An MFC Global Investment Management Company Timberland Investor First Quarter Do Forest Assets Continue to Hedge Inflation?

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1 Hancock An MFC Global Investment Management Company Timberland Investor First Quarter 25 Do Forest Assets Continue to Hedge Inflation? For investors concerned about inflation, timberland has historically generated strong riskadjusted real returns. In contrast to most financial assets, timberland has proved to be a good hedge against inflation, especially against unanticipated inflation. This means that investors can, to some degree, immunize a mixed-asset portfolio against unanticipated inflation by investing in timberland. Over a decade ago,washburn and Binkley (13) analyzed the inflationhedging properties of forestry investments, concluding that timberland has been a particularly good hedge against unexpected inflation. They further analyzed the degree to which expectations of inflation have been capitalized into the value of forest assets. They found timberland in the West and South to be overvalued during times of relatively high expected inflation and undervalued when the rate of inflation is anticipated to be relatively low. The data in the original paper spanned only the period 15-17, and the measures of timberland returns were far less precise than those available today. As a result, we have updated the original work. Methodology The analysis is based on the theoretical foundation that the expected nominal rate of return for any asset is equal to the risk-adjusted real rate that investors expect from the asset plus the expected rate of inflation (Fisher 10). The first examination is by way of a basic two-factor model relating timberland returns to overall market returns and unanticipated inflation (See End Notes on page 2 for details). The response of real rates of return to unanticipated inflation Small Stocks Corporate Bonds Twenty-year U.S. Bonds Five-year U.S. Bonds One-month U.S. Treasury Bills U.S. Northeast Timberland U.S. West Timberland U.S. South Timberland U.S. Timberland We measure unexpected inflation as the difference between realized US consumer price inflation (measured by the CPI-U) and a measure of expected inflation based on a model of short-term US Treasuries (Hartzell et al 17). The model parameters measure the response of real rates of return for each asset to unanticipated inflation. If the value of parameter ϒ 2 is equal to zero, the asset has been immune to unexpected inflation. The asset has hedged greater-than-expected inflation if the resultant parameter is greater than Poor inflation hedge Good inflation hedge zero, and lower-than-expected inflation if less than zero. We estimated this equation for timberland and other assets over the period using annual data. For timberland, we combine the John Hancock Timber Index, an 8-quarter rolling average of timber prices, for the years 10 to 16, with the NCREIF Timberland Property Index returns from its inception of 17 to the present (See Historical Returns for Timberland RN-23 for more detail on the John Hancock Timber Index). continued on page 2 Hancock Timber Resource Group High Street, Boston, MA

2 Do Forest Assets Continue to Hedge Inflation? continued We compared our results for timberland with those of financial assets such as stocks and bonds. The graph on page 1 (along with Table 1 on page 6) shows the results. The results are consistent with the earlier analysis. Timberland has been a strong hedge against unexpected inflation (positive value of the ϒ 2 parameter), with the US Pacific Northwest performing particularly well in this regard. Financial asset returns, on the other hand, have responded poorly to unanticipated inflation (negative value of the ϒ 2 parameter). Asset pricing theory suggests that, all else equal, investors prefer a portfolio with returns that are insensitive to departures from inflation expectations. With this in mind, an investor can add timberland (an asset that hedges higherthan-expected inflation) to a portfolio of financial assets (assets that hedge lower-than-expected inflation) to help insulate it against unexpected inflation. A second measure of the relationship between forest asset returns and inflation is a measurement of the efficiency of timberland markets in incorporating inflation expectations. This measure of market efficiency could point out whether inflation expectations can be used to identify when timberland is priced to generate returns that depart from those justified by its level of risk. The model relates nominal returns for timberland to expectations of both real returns for timberland and inflation (See End Notes on this page for details). We use the expected real rates of return generated from the two-factor model above, and the same measure of expected inflation, which again is based on a model of short-term US Treasuries. The parameter associated with expected inflation (β 2 ) measures the degree to which inflation expectations are incorporated into nominal return expectations. If the parameter