4.2 TIMOs and institutional investments in plantations

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1 4.2 TIMOs and institutional investments in plantations MARJO MAIDELL Institutional investors The popularity of forests as an investment has grown in recent decades. Institutional investors in particular such as pension funds, university endowments and trust funds have increased the extent of forest investments in their portfolios. Typically these investors are looking for an asset with a steady cash flow that provides MANAGEMENT diversification, long-term profitability and ongoing ORGANIZATIONS earnings that meet an established risk-reward ratio. They see forests as a hard asset that generates real investment-based returns, unlike assets such as company shares, which are subject to market forces SEARCHING FOR A DIVERSIFIED (Haltia and Leppämäki 2000). TIMBER INVESTMENT (TIMOS) ARE OFTEN USED BY INSTITUTIONAL INVESTORS TIMBERLAND PORTFOLIO, INCLUDING GREEN PROJECTS. The main interest in forest investments stems from the diversification potential that forests provide for portfolio holders. And, since many institutional investors have a long-term investment horizon, they also value forests inflation hedging potential. That potential is based on two factors: the biological growth that results in greater timber volume and value; and possible increases in timber and forestland prices (Zinkhan et al. 1992). Empirical evidence seems to support this ability to hedge un inflation (Washburn and Binkley 1993). Unlike the case with many agricultural crops, harvests may be postponed if timber prices stagnate. Another reason for investment in forestry is the high return; in the U.S., for example, the Timberland Index published by the National Council of Real Estate Investment Fiduciaries (NCREIF) showed nominal returns of 15% (p.a.) for institutional investors between 1987 and Part of this notable increase was due to the earlier undervaluation of forest estates. As with investing in general, historical returns are not a guarantee of future values. In some cases, however, the earlier and, to some extent, unrealistically high returns have been used to advertise the profitability of timberland investments. The Marjo Maidell has been assigned by Indufor Oy to write her Master s thesis on international forest investing for the University of Helsinki. 81

2 ETFRN NEWS: SEPTEMBER 2008 annual return of NCREIF between 2000 and 2007 has been somewhat lower, at 9% (p.a.), but is still attractive enough to encourage institutional investments. Institutional investors on average invest only 1 3% of their assets in timberland. The estimated value of timberland investments rose to approximately 19 billion in 2007 (FAO 2007). The size of a typical plantation investment ranges between 20,000 and 100,00 ha. Most timberland assets are located in the U.S. but notable investments have also been made in Europe, Russia and New Zealand. Less developed markets, such as countries in Latin America, Southeast Asia or Africa, are strongly emerging in the plantation investment business. The rising interest in early-stage plantation development in these countries results from the potential for high returns. Timber Investment Management Organizations (TIMOs) TIMOs are often used by institutional investors searching for a diversified timberland portfolio. TIMOs, first used in the 1980s in the U.S., are the most widely used mechanism for forestland investment. They provide timberland funds and management of individual timberland accounts (Table 1). Silvicultural management of the forest may also be the responsibility of TIMOs. TIMOs have seen rapid growth in their asset base in the past two decades in the U.S. and continued growth is (Siry and Cubbage 2001). Table 1. TIMOs: how they work Actors Investment managers Asset managers Property managers Field contractors Source: Modified from Hall 2008 Responsibilities Capital raising Financial analysis, due diligence Timberland investment administration Financial reporting Forest analysis and due diligence Inventory design and planning Timber sale negotiation, management Operations planning and oversight Forest operations reporting Inventory execution and monitoring Harvest set-up and monitoring On-site operations monitoring Operations execution site preparation planting other silviculture treatments roadwork harvest inventories surveying and mapping 82

3 4.2 TIMOS AND INSTITUTIONAL INVESTMENTS IN PLANTATIONS Determinants of plantation investments The emerging plantation countries, mainly located in the tropics, provide substantial opportunities for timberland investors. Attractive growth rates result in shorter rotations and greater yields, which means that smaller areas of land can be used than in temperate or boreal areas. The number of years between establishment and the first harvesting revenues can also be significantly shorter. In addition, the cost structure is relatively light, a labour force is available, and many of these areas have rapidly developing markets for wood-based products. The risk profile in emerging markets is different, however. Country risk is one of the criteria of investment. It refers to the factors that influence the business environment and investment climate in a particular country. Four drivers relate to plantation investment and country risk: social, environmental, financial and technical (Table 2; see also Haltia and Keipi 1997). Table 2. Risks related to plantation investments Social Environmental Financial Technical land tenure conflicts with stakeholders employees local populations NGOs public sector illegal logging erosion forest fires pests water biodiversity hotspots conversion of native forests timber price volatility liquidity withdrawal of subsidies/tax benefits changes in environmental legislation costs higher than market demand exchange rate location in relation to markets operational efficiency management capacity yield lower than plantation areas smaller than existing infrastructure Source: modified from Seppänen and Haltia 2007; Lehtonen 2008 Diversification is the key tool for reducing the risks present in plantation forestry. Diversification can be applied to countries, regions, tree species, age classes, grades and management regimes. Effective management planning, operational guidelines and training can also decrease the risk of plantation investment. 83

