Thursday, February 14, 2008

ETF as Surrogate for Timberland Investment

In the Feb. 18th issue of Business Week, there is an article entitled "Wood Paneling for Your Portfolio". I'll start with a couple of quotes from the article and then I'll disect them.

"Buying timberland is one of the ways big guys running pension plans and endowment funds have diversified their holdings away from financial market trends and earned fairly stable double-digit returns to boot. But timberland has been mostly off-limits to individual investors, because it requires millions of dollars to buy in."

"Enter the Claymore/Clear Global Timber Index ETF. It's a new exchange-traded fund that invests in stocks of companies with the world's greatest exposure to timberland. It amps up the exposure by weighting the 27 stocks in the portfolio not by market capitalization but by actual acres companies own."

"This sort of everyman version of a timberland play..."

Okay, that's enough. I've been reading about this ETF as a surrogate for timberland ownership since its inception and I would like to say very LOUDLY and clearly that this is NOT a timberland play.

First, let's consider the above quote "timberland has been mostly off-limits to individual investors, because it requires millions of dollars to buy in." No it does not. Small tracts of timberland with all of the advantages of larger tracts are available for purchase. The use of a LLC allows investors to combine financial resources to acquire larger tracts. You can even purchase timberland within an IRA. Consulting foresters in all regions of the country are available to assist with appraisals and management. Many of these consultants are the same people assisting the institutional investors with timberland acquisition and management. If you want a timberland pure play, you will have to buy timberland and it is within the reach of most investors. If you want to get an idea of what is available for sale and pricing, just do a Google search on timberland for sale or consulting foresters in your geographic area of interest. If you want to learn more about buying small tracts of timberland, you might want to buy and read Curtis Seltzer's "How To Be a DIRT-SMART Buyer of Country Property". There is a lot of info in it that can put you on the right road. Before you buy, you will still need a consulting forester or someone else very familiar with timber values, land productivity and the local market. If you want to delve into the concept of timberland as an investment, I'd recommend "Timberland Investments" by Chris Sinkhan, et. al. which is pretty much the classic in that field.

So, no, you don't need "millions of dollars" to buy timberland!

Now let's look at the Claymore/Clear Global Timber Index ETF and see why it is not an "everyman version of a timberland play". To be fair to Business Week, they are not the only ones promoting this ETF as a surrogate for owning timberland. I have seen at least a dozen articles with similar comments.

Below is a list of the holdings in the Clear Global Timber Index along with the percentage weighting of each. As you scroll down through the list, ask yourself the following questions.


  • Is the primary asset of this company timberland?

  • Does this company own any land or has it sold its timberland?

  • Is the stock weighting in the portfolio "by actual acres companies own" as claimed in the article?

  • Is this company forced to acquire its timber on the open market (or at market price if there is a fiber supply/lease agreement)?

  • What level of fiber self-sufficiency does this company have?

  • Does this company grow and sell more timber than it uses?

  • Is this company the exact opposite of a timberland play?

  • Is this index/ETF more reflective of the global pulp and paper industry index than timber or timberland?
Clear Global Timber Index
Top Fund Holdings as of 2/13/08

Name/Weight
INTERNATIONAL PAPER CO/5.48%
VOTORANTIM CELULOSE E PAPEL SA/5.46%
ARACRUZ CELULOSE S.A. ADR/5.17%
POTLATCH CORP/4.86%
SINO-FOREST CORP/4.83%
RAYONIER INC/4.78%
SVENSKA CELLULOSA AB-B SHARES/4.77%
SAPPI LTD/4.74%
TIMBERWEST FOREST CORP/4.61%
PLUM CREEK TIMBER CO INC/4.60%
WEYERHAEUSER CO/4.60%
SUMITOMO FORESTRY CO LTD/4.56%
HOLMEN AB SER B/4.55%
MEADWESTVACO CORP/4.49%
GUNNS LTD/4.45%
OJI PAPER CO. LTD./4.33%
SMURFIT KAPPA GROUP PLC/4.28%
GRUPO EMPRESARIAL/3.76%
CHINA GRAND FORESTRY RESOURCES/3.22%
DELTIC TIMBER CORP/2.71%
WEST FRASER TIMBER CO LTD/2.67%
HOKUETSU PAPER MILLS LTD/2.48%
GREAT SOUTHERN PLANTATION/2.13%
CANFOR CORP/1.25%
TIMBERCORP LTD/1.21%

If you answered the questions, it should be very clear that this index is NOT a timberland play but in many cases, it is just the opposite. For example, as timber and timberland prices increase, you would expect the value of the index to increase as well. Here is a quote from MeadWestvaco's news release following its last quarter.

"Higher input costs for wood ...negatively impacted profitability."

The corporate structure of many of the key holdings above is very similar to that of MWV. This ETF may be a good investment, I can't say, but it is certainly NOT a surragate for timberland ownership. It reflects a global pulp and paper play.

