Money Grows On Trees

By Aaron Levitt | November 17, 2010 AAA

With a variety of asset classes becoming ever more correlated, investors have been looking towards alternative means of diversification. Moving beyond just stocks and bonds, portfolios have become sophisticated with new positions in a variety of unconventional plays. Funds such as the ProShares Credit Suisse 130/30 (NYSE:CSM), which follows a long/short allocation, have become popular with investors. Along with a mixture of commodities, currencies, options and junk bonds; today's modern portfolio looks nothing like our grandparents' retirement accounts. One alternative asset class that is often overlooked by retail investors can provide low correlations to traditional holdings, while providing hefty income.

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Going to the Woodshed
Timber as an asset class has renewed interest from investors as a way to diversify away from stocks and bonds. The growth of trees, pulp sales and land appreciation all show lower correlations to more liquid asset sectors. Timber currently shows a correlation of -0.01 to large cap stocks, -0.36 to long term bonds and only a 0.12 correlation to standard commercial property. These investments in timber have produced nearly 7% annualized returns over the past 10 years through October 31. This compares with a 0.4% annualized loss for S&P 500 over the same period. It's no wonder that institutional investors have plowed nearly $40 billion into timber investments over the last decade.

The time may be right for investors to consider timber. Lumber prices have fallen by 50% from their 2005 highs, but have rebounded from their lows. Selling pressures have eased off and a typical forest can grow up to 7% annually, allowing investors to wait for higher prices and still 'grow" their investment. In addition, many public timberland stocks are trading at discounts to the value of the land they own, and the price for timberland in the private market versus their share prices.

Creating Your Own TMO
While institutional investors will often invest in timber management organizations (TMO's), which own and manage forest land and profit when they sell logs, most retail investors can't participate in these transactions. The average initial investment for a TMO is in the $1-5 million range and a 10- to 15-year lock-up period. Individuals can buy into the sector through real estate investment trusts that own and lease timberlands and exchange traded funds that follow timber indexes. While these investments tend to track stocks more closely than raw land, they still represent a good diversified income opportunity for investors.

For investors looking for a broad-based play on timberland, there are two ETFs in the sector. The Claymore/Beacon Global Timber Index (NYSE:CUT) and the iShares S&P Global Timber & Forestry (Nasdaq:WOOD) offer a diversified way to play the entire timber spectrum. Both follow a basket of companies that include timberland owners as well as those that sell finished goods such as paper and packaging. Both have performed admirably, with WOOD more than doubling since its 52-week low. Investors still might want to consider CUT over WOOD, due to its increased weighting in international stocks, including Fibria Celulose (NYSE:FBR).

For a more direct play on timber and lumber prices, investors can bet on a handful of REITs that participate in the sector. The largest of which being Plum Creek Timber (NYSE:PCL), which owns about 7 million acres across 19 states. The REIT has been selling acreages recently to private investors at higher prices, and using the proceeds to buy back stock. In doing so, Plum Creek has increased its ratio of acres per share. Plum Creek currently yields about 4.5%. Similarly, rival Potlatch (NYSE:PCH) owns nearly 1.6 million acres worth of timberlands and currently yields 5.7%, and Rayonier (NYSE:RYN) just increased its dividend.

The Bottom Line
As investors continue to become more sophisticated, so do their portfolios. Timberland and lumber offer a great long-term uncorrelated asset class. By investing in companies such as Pope Resources (Nasdaq:POPE) and it's 3.1% dividend, or through the various exchange traded funds, investors can add this often ignored asset class to their portfolios and gain its diversification benefits. (For related reading, take a look at Timber Investments Cut Down Portfolio Risk.)

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