4 ETFRN NEWS: SEPTEMBER 2008 Typically, a dedicated team with broad experience and expertise is required to realise the full range of opportunities available from timberland. TIMOs can help institutional investors manage the risks associated with nondiversified forest assets and poor planning and management. By using TIMOs the investor can secure in addition to diversification benefits effective forest management. Forest certification provides another way to mitigate the risks related to inadequate operational quality and environmental planning, inability to comply with national requirements and endangering market reputation. International certification schemes (FSC and PEFC) or national plans aim to guarantee a well-managed production chain by requiring compliance in all aspects of economic, social and environmental sustainability. This is in line with the long-term investment horizons of institutional forest investments. Environmental issues Institutional investors are interested in the diversification benefits and financial performance of their investment. It can be assumed that intensive forest management is in line with these objectives. Siry and Cubbage (2001) state that in the southern U.S., intensive management includes more efficient site preparation, genetically modified seedlings and applications of herbicides and fertilizer. Financially profitable plantation management does not, however, necessarily mean intensified operations. Many non-timber values of the plantations have been included in the timberland appraisals in recent years, as the land value under multiple uses may be greater than that for industrial forestry. Recreational uses have also proved to produce competitive revenues in the forms of recreational leases, hunting leases or construction of apartments. Conservation agreements also provide a potential source of income for investors, who might be willing to lengthen the rotation period and engage in more sustainable management in order to receive secured lease revenues (as in the Forest Biodiversity Programme for Southern Finland METSO). Permanent conservation, resulting in biodiversity values or water-regulating services, might also prove profitable in certain circumstances. Carbon trading may also have a significant influence on management. Afforestation or reforestation projects have the potential to contribute to the sale of carbon credits. The value of carbon markets is to grow (Killmann et al. 2008) but the effect of this process on plantation establishment and management regimes remains to be seen. Revenues originating from non-wood services are attractive to investors because they increase the diversity of the forest portfolio. Some institutional investment strategies require a certain percentage of the capital to be allocated to so-called climate-change portfolios or green portfolios. The value of forests includes numerous environmental services, such as biodiversity conservation, carbon sequestration and erosion prevention. A sustainably managed forest can be an important 84

5 4.2 TIMOS AND INSTITUTIONAL INVESTMENTS IN PLANTATIONS instrument in mitigating the effects of climate change. Therefore, certified forests that produce both timber and ecosystem services have become part of environmentally sustainable portfolios. References FAO Corporate Private Sector Dimensions in Planted Forest Investments: Planted Forests and Trees. Working Paper FP/40E. Rome: FAO. Hall, R.W History and General Overview of Timberland Investments. Workshop document presented at the Plantation Investment Asia conference, Singapore, March 25 27, Haltia, O.P.J. and K. Keipi Financing Forest Investment in Latin America: The Issue of Incentives. In Kari Keipi (ed.). Forest Resource Policy in Latin America. Washington, D.C: Inter-American Development Bank. Haltia, O.P.J. and M. Leppämäki Do Shareholders Care about Corporate Investment Returns? Finnish Economic Papers, Vol.13, No.1. f2000_1b.pdf. Killmann, W., J. Carle, S. Braatz and A. Whiteman Investing in Forestry and Carbon for Profit and Environment. Presentation given at the Plantation Investment Asia conference, Singapore, March 25 27, Lehtonen, P International Finance and Investment for Plantation Owners. Workshop document presented at the Plantation Investment Asia conference, Singapore, March 25 27, Seppänen, P. and O. Haltia Determinants for Investments in Tropical Forests. ITTO West and Central Africa Forest Investment Forum: Issues and Opportunities for Investments in Natural Tropical Forests, Accra, Ghana, August 28 30, Siry, J.P. and F.W. Cubbage A Survey of Timberland Investment Management Organizations Forestland Management in the South. In Zhang, D. School of Forestry and Wildlife Sciences. Proceedings of the 31st annual Southern Forest Economics Workshop, Atlanta, Georgia, March 27 28, 2001, pp Washburn, C.L. and C.S. Binkley Do Forest Assets Hedge Inflation? Land Economics 69 (3): Zinkhan, F.C., W.R. Sizemore, G.H. Mason and T.J. Ebner Timberland Investments: A Portfolio Perspective. Portland, Oregon: Timber Press. 85