So..., is it possible to invest in stock as a timberland play? Maybe, kind of, in a way. At a minimum, we can do a heck of a lot better than this ETF. We'll do it by creating a basket of stocks from the above list that really are backed up by timberland and that have little or no exposure to pulp and paper. Let's also eliminate the bulk of the foreign stocks which, to a degree, have currency exchange risk associated with them (You may think that the dollar will continue to decline so they will be a good investment but that is not timberland investing, that's currency investing - then again, you might think that the dollar is about to turn around...).

Let's start by putting check marks by Plum Creek, Potlatch and Rayonier. All have significant timberland acreage, little or no exposure to pulp and paper, and a tax efficient corporate structure (REIT). The timberland in these three stocks provides plenty of geographic, species and market diversity. That diversity substantially reduces many of the risks associated with both timberland and stock investing. I believe that this basket will come as close to owning timberland as you can get. If you want to add a few more, consider Deltic Timber (timberland and lumber mills), Pope Resources (a MLP), and Weyerhaeuser (six million acres but pulp and paper, lumber mills, currency risk, and inefficient tax structure). Weyerhaeuser is a particularly interesting addition because its current market cap is less than estimates of the timberland value. In addition, a probable change in the tax structure will likely result in a significant increase is share price. So let's create a basket with three to six of these stocks and forget the ETF. It will be more reflective of a timberland investment.

But remember, too, that it is NOT timberland. It is stock - be that good or bad. On the positive side, the stock basket is much more liquid than a timberland investment. The stable, continuously rising value of timberland will be absent. Daily values will change with the stock market. Value will rise and fall with major market influences like housing. Quarterly profit will impact the stock price (no matter how foolish). Last week an analyst reported that Potlatch was a better buy than Plum Creek. I checked the stock prices for the two of them and Potlatch was up about 3.5% and Plum Creek was down by 3.5%!!! The value of the timberland at neither company had changed one penny but the difference in value of the two companies was 7%! These types of moves may be foolish but they are also reality.

So..., this may raise a couple of questions in your mind. First question: How can we do a better job at selecting stocks to "kind of" mirror timberland investments than a professional investment firm like Claymore? Answer: Due to laws and regulations that apply to mutual funds and ETF's, they are restricted from taking a position that exceeds 5% of the fund. That means that they must take a bare bones number of 20 different companies in the ETF and there are not 20 companies out there that even approach being true timberland plays. We win not because we are better but because we are blessed with more flexiblity.

Second question: How could Business Week's assesment be so far off? Answer: ?? --Brian

9 comments:

  1. Brian,

    Good of you to expose the weakness in the BusinessWeek article. I, too, was dismayed when I saw the article and thought that the CTGI ETF was a pulp and paper play marketed to appear as a timberland play. I hope you will forward your blog entry to the BW editors.

    Chris Zinkhan, in his Timberland Investing book to which you refer, describes the concept as a "synthetic" timberland investment and points out the shortcomings, as you have, where manufacturing facilities are involved.

    One should also call attention to the various club accounts or pooled account funds being raised by TIMOs. Some of these accounts have investment opportunities below $10 million.

    For those looking for timberland investment opportunities at less than $1 million, it seems that the recreational tract market has much supply to offer and many sellers (or sellers' agents) offer a heap of information about the tracts via the Internet.

    However, it may be difficult to obtain desirable investment diversification below $1 million. On the other hand, timber insurance is becoming increasingly available and poor investment diversification has not stopped a large segment of the population from purchasing a house.

    Chris Elwell

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  2. I have to agree wholeheartedly with Brian. Many of the investments held by this ETF are truly anti-timber. Some may have held timberland at one time, but have sold it off and are now at the mercy of timber markets.

    A more reasonable list for such an ETF would be:

    Three publicly trade Timber REITs:
    PCL - Plum Creek
    RYN - Rayonier
    PCH - Potlatch

    Two publicly traded industrial companies still holding timberland:
    WY - Weyerhaeuser
    MWV - MeadWestvaco

    A few companies that are a mixture of timberland and real estate plays:
    JOE - The St. Joe Co
    FOR - Forestar Real Estate Group

    A couple of smaller mixed (timberland, mills, real estate, consulting) plays:
    DEL - Deltic Timber
    POPEZ - Pope Resources

    Two pure play Canadian stapled units/unit trusts:
    TWF-UN.TO - TimberWest Forest
    ADN-UN.TO - Acadian Timber Income Fund

    A mixed energy/timberland asset company (owns Island Timberlands and Longview Fibre):
    BIP - Brookfield Infrastructure Partners

    A few international options:
    SNOFF.PK (or TRE.TO) - SINO-FOREST CORP
    CFZFF.PK (or CFZ.V) CATHAY FOREST PRODUCTS

    That gets us to 14 holdings, a few under 20 required, but a great start.

    A few more, obscure and/or thinly traded options to round things out might be:
    PVR - Penn Virginia Resource Partners -- a coal company that recently purchased some MWV timberland in WV.
    KEWL.PK - Keweenaw Land Association -- low market cap, and extremely low trading volume.

