversification:
4) Investment Style and Strategy Diversification
Risk can be mitigated by broadening the range of strategies and products
 Choose more than one fund or manager
 Managers are differentiated by…
1.
Their investment strategies
2.
How they practice forestry and perform
property management functions
3.
Respond to, take advantage of,
biological and market shifts
 Seek exposure to different market
segments
 Large, middle and small transactions
 Reach non-timber markets such as
ecosystem services, conservation
values, recreational leases, etc.
 Acquire different asset types
 Fee simple (freehold) ownership of land
and standing timber
 Timber cutting rights
 Timberland leases
 Fiber / timber supply agreements
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Summary and Recommendations
Risk management should not just assess country exposure
 Globalization means timber markets are
interlinked
 Systemic market risk means diminishing
returns of country diversification beyond 4 or
5 countries
 Equal levels of risk reduction can be
achieved when a portfolio…
 Holds a range of commercial timber species
 Is exposed to a variety of regional or local
markets
 Produces several different log products or log
grades
 Has properties stocked with timber of
different ages that mature at different times
during the investment term
 Has exposure to non-timber income sources
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Summary and Recommendations
There are tradeoffs and choices involved in setting a diversification strategy
 Investors have a choice of active or
passive risk management
 There is a tradeoff between
diversification and expected return
 The highest degree of control over one’s
diversification strategy can be achieved
by investing through a TIMO separate
account
 Investor has say
y over exactly
y which
markets and types of timberland assets
will be acquired and sold
 Timberland assets benefit from economies
of scale
 Smaller, numerous investments held
across several countries, regions or more
markets will raise your fixed and variable
costs (and lower investment return)
 But such a vehicle usually requires a large
allocation of capital,
p , which some investors
may not be able to accommodate
 Investing in a TIMO comingled fund
provides for passive diversification
 Beyond the initial selection of the fund, an
investor’s capacity to manage risk is
limited
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