is different from 1, we conclude forest assets are inefficient at processing information about expected inflation. Further, in periods where high inflation is expected, a parameter value greater than one indicates the asset is under-priced, where a parameter value less than one indicates the asset is over-priced (See Table 2 on page 6 for detailed results). Our results show timberland markets in the South to be inefficient at processing information about inflation expectations. Southern timberland proved to be over-priced when high inflation is expected and under-priced when low inflation is expected. Although estimates for timberland in the West and Northeast were not significantly different from one, western timberland markets have been less efficient processors of inflation information than markets for timberland in the Northeast. Our estimates for financial markets were similar to past findings: government and corporate bonds have been inefficient at processing expected inflation information and under-priced during periods of high expected inflation. Our outcome for equity markets, although inefficient at processing inflation information, proved different than the prior results. The original analysis found stocks to be under-priced during periods of high expected inflation.we find to the contrary, that stocks proved to be over-priced when high inflation is expected and under-priced during periods of expected low inflation. Conclusion The results of our updated analysis of timberland s ability to hedge inflation depend on the geographic location of the investment just as the original analysis concluded.timberland has been a strong hedge against unexpected inflation, with the U.S. Pacific Northwest a particularly effective hedge against higher-than-expected inflation. We also found markets for timberland in the U.S. South and to a lesser extent in the U.S.West and Northeast, to be inefficient at incorporating expectations of inflation into forest values. Southern timberland, in particular, has been overvalued during periods of relatively high expected inflation. Given these results, an investor could combine an investment in timberland, a hedge against higher-than-expected inflation, with financial assets that hedge lower-than-expected inflation, to structure a portfolio whose value is insensitive to unanticipated inflation. Summarized from C.S. Binkley, C.L.Washburn and M.E.Aronow, Timberland: The Natural Alternative in The Handbook of Inflation Hedging Investments, Robert Greer editor. 25. End Notes Table 1: Two-factor model: r i,t = ϒ 0,i + ϒ 1,i R m,t + ϒ 2,i UI t + ε i,t (1) Where r i,t = real rate of return from asset i in period t R m,t = market return in period t (measured here by the S&P 5) UI t = unexpected inflation in period t ε i,t = an error term, assumed to be normal ϒ 0,i, ϒ 1,i, ϒ 2,i = parameters to be estimated for each asset i. Table 2: Fisher Relationship: R i,t = β 0,i + β 1,i ER t + β 2,i EI t + ε i,t (2) Where R i,t = nominal return from asset i in period t ER t = expectation of real return in period t EI t = expectation of inflation in period t ε i,t = an error term, assumed to be normal β 0,i, β 1,i, β 2,i = parameters to be estimated for each asset i. Literature Cited Fisher, I. 10. The Theory of Interest. Reprinted in 15. Clifton, NJ: A. M. Kelley. Hartzell, D., J.S. Hekman, and M.E. Miles. 19. Real Estate Returns and Inflation. AREUEA Journal 15: Washburn, C.L., and C.S. Binkley. 13. Do Forest Assets Hedge Inflation? Land Economics. 69(August): Hancock Timberland Investor First Quarter 25

3 Quarterly Average Regional Composite Prices for Softwood Sawtimber Stumpage (US$ per MBF) $1,0 $8 $6 $4 $2 Sources: Log Lines, Timber Mart-South, New Zealand Ministry of Forestry and HTRG analysis U.S. Pacific Northwest Export U.S. Pacific Northwest Domestic U.S. South U.S. Northeast New Zealand Export Figure 1. Softwood Sawtimber Stumpage Prices Sawtimber stumpage prices moved upward in all major timber markets in the first quarter. New Zealand radiata logs as measured by our composite log mix of J, K and A sorts rose nearly to 25 percent, with log prices in Korea a large driver of the increase. Likewise, Douglas-fir export-grade logs in the U.S. Pacific Northwest rose $21 per MBF. Both low inventories in Pacific Rim markets and continued strong demand in both the U.S. and Pacific Rim moved prices upward, whether Douglas-fir stayed in the U.S. or was shipped overseas.wet weather across much of the U.S. South moved average pine sawtimber prices $7 per MBF above fourth quarter prices. Quarterly Average Prices for U.S. South Lumber and Sawlogs ($ per MBF - lumber scale) $6 $5 $4 $3 $2 $1 Southern Pine (Westside), Kiln Dried, 2x4 #2, Random Length Lumber Southern Pine Sawlogs Sources: Random Lengths and Timber Mart-South Southern Pine Chip-n-Saw Logs Figure 2. Lumber and Sawlog Prices in the U.S. South Prices for southern pine lumber remained strong, with Westside 2x4 averaging $3 per MBF in the first quarter, a steady climb throughout the quarter from year-end values of $375. As housing