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Institutional investors are axing timber allocations, but some question if the timing is right

Freshly cut trees sit stacked before transport to a sawmill in British Columbia. Investors are cutting allocations to timber because of poor returns.

Updated with correction.

Investors tired of poor returns are getting out of timberland at what some say is the wrong time.

Leading the exit are CalPERS and Harvard.

The California Public Employees' Retirement System, Sacramento, in the third quarter sold most of its $2 billion timberland portfolio, with few plans of investing again; instead, the $358.9 billion system will focus on core real estate.

CalPERS' consultant said the fund sold the investments at a loss.

CalPERS sold the portfolio, Crown Pine Timber, because of its underperformance, Andrew Junkin, president of Wilshire Consulting, one of CalPERS' general investment consultants, told the investment committee at its Aug. 13 meeting.

"We know that (performance struggled) largely due to that one asset with lots of concentration in the Southeast timber markets," he said. Mr. Junkin noted Southeast timber prices have been down since the financial crisis because that is the timber used in home construction. Other factors contributing to the portfolio's underperformance, he said, were "just the poor timing on the purchase ... you can't know in advance that the market's going to collapse," leverage and "a challenging governance structure."

CalPERS chose to sell the portfolio because there was "a very large principal payment coming up," Mr. Junkin said. "Challenges of this investment included onerous debt arrangements, unfavorable supply agreements and sawtimber market pricing below pro forma causing an increasingly heavy drag on cash flow," according to a report to the board by Wilshire in August.

CalPERS' forestland portfolio underperformed its benchmark for the one, three, five and 10 years ended June 30. The portfolio earned 1.9% compared to the 3.8% benchmark return for the year; an annualized -2.4% (3.4% benchmark) for the three years; -1% (6.1%) for the five years; and -1.1% (4.1%) for the 10 years ended June 30. These returns do not include additional markdowns from the sale of the Crown Pine Timber portfolio, Mr. Junkin said.

Meanwhile, Cambridge, Mass.-based Harvard Management Co., which manages Harvard University's $37.1 billion endowment, is also selling off portions of its timberland portfolio, sources said.

Harvard Management Co. reported in September that natural resources, including timber, experienced a challenging year in its 2017 fiscal year and the endowment took write-downs and sold assets, some at or above their previous valuations. "Our natural resources platform will take multiple years to reposition," the report noted without providing details. Harvard is reportedly attempting to sell majority or minority stakes in a $700 million portfolio of timberland in South America.

Fundraising by timber investment managers is way down. Two funds raised a combined $600 million so far in 2018, down from seven funds that raised $1.4 billion in all of 2017 and eight funds that raised $3.1 billion in 2008, according to data from London-based alternative investment research firm Preqin.

More than 30 timberland funds manage about $57 billion of assets for investors "who cite the long-term investment horizon, low correlation with the general economy, biological growth regardless of economic conditions and a relatively stable stream of cash flows as appealing characteristics of the asset class," according to a recent report by MetLife Inc.'s agricultural finance group, which oversees agricultural and timberland assets.

Matthew Lynch, Hartford, Conn.-based managing director and head of real estate and private markets at UBS Asset Management, said poor returns are driving investors out of the asset class into other real asset sectors.

Timberland assets earned 0.48% for the quarter ended June 30, down from 0.92% in the prior quarter and 0.7% in the second quarter ended June 30, 2017, the NCREIF Timberland index showed. The Total Timberland index had a 3.57% trailing return for the year ended June 30. Timberland market value per acre was $1,804 as of June 30, down from $1,824 a year earlier, according to NCREIF.

The falling returns are due, in part, to changes in the journalism world.

"Timber returns have been consistently lower than farmland returns ... partially due to reduced demand for newsprint," Mr. Lynch said. "Media is bigger than it has ever been but daily newspaper print component is smaller."

UBS Asset Management sold its timber investment management business in 2003.

Board, printing and writing papers, newsprint, tissue and pulp end-markets together amount to 32% of total U.S. softwood demand, according to report released this year by BTG Pactual's Timberland Investment Group, New York.

Between January 2017 to June 2018, average prices for commonly traded lumber in the U.S. increased by 40%, according to the Wood Resource Quarterly. During the same period, sawlog prices were practically unchanged in the South and rose about 28% in the Western U.S.

Log prices in the Pacific Northwest declined 2% year-over-year to March 31, but lumber prices increased by around 30% since then, according to a report prepared for the New Mexico State Investment Council's Aug. 28 meeting by its real asset consultant, The Townsend Group.

In a report to its investment committee, staff at the Santa Fe-based council acknowledged that "overall timber and agriculture investment opportunities have … been recently challenged," according to a summary of the meeting. One of them was Brookfield Timberlands Fund V; Brookfield Asset Management returned the money due to lack of reasonable opportunities, said Charles Wollmann, spokesman for the $23.3 billion endowments, in an email.

The New Mexico State Investment Council had a $258.5 million timber portfolio as of June 30. The endowments have a 9.7% allocation to real assets, which includes a zero to 20% target range to timber.

"We are likely to keep our same position and don't foresee much new money going into our timber or agricultural portfolios in the immediate future. Energy and infrastructure — which move the needle the most — are the current focus," Mr. Wollmann said.

Indeed, the council in 2017 released a total of $95 million in unfunded commitments to two timber managers.

Wrong time?

Some industry insiders say institutional investors are downsizing their timber exposure at the wrong time, when prices for timberland are way down. They also say the investors got into their current portfolios at the wrong time.

During the Aug. 13 CalPERS investment committee meeting, Andrew H. Junkin, president of Wilshire Consulting acknowledged timing and the type of timber in CalPERS' portfolio caused the underperformance of the Crown Pine timber portfolio.

“Crown Pine, which has been an investment of yours that has struggled, has had significant exposure to southeast (timber)” and southeastern timber prices have been flat for the past three years, Mr. Junkin said.

This one investment hurt CalPERS' timberland portfolio, in part, due to poor timing of the investment, he said.

“Timber prices in the Southeast were hit pretty hard in the global financial crisis, because that tends to be the market that's used for home construction,” Mr. Junkin explained.

However, timberland is a cyclical asset class, noted Bob Ratliffe, Seattle-based president of timber manager Silver Creek Capital Management LLC.

Housing starts are up, albeit on a slow and steady pace, which is putting Southeast timber “on the right trajectory,” he said.

Some timber managers and investors are buying timberland, seeing opportunities as some holdings are priced at a discount.

In July, CatchMark Timber Trust Inc. alongside BTG Pactual Timberland Investment Group, British Columbia Investment Management Corp., Highland Capital Management and Medley Management Inc. bought 1.1 million acres of prime East Texas timberland from CalPERS for $1.39 billion.

The market value of CalPERS' investment in Crown Pine Timber — known as Lincoln Timber, a hedge fund of one managed by timber management organization Campbell Global — was $1.6 billion as of June 30. In October 2007, CalPERS had committed $2.2 billion to invest in 1.5 million acres in eastern Texas and western Louisiana, documents on CalPERS' website show.