Chapter 13
The Role of Real Assets
Portfolio Construction, Management, & Protection, 5e, Robert A. Strong
Copyright ©2009 by South-Western, a division of Thomson Business & Economics. All rights reserved.
1
Gold still represents the ultimate form of payment in
the world.
Alan Greenspan
2
Introduction

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
• Most portfolio investments are real assets
– Stocks
– Bonds
– Bank certificates of deposit
3
Real Estate
Investment Characteristics
 Immobile
• Land cannot be moved
 Indestructible
• Land cannot be destroyed
 Nonfungible
• Every plot of land is unique
4
Real Estate 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
5
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
6
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
7
Developed and
Undeveloped Property (cont’d)
 Undeveloped
(raw) property has no
improvements
• e.g., undeveloped lots
• Investors purchase undeveloped property:
– To speculate
– For timber, crop, or livestock production
– For the production of subdivided lots for resale or
development
8
Pension Fund
Investment in Real Estate

U.S. pension funds have over $170 billion
invested in real estate
• Office buildings (33%) and malls (30%) account for
most of pension funds’ allocation to real estate

Real estate investment trusts (REITs) are popular
and convenient to purchase real estate
• Ownership, and cost, is divided into many shares
9
Timberland
 Timberland
is a very viable investment form
of real estate for large portfolios
 The
U.S. encompasses about 2.27 billion
acres, of which about 20.9 percent are
timberland
10
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 or forest
product companies
11
Institutional Interest
in Timberland (cont’d)
 Examples
of institutional interest:
• In 2001, Harvard Management put 6 percent of
its portfolio into timberland
• In 2008, California Teachers’ Retirement
System increased its real estate percentage to
10 percent, or $17.4 billion
• Timberland investment management
organizations (TIMOs) managed about $16
billion in timberland near the end of 2006
12
Portfolio Aspects
of Timberland
 Loans
are routinely secured with timberland
by life insurance companies
 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
13
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
14
Timberland Investors
 The
largest current owners of timberland for
pure investment purposes are:
• California Public Employees Retirement
System
• John Hancock Financial Services
• New Hampshire State Employees Retirement
System
15
Timberland Ownership in the
United States (thousands of acres)
Owner Class
1952
1970
2002
Federal
103,124
107,108
147,278
State, County, and
Municipal
27,216
29,010
37,559
Forest Industry,
Farmer Owned,
and Other Private
358,269
363,576
356,261
Total Timberland
488,609
499,697
541,098
Total Forestland
664,194
753,549
748,923
Source: Agricultural Statistics” 1956, 1976, 2004, United States Department of Agriculture, U.S. Government Printing Office.
16
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
17
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
18
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
19
Biological & Productivity Risks

Biological risk is the risk of loss due to natural events:
•
•
•
•

Fire
Insects
Disease
Wind
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
20
Economic Risks




Price
Demand
Liquidity
Management risk means that
• poor management practices can erode the value of timberland

Liquidity risk
• relatively limited market for timber and timberland

Regulatory risk
• statutes and ordinances limit forest management and land use
options
21
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
22
Problem of
Lack of Information (cont’d)
 Examples
of timber indexes:
• Wachovia’s Timberland Performance Index
(TPI)
• The Warnell School’s Timber Mart South
• Log Lines
• National Council of Real Estate Investment
Fiduciaries
23
Timberland as
A Portfolio Component
 Virtually
all studies of timberland find very
low or negative correlation between
timberland and other investment
alternatives
24
Timberland Correlation
Coefficients (1960–2002)
Investment
Timberland
Commercial real estate
Correlation Coefficient
1.00
–0.08
S&P 500 index
Small cap equities
–0.17
–0.10
International equities
Treasury bills
–0.14
0.04
Long-term corporate bonds
Inflation
–0.32
0.39
Source: Data from Hancock Timber Resource Group. “Timberland as a Portfolio Diversifier,” Research Notes, 2003.
25
Future Timberland Prospects
 An
increasing number of portfolio managers
may discover timberland as an investment:
• Asset allocation strategies are in vogue
 Pension
funds will probably continue to be
the principal private investors
26
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
27
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
28
Real Estate Investment Trusts
 A real
estate investment trust is a
convenient means of investing in a portfolio
of real estate properties
• It is essentially a closed-end investment
company including real estate
• It usually owns and operates a variety of forms
of income-producing real estate
29
REIT Distribution Rules
 As
long as a REIT distributes at least 90
percent of its taxable income to its
shareholders, the firm is able to deduct the
dividends from its corporate taxable income
• Most REITs distribute all their income and pay
no federal taxes
30
Types of REITs
 Equity
REITs own and operate incomeproducing real estate
• Probably the most popular and common type
 Mortgage
REITs buy mortgages or lend
money directly to property purchasers
 Hybrid REITs own and operate properties
as well as engage in the financing of
property
31
Types of Real Estate Value
value is “the most probable price
which a property would bring in a
competitive and open market under all
conditions requisite to a fair sale, the buyer
and seller acting prudently, knowledgeably
and assuming the price is not affected by
undue stimulus”
 Market
32
Types of Real Estate Value
(cont’d)
 Fee
simple value is a measure of what a
property would be worth if there were no
leases encumbering it
 Leased fee value is the value of the
property given its existing leases
 Leasehold value is basically the value of
the lease
33
Types of Real Estate Value
(cont’d)
 Investment
value is the value of a property
to a particular investor and may be more or
less than market value
 Assessed value is the basis on which the
city levies property taxes
34
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
35
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 –0.04
36
Determinants of the
Price of Gold
 The
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
37
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.
38
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
39
Gold 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
40
Gold 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
41
Gold Bullion (cont’d)
 Shortcomings
of bullion:
• Subject to theft
• No income productivity
• Lack marketability
42
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
43
Shares in Mining Companies
 Purchasing
shares in mining companies is
the most popular form of gold ownership in
the U.S.
• South African mining companies
 Some
mutual funds specialize in gold or
other precious metals
44
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
45
Coins
 Gold
coins are popular with investors and
gold speculators
 A coin’s
intrinsic value is the higher of:
• Its bullion value
• Its fiat value
– The value assigned by the issuing government
46
Popular Coins
for Investment
American Eagles
Canadian Maple Leaf
Australian Nugget
Mexican Peso
Austrian Philharmonic
South African Krugerrand
47