demand remains strong and the summer building months come upon us, analysts expect continued strength in end-use solid wood markets. Quarterly Average Prices for U.S. Pacific Northwest Lumber and Sawlogs ($ per MBF - lumber scale) $5 $4 $3 $2 Figure 3. Lumber and Sawlog Prices in the U.S. Pacific Northwest Douglas-fir and hem-fir lumber prices in the U.S. Pacific Northwest bounced back from fourth quarter s price retreat, ending the quarter 19 and 24 percent, respectively, higher than last quarter s average. Delivered log prices for both Douglas-fir and whitewoods responded with $10 per MBF (lumber scale) increases for the quarter. $1 Douglas-fir, Green, 2x4 Lumber Hem-fir (Coast), Kiln Dried, 2x4 Lumber Douglas-fir Sawlog Whitewood Sawlog Sources: Random Lengths and Log Lines Hancock Timberland Investor First Quarter 25 3

4 Quarterly Average Regional Composite Prices for Softwood Pulpwood Stumpage ($ per ton) $40 $35 $30 $25 $20 $15 $10 $5 U.S. Pacific Northwest U.S. Northeast U.S. South Figure 4. Softwood Pulpwood Stumpage Prices U.S. pulpwood prices were up in all three regional markets this quarter.wet weather in the U.S. South, particularly in the western portions of the region, buoyed prices to unexpected levels. Some price reports showed spot prices for southern pine pulpwood upwards of $20 per ton. South-wide, prices averaged the quarter at $7.20 per ton, a level last seen in mid-23. $-5 $-10 Sources: Log Lines, Timber Mart-South and HTRG analysis Quarterly Average Prices for Market Pulp ($ per metric ton) and U.S. Pulp Logs ($ per 10 tons) $9 $8 $7 $6 $5 $4 NBSK Market Price Douglas-fir Pulp Logs Figure 5. Market Pulp and U.S. Pulp Log Prices Market pulp prices rose $44 per metric ton in the first quarter, with FOEX reporting Northern Bleached Softwood Kraft (NBSK) at $645 per metric ton. Delivered pulpwood prices in the South rose $2.35 per ton on average, or 10 percent, to $26 per ton, a price not seen in the South-wide average since early 18. $3 $2 $1 Southern Pine Pulp Logs Sources: FOEX Industries Ltd, Log Lines and Timber Mart-South 0 Quarterly U.S. Timberland Values ($ per acre) $2,5 $2,0 $1,5 Pacific Northwest Figure 6. U.S. Timberland Values in Private Property Markets As expected, private timberland values, as measured by the NCREIF Timberland Property Index, moved little this quarter since a large majority of the properties in the Index are not revalued until year-end. $1,0 $5 South Source: NCREIF 89 4 Hancock Timberland Investor First Quarter 25

5 Quarterly EBITDDA Multiples for Privately Traded Timberland (trailing 4-quarter EBITDDA) South Pacific Northwest Figure 7. U.S. Timberland Valuation Multiples in Private Property Markets The pricing multiple in the South fell as this quarter s income ($8 per acre) replaced an unusually weak first quarter income ($4 per acre) last year, boosting the 4-quarter trailing EBITDDA average. In the Pacific Northwest, with market values remaining at last quarter s level and first quarter earnings similar to prior quarters, there was no change to the regional pricing multiple this quarter. 10 Sources: NCREIF and HTRG analysis 0 Monthly Securitized Timberland Share Value (Indexed to 1 at start date) Rayonier Plum Creek Crown Pacific U.S. Timberlands The Timber Company Deltic TimberWest Figure 8. Hancock Securitized Timberland Index A mid-quarter increase in share prices for both Rayonier and Plum Creek who combined, make up percent of the Index on a market capitalizationweighted basis made up for the January drop in share price for both companies, resulting in the Hancock Securitized Timberland Index ending the quarter about where it began. 80 Index 40 Source: HTRG analysis 0 12/ 12/ 12/ 12/ 12/ 12/ 12/ 12/ 12/ 12/ Quarterly U.S. South Timberland Values ($ per acre) $1,4 $1,2 $1,0 $8 $6 $4 $2 Private Property Market Public Equity Market Sources: NCREIF and HTRG analysis Figure 9. U.S. South Timberland Values in Public Equity and Private Property Markets Public market timberland values in the South moved down slightly from fourth quarter levels yet remain above private timberland values again this quarter. Strong lumber markets and wet weather in the South combined to keep results for both Rayonier and Plum Creek the major drivers of our public timberland market sample strong compared to first quarter a year ago. First-quarter private southern timberland values, as measured by the NCREIF Timberland Property Index, do not adequately reflect the market s strength as most properties in the Index are not appraised until year-end. Hancock Timberland Investor First Quarter 25 5

