Chapter Twelve
The Role of Real Assets
KEY POINTS
Modern investment decisions involve more than just stocks and bonds. Pension funds are
rapidly discovering the role that “non-traditional” assets like gold and timberland can
play in their portfolios.
This chapter provides an introduction to real estate and real estate investment trusts.
There is a particular focus on timberland, as this is a little-known but increasingly
important pension fund asset.
TEACHING CONSIDERATIONS
The trade publication Pensions and Investments has an article about timberland on a very
regular basis. As with many developments in finance (such as futures and options usage),
the broader market is sometimes slow to get the word.
Pension funds have known about timberland for years, yet the individual investor is
usually surprised to learn that institutions hold this asset in such quantity. As the chapter
shows, this material is intended as a primer on the basic principles of timberland
investment. The notion of product class shift (Figure 12-3) is an often-overlooked aspect
of a forest. While there is a continuing problem with a lack of a consistent timberland
index, the evidence is clear regarding timberland's general tendency to move counter to
the stock market, thereby providing significant portfolio diversification benefits.
Point out the fact that the whole idea of the time value of money actually began in the
forestry literature. Note the Faustmann reference after chapter two.
Gold is a better-known asset than timberland, and in some respects just as important.
There are various ways to invest in gold, ranging from actual securities to bullion bars.
Many institutions that choose to hold gold do so because of a belief that gold is an
inflation hedge or because of a perceived tendency for gold to move counter to the equity
markets and provide diversification benefits.
There is an excellent videotape available from the National Geographic Society entitled
simply “Gold.” This hour-long production is a very good overview of the pricing,
mining, and heritage of gold.
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Chapter Twelve
The Role of Real Assets
ANSWERS TO QUESTIONS
1. A financial asset has a corresponding liability; a real asset does not, although one
might be produced to finance the asset.
2. Developed land is better suited to generating income than undeveloped land. Most
investors buy undeveloped land with the intent of selling it later at a profit.
3. Real estate is the tangible asset; real property is a legal interest in real estate.
4. Residential, commercial, industrial, farm, special purpose.
5. All land areas are unique; even adjacent plots will differ concerning their microsite
factors. This means they are not all equally desirable, and therefore not equally
valuable.
6. As collateral, as a strategic investment, as a pure investment.
7. Volume of wood, diameter of the trees, market price of the species.
8. Timber prices, land values, product class shifts, biological growth.
9. Biological risks deal with the possibility of loss from a natural event such as fire,
wind, disease, or insects. Economic risks deal with liquidity, regulatory, or
management issues.
10. Such an index probably should be based on both the market value of a species of
timber and a reflection of the usual timber growth rate. It is likely that more than one
index will always be necessary to provide complete information about timber prices.
11. No. Poor management can adversely affect the value of just about anything.
12. Larger trees are worth much more than smaller trees. As the diameter of a tree passes
through certain thresholds, the tree becomes suited for more expensive purposes.
Forests that are undergoing a product class shift are more valuable than younger
forests.
13. Such an index ignores the fact that trees act as their own factory. This means that
there will be an increase in the value of the wood even if the market price remains
constant.
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Chapter Twelve
The Role of Real Assets
14. Relative value of world currencies, anticipated inflation and its impact on oil prices,
world uncertainty, extraordinary demand (such as the Japanese gold coin
phenomenon), and the London fix.
15. Bullion, gold shares, gold certificates, gold coins.
16. A twice-daily settlement price for gold determined by a group of British banks. The
London fix seeks to find an equilibrium price balancing supply and demand.
17. The “European cartel” refers to the London fix, and this is not really a cartel. Also,
the London fixing procedure probably would not be able to manipulate the market
price of gold beyond the equilibrium value for very long.
18. Many pension funds have begun to include managed futures in their portfolios for
precisely this reason.
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