Hedge Funds Miss the Forests, and the Trees

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

Everyone knows that money doesn’t grow on trees. Everyone except Yale, Harvard, Calpers, and many other cutting-edge institutions that have been gobbling up trees, or, rather, timberlands for many years. The hedge funds, though, have taken this maxim to heart. They have yet to see the forest.


Investing in timber has been a lucrative undertaking for many institutions and high net worth individuals over the past 20 years. Most of these players have invested through Timber Investment Management Organizations, or TIMOs.


The rise of the TIMOs began in the 1980s when forest products companies began to divest themselves of timberlands. At the time, the industry was short of capital and unable to take advantage of the attractive returns that timberlands can offer.


Most of the nation’s 350 million acres of timberland were owned by forest products suppliers that wanted to have secure access to raw materials supplies when prices were high; the consequent erratic harvesting of the properties led to less-than-optimal performance.


The companies also responded to the reality that Wall Street gave them little credit for the properties, which were carried on their books at low values. Further, the industry was frustrated by accounting regulations that prohibited any recognition of increased value from trees that grow very, very slowly.


At the same time, the passage of ERISA regulations in the mid-1970s had encouraged pension managers to diversify, and they were eager to do so. Institutions were attracted to the long-term appreciation of timber assets, but were not in a position to invest directly.


Hence, the arrival on the scene of the TIMO. These organizations, like private equity firms, created pooled funds that were then invested in timber properties. The selling points for the institutions included the remarkably stable and competitive returns available from timber and the low correlation between this asset class and nearly everything else.


Indeed, between 1988 and 2003, annual returns from timberland were about 15%, according to a widely followed benchmark (the NAREIF Timberland Property Index), outpacing bonds and equities by a sizeable margin. Moreover, the index was off in only one year – 2001 – when it dropped a little more than 5%.


For the same period, the correlation between timber assets and the Lehman bond index was below .1, or extremely low.


These attributes did not go unnoticed. By the late 1980s, investors were responsible for buying over 80% of the timber properties coming onto the market, and had overtaken the forest products companies in terms of ownership. Whereas institutions had owned about $1 billion of timber assets in 1989, holdings today top $15 billion.


A number of factors came together in the 1990s to create a surge in timber prices, including massive hysteria about the spotted owl. Remember him? Concern about the possible extinction of this previously unsung bird in the northwestern part of America makes the current flap over Pale Male look like a tea party.


Justified or not, the concern about the effects of logging in the owl’s habitat provoked a shutdown of harvesting on some federal lands in the northwest, driving wood prices sky-high.


Also pushing prices higher were booming housing starts, a strong economy, and a surge in demand from Asia. These factors continue today, and the TIMOs continue to generate attractive returns for investors.


Eva Greger, Managing Partner at Grantham Mayo, Van Otterloo & Company’s Renewable Resources unit, manages $1.2 billion invested in timber properties. Her group just closed another fund, raising $650 million in additional assets.


Her goal? To earn between 7% and 9% returns net of inflation and fees. That’s a compelling alternative to many asset classes – including those invested in by most hedge funds this year. So why haven’t the hedge funds joined the party? No patience. The money invested with Ms. Greger is locked up for 10 years – longer than is demanded by any other investment class, including private equity. Like a private-equity investor, Ms. Greger typically takes up to two years to put the money to work.


Unlike a forest products company, Ms. Greger’s fund can report gains in her fund’s value by conducting an annual appraisal of the properties in the portfolio. Also, the assets held by Grantham Mayo, and by other TIMOs, are managed for long-term appreciation and can maximize value in ways that a vertically integrated company cannot.


The fund does not employ much leverage, since having to meet debt obligations might compromise this unfettered long-term decision-making.


Managing a TIMO is like running any other kind of portfolio. Ms. Greger is responsible for finding properties that are undervalued, analyzing the potential of a given investment, and providing the portfolio with a decent level of diversification.


In this endeavor, she and her team personally visit properties that are on the market, employ local forestry people to perform inventory evaluation, (we have all heard of tree huggers – but tree counters?) and talk to local mills to assess sales prospects.


Diversification is mainly geographical. Ms. Greger focuses on purchases in countries she deems to have little political risk, such as New Zealand, Australia, and Uraguay, in addition to America. Despite significant transportation costs, the industry operates globally.


Some diversification is also achieved by investing in different kinds of wood products, such as hardwoods, which are used to make flooring and furniture, and softwoods, which are used to build homes.


There is no way to hedge performance. Though there are some futures instruments relating to lumber and pulp, none is a good proxy for timber values. Also, with such a long-term horizon, hedging would not make much sense.


Some TIMOs, to the consternation of environmentalists, have bought up timber properties, especially in the South, that are being broken up into real estate parcels. This introduces a whole new element into the equation, and creates new investment opportunities for the managers.


Grantham Mayo’s first fund, started in 1998, has done well, and benefited by being early on the scene. Current offerings will likely have less positive results, because of the increased activity in the sector. However, as Ms. Greger points out, the investment is illiquid, and should therefore continue to command some premium. Like private equity and hedge funds, TIMOs charge fees that are performance-based.


So far, wealthy individuals and institutions have been the primary investors in the timber arena. The hedge funds have been discouraged primarily by timber’s illiquidity.


However, with the convergence of hedge funds and private-equity investors, that could change. The lockups being required by some recent entrants into the hedge fund industry are geared toward longer-term holdings and could well open the door for the funds to enter the timber arena at long last.


That could be as exciting for the usual harried fast-paced hedge investor as, well, watching trees grow.



Ms. Peek is a former managing director at Wertheim-Schroeder, now a part of Citigroup.


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