6 Do Forest Assets Continue to Hedge Inflation? continued Table 1.: Two-factor Model Table 2.: Fisher Relationship ASSET Y 0 Y 1 Y 2 R 2 Timberland U.S * South * Pacific Northwest * Northeast * Financial Assets One-month * U.S. Treasury Bills Five-year * U.S. Treasury Bonds Twenty-year * U.S. Treasury Bonds Corporate Bonds * Small Stocks * Note: Standard errors of the coefficient estimates are given below coefficient. An asterisk (*) indicates that the coefficient estimate is different from zero at the 0.10 level of statistical confidence. Sources: Ibbotson Associates Database, Federal Reserve, HTRG Research ASSET B 0 B1 B 2 R 2 Timberland U.S South Pacific Northwest Northeast Financial Assets One-month U.S. Treasury Bills Five-year U.S. Treasury Bonds Twenty-year U.S. Treasury Bonds Corporate Bonds Small Stocks Note: Standard errors of the coefficient estimates are given below coefficient. An asterisk (*) indicates that the coefficient estimate is different from zero at the 0.10 level of statistical confidence. A plus sign (+) indicates that the slope estimate is different from one at the 0.10 level. Sources: Ibbotson Associates Database, Federal Reserve, HTRG Research Research Team NOTES: Courtland L. Washburn, Ph.D. Managing Director and Chief Investment Officer cwashburn@hnrg.com Peter D Anieri Director of Portfolio Management & Research pdanieri@hnrg.com Mary Ellen Aronow Senior Forest Economist maronow@hnrg.com Hancock Timber Resource Group is a division of Hancock Natural Resource Group, Inc., a registered investment adviser and wholly owned subsidiary of Manulife Financial Corporation. Figure 1. The composite price for southern sawtimber is based on quarterly average Timber Mart-South published prices for pine sawtimber and chip-n-saw stumpage. Pacific Northwest prices are derived from quarterly average Log Lines published prices for whitewoods and Douglas-fir with internal analysis of logging costs for stumpage calculations. New Zealand export prices are based on New Zealand Ministry of Forestry quarterly average published prices for Radiata unpruned A, J and K sort export logs with internal analysis of logging costs for stumpage calculations. Northeast sawtimber prices are calculated from internal analysis. Figure 2. Quarterly southern pine (westside), kiln dried, 2x4 #2 lumber price published by Random Lengths. Timber Mart-South published southern pine sawlog and chip-n-saw log prices converted to lumber scale using RISI historical lumber recovery rates as published in North American Lumber Forecast. Figure 3. Quarterly Douglas-fir, green 2x4 lumber (Portland rate) and Hem-Fir (coast), kiln dried, 2x4 lumber prices published by Random Lengths. Douglas-fir and whitewood sawlog prices derived from Log Lines published prices for #2 and #3 sawlogs in various regions in the Pacific Northwest converted to lumber scale using RISI historical lumber recovery rates as published in North American Lumber Forecast. Figure 4. Pulpwood composite prices are derived from quarterly average Timber Mart-South published prices for southern pine pulp wood stumpage, Log Lines published whitewood and Douglas-fir pulp logs with internal analysis of logging costs for the Pacific Northwest, and HTRG analysis of Spruce/Fir pulpwood in the Northeast. Figure 5. Quarterly NBSK pulp prices derived from daily list prices reported by FOEX Industries Ltd. Southern pine pulp log prices published by Timber Mart-South. Pacific Northwest Douglas-fir pulp log prices published by Log Lines. Pulp log prices expressed in multiples of 10 to accommodate market pulp pricing scale. Figure 6. Regional NCREIF timberland market value per acre is derived by dividing the total regional market value at quarter end by the number of acres reported in that region. Market values for Northeast timberland were re-estimated for the period 18Q4 through 19Q3 to adjust for what we believe to be an anomalous property included in the NCREIF database during those quarters. Figure 7. EBITDDA multiples are calculated using NCREIF timberland value per acre at quarter end divided by a trailing four-quarter average NCREIF net income per acre. Figure 8. The Hancock Securitized Timberland Index (HSTI) uses a base-weighted aggregate methodology (similar to that used to construct the S&P 5) to calculate a market capitalization-weighted value for seven publicly traded timber-intensive forest products companies. Base weights were readjusted for the emergence of new companies or at the beginning of each year. Dividends are not reinvested. The companies included in the HSTI have no investment relationship with the Hancock Timber Resource Group. Figure 9. Public equity derived from our Timberland Enterprise Value per Southern Equivalent Acre (TEV/SEA) for five timber-intensive publicly traded companies compared to southern timberland values per acre calculated from the NCREIF database. TEV is a quarterly estimate based on total enterprise value (total market equity + book value debt) less estimated value of processing facilities, other non-timber assets and non-enterprise working capital. SEA uses regional NCREIF $/acre values to translate a company s timberland holdings in various regions to the area of southern timberland that would have an equivalent market value. 25 Hancock Natural Resource Group, Inc. References to expected investment performance in this newsletter are based on historical information and are based on management's projections. Potential for profit as well as for loss exists. 6 Hancock Timber Resource Group High Street, Boston, MA