Saturday, November 10, 2012

Investing in Forests

Investment Query: I came across an interesting article. It unfolded a new path of investments to me. Now I understand that this is not a practical idea, but is it possible in the future that people will start investing in forests?

Mr. Gerard Colaco: Throughout the history of investment, various individuals and institutions have come out with, what on paper at least, appear to be attractive alternative investment avenues. The only problem with these avenues is that their long-term track record and many times even their intermediate track records are dismal.

The very sentence of the article sent by you is faulty. It states that unlike stocks and shares, timber growth is not affected by economic circumstances. Nonsense. Timber growth can be affected by disease, climate change, forest fires, storms, amendments to government regulations relating to forestry, acquisition or sudden declaration of certain areas as ‘protected’ with a ban on felling trees, etc. Companies offering schemes based on forestry are often poorly regulated and there can be any amount of mismanagement and fraud in these outfits.

In fact in India, there have been numerous investment schemes based on agriculture, teak plantations, etc., all of which have failed, creating huge losses for their investors in the process. There are some false statements made in the article. Values of all real estate properties, including timber plantations can fluctuate and have fluctuated in the past. The mere fact that the trees grow is not sufficient to insure against the possibility of a downturn in timber prices in the event of a global recession or real estate market fall. Timber growth and timber property prices are two entirely different things.

The statement that physical assets are safer than financial assets is also false and indicates a flawed understanding of investment. It is true that a physical asset can be seen to exist and continue existing. But so can almost all companies in a diversified portfolio of blue chip stocks. Equity has also proved itself to be a very safe investment over the long term. We have 410 years of stock market history testifying to this.

The argument of growing population in developing countries providing demand for timber can be applied to other asset classes as well. For example, the growing Indian population, has added to the demand for gold, medicine, healthcare facilities, food, banking services, automobiles, telecom services, etc., etc., and not just the demand for timber.

Returns on timber are also region-specific. You need not get the same returns in all countries. In fact, timber returns in developing countries are higher than in developed countries. When you invest across geographies and countries, there is also the foreign exchange risk to be taken into account. Costs of registration fees on the acquisition of timber properties and agents' fees on the sale of timber can also eat into returns. If the forestry investment is packaged through a collective investment scheme, the managers of this scheme would charge their fees and expenses, thereby affecting returns.

Demand for timber can also be affected by wood substitutes. There is a great variety of timber products. Some may be in demand at a particular time. Others may not. The case of softwood in the US is illuminating. During the global financial crisis, when housing construction reduced drastically, the demand for softwood plummeted. Several sawmills turned sick and even closed down. Timber, like all other investments, is not magically exempt from risk.

One point on which I fully agree with is that an investment in forestry is non-correlated to other types of growth investments and offers an opportunity for diversification. But only people with a very high net worth can indulge in the luxury of an investment in forestry, and that too, if this kind of investment is well regulated. Most other investors would do well to stick to a sensible programme of investment and allocation to normal avenues of debt, equity and real estate.