Canadian Investment Review

Reality Check

Written by Courtland Washburn on Thursday, February 4th, 2010 at 1:38 pm

AgricultureInstitutional investments in timberland and agriculture are typically portfolios of directly-owned properties diversified by geography, and crop type or species. Agriculture property is further broken down into farmland used to grow annual row crops like corn, which is usually leased to farm operators, and permanent crops such as orchards or vineyards, that are typically internally managed.

In the past decade, about US$35 billion of U.S. timberland has transferred from paper and forest product companies into the hands of financial investors, with two-thirds directly owned and the rest owned through shares of publicly traded timber REITs. There remain significant sums of additional financial capital seeking to invest in both timberland and farmland.

The attraction to timberland and farmland is the negative correlations –and consequent high diversification benefits–of the two asset classes relative to most other assets. In the 30 years through 2008, timberland and farmland both showed negative correlations with U.S. large cap equities, non-U.S. equities, long term corporate bonds and U.S. Treasury bills. Both assets were positively correlated to inflation, though, making them good hedges against that risk. One study showed a statistically significant positive correlation between two categories of U.S. timberland and inflation over a 48-year period through 2008.

Price and performance
This begs the question of how timberland and farmland performed during the recent financial crisis, when correlations between many assets rose. The answer is that while timberland and farmland returns fell, they remained positive in calendar 2008 (when returns on the S&P 500, investment grade corporate bonds and commercial real estate were all negative). In the first half of 2009, timberland returns have been flat, while farmland is up 2.5%.

Hancock Timber Resource Group expects timberland prices to fall over the near term so that cash yields and expected total returns can rise to levels that are attractive for investment capital. Farmland yields have not compressed in recent years, but farmland prices could yet be pulled down by conditions in broader capital markets.

Even though timberland and farmland came through the recent financial crisis relatively unscathed, the two asset classes are not immune to extreme conditions in capital markets. The re-pricing of risk across capital markets has put upward pressure on yields (and concurrent downward pressure on property prices). Both asset classes are less liquid in a declining market, price discovery can be difficult and reported values lag actual market conditions. A crucial issue: whether required returns on timberland, farmland and other real assets have now been permanently reduced relative to other asset classes.

Courtland Washburn is Managing Director and Chief Investment Officer with MFC Global/ Hancock Natural Resource Group

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