Chapter 14
The Role of Real Assets
1
Though wisdom cannot be gotten for gold, still les
can it be gotten without it.
- Samuel Butler
2
Outline
 Introduction
 Real
estate in general
 Timberland in particular
 Gold
3
Introduction
 Most
portfolio investments are financial
assets, such as:
• Common stock
• Corporate bonds
• Bank CDs
4
Introduction (cont’d)
 Real
assets:
• Are assuming an increased role in some of the
country’s largest pension funds and in private
investor portfolios
• Include timberland and gold
• Do not have a corresponding liability unless
one is created to finance the purchase of the
real asset
5
Real Estate in General
 Investment
characteristics
 Developed and undeveloped property
 Pension fund investment in real estate
6
Investment Characteristics
 Characteristics
of land:
• Immobile
– Land cannot be moved
• Indestructible
– Land cannot be destroyed
• Nonfungible
– Ever plot of land is unique
7
Investment
Characteristics (cont’d)
 Characteristics
of land (cont’d):
• Land is typically a long-term investment
– Especially for institutional timberland owners
• Land can be a short-term investment
– E.g., timberland may be used for development or the
extraction of minerals
8
Real Estate Categories
Residential
Commercial
Owner
occupied
Office
buildings
Light
Timberland
manufacturing
Cemeteries
Rental
Store
properties
Heavy
Pastureland
manufacturing
Churches
Lofts
Mining
Ranches
Government
properties
Theaters
Orchards
Golf courses
Garages
Farmland
Parks
Hotels and
motels
Industrial
Farm
Special
Purpose
Public bldgs.
and streets
9
Developed and
Undeveloped Property
 Developed
property is land with
improvements on it
• E.g., shopping malls and apartment complexes
• Purchased by investors for:
– Income-producing characteristics
– The tax advantage from depreciation of buildings
10
Developed and
Undeveloped Property (cont’d)
 Undeveloped
(raw) property has no
improvements
• E.g., undeveloped lots
• Investors purchase undeveloped property:
– To speculate
– For the production of subdivided lots for resale or
development
11
Pension Fund
Investment in Real Estate
 U.S.
pension funds have nearly $100 billion
invested in real estate
 In
2000, the average pension fund had about
20 percent of assets invested in real estate
• Real estate investment can be convenient
through a real estate investment trust (REIT)
12
Timberland in Particular
 Introduction
 Institutional
interest in timberland
 A timberland investment primer
13
Introduction
 Timberland
is a very viable investment form
of real estate for large portfolios
 The
U.S. encompasses about 468 million
acres of timberland
14
Institutional Interest
in Timberland
 Innovative
forms of ownership in
timberland have been developed:
• Public limited partnerships
• Closed-end investment companies in
timberland
• Securitized units of timberlands of forest
product companies
15
Institutional Interest
in Timberland (cont’d)
 Examples
of institutional interest:
• Timberland investment management
organizations (TIMOs) managed about $9
billion in timberland near the end of 2001
• In 2001, Harvard Management put 6 percent of
its $18.3 billion portfolio into timberland
16
A Timberland
Investment Primer
 Timberland
as an asset
 Timberland investors
 Timberland returns
 Timberland risks
 Problem of lack of information
 Timberland as a portfolio component
 Future prospects
17
Timberland as An Asset
 Timberland
as collateral
 Timberland as a strategic investment
 Timberland as a pure investment
18
Timberland as Collateral
 Loans
are routinely secured with timberland
by:
• Life insurance companies
• The Federal Land Bank
19
Timberland as
A Strategic Investment
 Timberland
serves as a strategic investment
when owning it:
• Helps ensure the long-term viability of a
company or
• Reduces the volatility of a company’s cash
flows
20
Timberland as
A Pure Investment
 Portfolio
managers hold timberland as a
pure investment:
• The property is held for its own investment
merits
• The property is not held as part of a strategic
plan or to assist in project financing
21
Timberland Investors
 The
largest current owners of timberland for
pure investment purposes are:
• CALPERS
• John Hancock Financial Services
• New Hampshire State Employees Retirement
System
22
Timberland Investors (cont’d)
Owner Class
1952
1970
1996
Federal
103,124
107,108
124,008
State, county,
and municipal
27,216
29,010
36,177
Forest industry,
farmer owned,
and other private
358,269
363,576
357,840
Total timberland
488,609
499,697
518,025
Total forestland
664,194
753,549
746,798
23
Timberland Returns
 Timber
grows on the land and is sold and
renewed
• Growing timber is stumpage
 The
value of a stand of timber depends on:
• The volume of wood on the acreage
• The size and quality of the trees
• The market price of the species of forest
products
24
Timberland Returns (cont’d)
 A timberland
investor’s return is a function
of:
• The acquisition cost and selling price
• Site productivity
– The ability of a site to grow timber, depends on
weather, soil conditions, etc.
• Management competence
– Silvicultural practices and management strategies
can affect return
25
Timberland Returns (cont’d)
 A timberland
investor’s return is a function
of (cont’d):
• Market price
– Investors have substantial discretion in regard to
time of harvest
– Price is influenced by the relative size of trees on the
land
26
Timberland Risks
 Biological
risks
 Economic risks
27
Biological Risks
 Biological
risk is the risk of loss due to
natural events:
•
•
•
•
•
Fire
Insects
Disease
Productivity
Wind
28
Biological Risks (cont’d)
 Productivity
risk refers to the possibility
that a stand of timber will not produce the
anticipated volume of wood due to:
• Species competition
• Drought
• Disease
29
Economic Risks
 Economic
•
•
•
•
•
•
risks include:
Quality
Liquidity
Demand
Price
Management practices
Changes in the regulatory environment
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Economic Risks (cont’d)

