Aquila: a guide to forestry investment vehicles

Nils von Schmidt is responsible for the acquisition and management of timber investments at Aquila Capital. He tells us which investment vehicles are suited to which LPs, whether they have €10 million or over €100 million to invest.

The shift by institutional investors towards alternative assets has been well documented in recent years. Investment into timberland doubled in the 10 years leading up to 2009 to over €120 billion worldwide.

Timberland benefits from a low risk profile, as well as long-term macroeconomic trends. Timber’s overall demand-supply ratio continues to lean towards a deficit, supporting returns. In the 27 years leading up to 2014, timber products prices had a 53 percent correlation with US inflation, which would be even higher but for a time lag.

Over time, new ways to invest in forestry have also turned up, from funds of funds and index funds to real estate investment trusts.

The preferred choice of access will be based primarily on the tax and regulatory requirements of each investor, their time horizon, required liquidity and in-house resources. Investments can be regionally diversified using club deals, fund of funds, direct investments, specially mandated managed accounts and even exchange trade funds or equity funds.

Club deal and direct investments

Going into a club deal or direct investment is the classic way to invest in forestry. It is much older than fund investments.

A club deal is often suited to high net worth individuals who know each other, and are aligned in terms of their investment targets, desired investment period and how long they expect to stay invested. They get together and typically buy a smaller or mid-sized timber property. Club deals normally range from about €20 million to €50 million, with individuals typically investing around €10 million each.

With a direct investment you have the option to influence the management very directly, but that also requires that you understand the investment. You can have a club deal without that knowledge, but you would need a great manager. In Europe, the availability of smaller forests together with the availability of forest management service providers can make this investment route more feasible.

Investors usually want to pass on an investment to the next family generation, or have it for inheritance tax purposes. However, very large institutional investors from Europe who have built up knowledge and in-house resources are also beginning to prefer this option over fund investments, [because] they want to have more say with regards to cash flows and timing of exit.

Funds

This is now another classic way to invest, [combining] capital from different sources unable to invest more. Forestry is capital intensive and often benefits from scale. Its history is closely linked to what happened in the US in the 1990s, when the timber industry divested and timber investment management rganisations (TIMOs) formed the first fund investments for institutional investors. Timber funds are an efficient means to invest, [starting] from about €100 million. From my perspective, funds with a €300 million to €500 million final closing target can be too large, and run the risk of taking too long to be invested and thus of returns becoming depressed.

Funds of funds

Funds of funds are fewer in number and have only been around since the late 2000s. Typically you get great diversification but you also have to be aware of adding another fee layer. That has to be cost efficient when looking at the diversification benefit. They can be good for institutions who don’t want to get too deeply involved, but seek stability and immediate diversification.

Diversification in funds of funds comes in geographies, species, managers and a combination of appreciating assets as well as cash-producing assets. A typical single fund for the most part focuses on appreciating assets such as greenfield-type projects. Cash-producing assets often involve investing in more mature forests that are ready to harvest. A good fund of funds should capitalise on the cash component.

Timber investment management organisations (TIMOs)

Managed accounts really require a strong track record on the part of the TIMO, and an investor with [truly] large funds or a strong commitment to forestry, because you wouldn’t open a managed account with less than €100 million to invest individually. They will become more important because the industry track record is improving while institutional investors are also gaining more expertise.

If you are that big as an investor, look for an investment manager that can offer diversification. Most TIMOs are in the US, and tend to invest in traditional regions like the US, Oceania and some parts of Latin America. Putting all eggs into one manager’s basket requires the manager to be capable of diversifying more broadly and this is hard to find.

Real estate investment trusts (REITs) and exchange traded funds (ETFs)

The beauty of these in terms of forest investment is that they are more liquid, because one basically invests in shares. That is very different from other forest investment types, which can be hard to sell quickly. Often the companies’ assets comprise of both forest as well as timber processing, so one gets much closer to general economic developments rather than the lack of correlation that makes timber investments generally attractive. It’s also worth watching this space for developments. Solving the illiquidity issue while maintaining the positive aspects of timber investments is a big task and most likely to be solved in this category.