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WHY INVEST IN TIMBERLAND?
PORTFOLIO DIVERSIFICATION
The opportunity for an attractive risk-adjusted return is not the only persuasive argument for adding commercial grade timberland to an investment portfolio. Another key benefit of holding timberland as an investment is to provide portfolio diversification. Commercial timberland, by its nature, is affected by a different set of macroeconomic and market factors than other asset classes. As a result, there will be limited correlation between returns from timberland and other asset classes such as stocks, bonds, and real estate. The addition of a low correlation timberland asset can expand the efficient frontier of the risk-to-return profile of the total portfolio.
NCREIF Timberland Index returns from 1990 through 2007 showed moderate to weak correlation against the major indices for publicly traded equities and fixed income securities (see Figure 3). In the case of commercial real estate, it is negatively correlated.
Figure 3 Correlation of the NCREIF Timber Index annual returns against inflation (CPI) and major market benchmark indices from 1990 through 2007.
Source: NCREIF, Ibbotson Associates
The benefits of diversification with timberland are to boost returns for a given target risk tolerance, or to reduce risk for a given target return. In other words, timberland can expand the efficient frontier, as shown in Figure 4. This efficient frontier represents a hypothetical portfolio consisting of large and small cap stocks, corporate bonds, long-term government bonds, US treasury bills, and commercial real estate and is based on the last 18 years of returns with and without timberland investments. Timberland is held in the portfolio at no more than 20% of asset value. As the chart indicates, timberland, even when held as a small portion of the total portfolio, can still impart a measurable reduction in the overall volatility of a portfolio while increasing the overall return.
Figure 4 Risk-to-return efficient frontier of a portfolio with and without timberland.
Based on the historical annual performance from 1990 to 2007 of the following asset classes: long-term government bonds, intermediate bonds, short-term bonds, large cap stocks, small cap stocks, US timberland, real estate, private equity and venture capital.
Source: NCREIF, Ibbotson Associates
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