    Bruce

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  3. Rather sneaky of you to cut off the rest of the article right when it says that the ETF is different from regular timber investment and later offers a genuine timber alternative. Here is the rest:
    This sort of everyman version of a timberland play isn't as effective a diversifier as what the bigger players can get, but it's not bad. Timberland values have moved in line with the Standard & Poor's (MHP) 500-stock index about 36% of the time over the past 20 years. The Dow Jones World Forestry & Paper Index (NWS), a useful proxy for the Claymore fund, correlates about 59% of the time. So for about 40% of the time, timber stocks zigged when the broader market zagged. The Claymore ETF could correlate even less with stick market swings given its extra weighting in acreage.

    An added attraction is the cheap price of timber stocks. The ETF's portfolio currently has a ratio of price to book value that's about 60% that of the average U.S. stock. On one measure of profitability, the ratio of price to cash flow, things look even better, with the ETF at an 80% discount to the average stock.

    While prices for timberland haven't dropped, stocks of paper and lumber companies have fallen because of concerns about housing and the U.S. economy. "Cutting down trees for lumber to build homes is only a small portion of what timberland is used for," says Andrew Corn, CEO of Clear Indexes, which designed the index the ETF tracks. "Timber is used for packaging first, paper second, and then lumber. Also, most timber companies are global players. China alone plans on building 50 cities the size of London in the next 30 years. They'll need a lot of wood." The ETF's top three holdings are U.S.-based International Paper and Brazilian companies Votorantim Celulose e Papel, and Aracruz Celulose.

    What pension plans like about timberland, as opposed to timber stocks, is its relatively stable value. When timber prices fall, tree farmers can delay harvesting their crop, and during that time the value of the tree expands as it grows. "If a tree stays in the ground an extra year, there's just more of it next year, and the quality of the tree is better," says Jerry Miccolis, a Morristown (N.J.) financial adviser who invests in timber stocks. "Tree farmers can afford to wait till the price cycle comes their way." The typical tree grows 7% a year, and timberland's steady returns have been double that over the past two decades.

    Another new option for investors seeking pure exposure to timberland is the Wells Timberland REIT. The non-traded real estate investment trust buys directly and has a $5,000 minimum. The trust is not fully invested and so has no performance track record. If you buy in, you'll have to lock up your money at least five years. You'll also pay hefty 10% commissions up front on your investment.

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  4. Dear Anonymous,
    I didn't intend to be sneaky and cut it off right there so let me pick it up right there! The first paragraph of your quote follows:

    "This sort of everyman version of a timberland play isn't as effective a diversifier as what the bigger players can get, but it's not bad. Timberland values have moved in line with the Standard & Poor's (MHP) 500-stock index about 36% of the time over the past 20 years. The Dow Jones World Forestry & Paper Index (NWS), a useful proxy for the Claymore fund, correlates about 59% of the time. So for about 40% of the time, timber stocks zigged when the broader market zagged. The Claymore ETF could correlate even less with stick market swings given its extra weighting in acreage."

    Okay, so the The Dow Jones World Forestry & Paper Index (NWS), a useful proxy for the Claymore fund, correlates about 59% of the time. While you may be right that its a good proxy for the Claymore fund it is NOT a good proxy for timberland.

    Here is the best correlation that I have seen between this ETF and timberland prices (source: MY Portfolio Manager, the entire post is well worth reading - http://www.myportfoliomanager.com/archives/135)

    "At first blush this seemed to be what I was looking for, but upon digging deeper its not even close. Using the hypothetical returns that Clear Indexes provided I compared them to the NCREIF Timber Index. Now I would consider something with a correlation north of .80 to be fairly significant. What I found was a negative correlation between the two on the order of -.167. Not exactly what I was looking for in a timber play, so I’ve moved on."

    Note that the correlation is actually negative. Nuff said. --Brian

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  5. Small private LLC type structured companies are one of the best ways to invest in timber land. They often take a bit more work and research up front. But the small investor can get much higher yields and safety than institutions though smaller private companies that buy and mange timber land. A group such as Panama Teak Forestry, which specializes in the high yielding tropical hard wood industry, is an extremely good example of this. These companies are not very liquid and do require a long term investment view. It also requires a bit more research on each individual investment opportunity, but the time invested can yield significant results as the yields in the smaller tropical hard woods sector of the timber industry often runs double what the soft wood sector pays out. It is available to smaller investors and is generally not bought up by the big funds because they are just too small and the tropical hard wood plantations are a very fragmented part of the timber industry. This leaves a great opportunity for the smaller investor willing to do a little research to find the best of these companies. With these companies sums as small as $100,000 can be invested and are great investment for individual IRA. The investor does need to do the proper due diligence because it is not already done for them on these companies. But as the article above points out you should do your due diligence on any investment.

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  6. An excellent article and some worthy points. Thanks for the read.

    Arrielle P

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