Management risk means that poor management
practices can erode the value of timberland

Liquidity risk exists because there is a relatively
limited market for timber and timberland

Regulatory risk stems from statutes and
ordinances that limit forest management and land
use options
31
Problem of
Lack of Information
 Problems
with constructing a standard
timber index:
• Must consider the growth in timber volume
• Must consider the low volatility associated with
land
• Focusing on timber prices alone biases the
return downward and biases volatility upward
• Timberland is nonfungible
32
Problem of
Lack of Information (cont’d)
 Examples
of timber indexes:
• Wachovia’s Timberland Performance Index
(TPI)
• The Warnell School’s Timber Mart South and
Timber Mart North
• Log Lines
• National Council of Real Estate Investment
Fiduciaries
33
Timberland as
A Portfolio Component
 Virtually
all studies of timberland find very
low or negative correlation between
timberland and other investment
alternatives
• Allows for substantial diversification benefits
34
Timberland Correlation
Coefficients (1960-2000)
Investment
Correlation Coefficient
Timberland
1.00
Commercial real estate
-0.11
S&P 500 index
-0.29
Small cap equities
-0.12
International equities
-0.22
Treasury bills
-0.02
Long-term corporate bonds
-0.30
Inflation
0.37
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Risk and Return
(1981-2000)
36
Future Prospects
 Introduction
 Index
problems
 Social risk
37
Introduction
 An
increasing number of portfolio managers
may discover timberland as an investment:
• Asset allocation strategies are in vogue
• Timberland allows for substantial portfolio
diversification
 Pension
funds will probably continue to be
the principal private investors
38
Index Problems
 The
lack of a consistent timberland index is
the single biggest barrier to increased
investment by pension funds:
• Continuous pricing by the market is difficult
due to:
– Lack of liquidity
– Timberland is not an exchange-traded product
– Regional variations
– The appraisal-based nature of timberland
39
Social Risk
 The
timber industry considers forestland to
be a renewable resource
 Many environmentalists do not consider
forestland to be a renewable resource
 The
length of reforestation depends on the
species
40
Gold
 Motivation
for gold investment
 Determinants of the price of gold
 The London fix
 Investing in gold
41
Motivation for
Gold Investment
 People
often buy gold because of the
security it is expected to provide during
times of trouble
• An insurance policy against inflation
• Particularly pronounced in Europe
• A currency without a country
42
Motivation for
Gold Investment (cont’d)
 Gold
can be an attractive investment
because:
• Gold has demonstrated returns that are
unrelated or even opposite to those of the stock
market
– The correlation between the Philadelphia Stock
Exchange’s gold and silver index and the S&P 500
index since 1986 has been 0.14
– The relationship is tenuous
43
Determinants of the
Price of Gold
 Strength
of the U.S. dollar
• Influenced by trade balances and protectionism
concerns
 The
strength of foreign currencies
• Stronger foreign currencies decrease the value
of gold measured in the home currency for
foreign investors
44
Determinants of the
Price of Gold (cont’d)
 Inflation
and rising oil prices
• An increase in the price of oil raises fears of
inflation and an increased price for gold
 International
finance uncertainty
• Investors turn to gold as a result of mounting
debt, third-world loans, etc.
45
The London Fix
 The
London fix is the price of gold that
reflects the relative buy and sell orders that
have been placed with member firms of the
London Gold Market
• The fix is determined twice each day at 10:30
a.m. and 3:00 p.m. London time
46
The London Fix (cont’d)
 Gold
prices also change in response to:
• Continuous exchange trading
• Economic news
• Political news
47
Investing in Gold
 Bullion
 Gold
certificates
 Shares in mining companies
 Coins
48
Bullion
 Gold
bars are bullion
• There are different sizes of gold bars (see next
slide)
 Investors
can acquire smaller quantities of
gold:
• 1-ounce bars
• Nuggets
• Gold dust
49
Bullion (cont’d)
Unit of Weight
Region Where Used
Equivalent Troy Ounces
One Troy
Ounce
USA, UK, Australia
--
100 Grams
Globally
10 Tola
India, Pakistan, Middle East,
Singapore
3.75
5 Tael
Hong Kong, Taiwan, China
6.017
10 Baht
Thailand
4.901
5 Chi
Vietnam
0.603
10 Dons
Korea
1.206
3.2151
50
Bullion (cont’d)
 Shortcomings
of bullion:
• Subject to theft
• No income productivity
• Lack marketability
51
Gold Certificates
 Gold
certificates are:
• Obligations of the issuer to deliver gold upon
demand
• Issued by banks
• Registered in your name
• Readily sold back to the dealer
 Gold
certificates have the risk that there is
no gold backing them
52
Shares in Mining Companies
 Purchasing
shares in mining companies is
the most popular form of gold ownership in
the U.S.
• E.g., Homestake Mining is the largest U.S.
gold-mining company
 Some
mutual funds specialize in gold or
other precious metals
53
Shares in Mining
Companies (cont’d)
 Owning
shares in mining companies or
mutual funds has advantages:
• Shares are instantly marketable
• Shares can generate some income through
dividends
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Coins
 Gold
coins are popular with investors and
speculators
 A coin’s
intrinsic value is the higher of:
• Its bullion value
• Its fiat value
– The value assigned by the issuing government
55
Popular Coins
for Investment
American Eagles
Canadian Maple Leaf
Australian Nugget
Mexican Peso
Austrian Philharmonic
South African Krugerrand
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