Return Characteristics of the Forestry Asset Class
The forestry asset class has been attractive to institutional investors due to low correlation to other asset classes, natural inflation hedging and low volatility of returns.
Sustainable and responsible management of forests can also contribute to climate change mitigation, promote a shift to more responsible production and consumption, support sustainable development, and advance a growing range of renewable products made from wood fibre.
The evolution of timber markets serving a growing global population, in conjunction with the circular bio-economy and the essential role of forests in the net zero emissions transition, provides investors with diverse opportunities in forestry investment internationally.
Returns from Income and Biological Growth
Forest investments have two primary components of return: (i) income from the sale of timber and of other forest-related goods and services and (ii) capital appreciation from biological growth and in some cases, land value appreciation. Forests produce a range of valuable products, such as sawnwood and plywood for construction; fibre for pulp and paper; biomass, biofuels, and cellulose based chemicals; and ecosystem services that may be monetised such as carbon sequestration sold in the form of carbon credits.
Conservation easements may also be sold. These markets are diverse and vary depending on tree species, geography, and markets. Forest investments also provide a biological component to returns as trees grow and increase in volume, and often value, over time.
A Hedge Against Inflation
Investment returns from forestry assets have demonstrated a positive correlation with inflation. This characteristic is driven by the fact that timber product demand is positively correlated with GDP growth and rise in economic activity. Where there is land ownership in a forestry asset, land value can also appreciate in periods of economic growth. Using third party data, New Forests has independently found the correlation of the National Council of Real Estate Investment Fiduciaries (NCREIF) timberland index with
the US GDP Deflator to be 0.46 over the 1987–2021 time period, and higher during shorter periods within that time.
Low Correlation with other Asset Classes
The addition of forestry assets to a portfolio can increase diversification and contribute un-correlated alpha to the performance of the portfolio. US timberland investment returns, as measured by NCREIF, have low correlations with most other asset classes such as equities and bonds. The fact that biological growth can provide as much as 50% of total forest investment returns supports low correlation with other asset classes.
Low Volatility of Returns
Partly due to the biological component of returns, forestry assets are characterised by low levels of return volatility. During periods of low timber prices, asset value can be stored “on the stump” and continue to contribute to capital appreciation through biological growth. Between 2009 and 2021, the average annual volatility of US timberland investment returns as measured by the NCREIF Timberland Index was 3.2% per year, significantly lower than equities, real estate, and 10-year US Treasury bond yields over the same period.