Are you interested in generating returns that consistently on-average beat the S&P 500, have a low correlation with other assets, and have low volatility of returns? Looking to get into the commodity markets, but worried that crude oil, natural gas, coal, and the soft food commodities have gotten ahead of themselves? No need to worry. We have the prefect investment for you - wood. No kidding, wood. And when I say investment, I mean investment. Waiting around for trees to grow is not for active day traders.
As reported by
IndexUniverse, it turns out that timber investments have outperformed stocks, bonds, and commodities over the long run. In fact, the NCREIF Timberland Index, which is the standard benchmark for this asset class, increased 18.4% last year, versus a 5.5% rise for the S&P 500. Over time, the Timberland Index has beat all the major asset classes, except small-cap stocks. From 1992-2006, returns for timber were 12.2%. During the same time, large cap stocks returned 10.6%, small cap stocks returned 15.4%, international equities returned 8.2%, and corporate bonds returned 8.0%. When you consider volatility using the Sharpe Ratio, timber has the highest risk-adjusted returns, even beating small cap stocks (the Sharpe ratio for small cap stock was 0.63%, while reaching 0.84% for timber). Since 1987, the timber index has had only one down year in 2001 (-5.25%). During the same time frame, the S&P 500 has been down four times (as low as -22.10%).
Timber as an asset class also has a very low correlation to other asset classes given that its primary driver (biological growth) is not as affected by sub-prime woes, dot-com meltdowns, or the next Enron. The trees just keep growing. Also, with timber there is always the threat of physical damage (who among us has not seen a California wildfire on TV recently). Yet for a diversified portfolio, physical losses usually only decrease returns by 0.1% annually, on average.
What are the downsides? First, timber has been attracting more attention lately, so some investors have been paying up for assets. There is a lot of institutional and private money chasing a limited number of trees, at least those open to harvest and investment. Some investors are now even looking overseas. As with any investment, overpaying can certainly lower returns. Second, trees are not liquid investments given that much of their return requires patience. When you look at the profits from trees, about 61% comes from biological growth, with 33% from the price of timber, and 6% from land appreciation. Selling at the right time, and waiting for the trees to get big enough to command top dollar, are key.
