Timberland as a Sustainable Investment

Doug Donnell, National Timberland Executive, Specialty Asset Management
U.S. Trust, Bank of America Private Wealth Management


Today, an increasing number of high-net-worth and institutional investors are attempting to promote their social and environmental values through their investment strategies. Timberland offers an opportunity to pursue both — an environmentally sensitive investment platform and financial advantages. Forests and timberland, when managed utilizing an environmental lens, aid in air and water quality protection, carbon sequestration and provides a source of renewable energy. As an investment, timberland may offer attractive risk-adjusted returns for portfolio diversification1 and can help hedge against inflation.2

INVESTMENT VALUE—TIMBERLAND CAN HAVE ATTRACTIVE SUSTAINABLE ATTRIBUTES

Many institutions and private investors, regardless of their commitment to supporting the environment or other social concerns, generally prioritize the financial viability and performance of their investment strategy over environmental concerns.

Historically, timberland has enjoyed an enviable long-term track record of performance even in the face of headwinds from such factors as housing stalls driven by economic downturns.3 Timber investments have three significant attributes: competitive total returns, low volatility and noncorrelation with traditional asset classes. These attributes are largely driven by the fact that the majority of timberland returns are derived from biologic growth. Quite simply, the trees will continue to grow despite any concern or impact from the financial marketplace. When you combine these attributes with the tax-efficient characteristics from capital gains treatment of harvest income and the inflation-hedging ability enhanced by biology, timberland can be a valuable asset class to affluent investors, family offices, foundations and institutional investors.

Timberland market risks may be largely mitigated by the optionality of timberland investments. In other words, the investor has an option to harvest and sell timber when biological maturity and favorable prices coincide. The alternative is simply to defer harvesting when markets are not favorable and let the timber continue to grow in both volume and value until prices improve or land use conversion opportunities occur.

CARBON SEQUESTRATION — A KEY TO ENVIRONMENTAL VALUE

Carbon Sequestration — The term describes long-term storage of carbon dioxide or other forms of carbon to either mitigate or defer global warming and avoid dangerous climate change. It has been proposed as a way to slow the atmospheric and marine accumulation of greenhouse gases, which are released by burning fossil fuels.

While timberland can be a distinctive and valuable investment asset class, its secondary attraction as a social values-based investment is less apparent but no less impressive, in our view. Environmentally focused investors will be pleased to learn that U.S. timberlands store roughly 88% of carbon inventory in the country, of which 63% is on privately owned forestlands.4 Private timberlands account for 70% of forest carbon sequestration annually.5

During harvesting, some carbon is released during the process but the remainder is retained in the logs. 50% of wood's dry weight is carbon and wood products retain most of the carbon over their lifetimes.6 Annually, the amount of carbon stored in wood and paper products can offset the emissions from 18 million passenger cars.7 Reforestation also allows trees to capture carbon in the atmosphere and forests' contribution to the removal of greenhouse gas has increased 14% in the past two decades.8

The use of wood-derived materials is featured in numerous everyday materials and demand for wood products in nontraditional uses continues to expand. Wood pellet consumption in the United Kingdom and other European countries has strongly influenced the United States wood bioenergy markets and has resulted in the construction of several new pellet mills in the Southeast.9 This is a positive development for timberland investors, both economically and socially, in that the shift from nonrenewable fossil fuels to renewable and sustainable energy from timber-based biomass opens new markets for timberland products.

The use of wood in construction also generates fewer carbon emissions than using steel-frame and concrete-frame buildings.10 Wood fibers and their cellulose derivatives are also present in many absorbent products, textiles, food, cosmetic and pharmaceutical excipients.11

Timberland combines investment value with the values of socially responsible investors who wish to further causes of importance such as alleviating climate change and promoting renewable energy. U.S. Trust has recognized that value and has developed an experienced team to manage such assets.

IN THE WOODS: WHERE VALUES MEET MANAGEMENT NATURALLY

Silviculture — Silviculture is the practice of controlling the establishment, growth, composition, health and quality of forests. Silviculture also focuses on making sure that the treatment of forest stands is used to preserve and to better their productivity.

When it comes to timberland investments, financial and social responsibility values are strongly correlated and served by the same management principles. In fact, physical risks for a forest, such as fire, pathogens and insects are mitigated by the same management standards that contribute to carbon sequestration and silviculture best practices.

U. S. Trust, as an active manager of timberland investments, routinely and carefully assesses each individual property in seeking to maximize economic return while maintaining a strong land ethic. For instance, when negotiating hunting leases, we often incorporate the establishment of wildlife food plots and habitat improvement which can enhance the property's environmental value while simultaneously increasing the market value. Some properties may have opportunities to participate in wetlands mitigation banks, creating the possibility of additional revenue. Additionally, a particular property may be a candidate for a wind farm, potentially creating another nonconsumptive energy source.

Conservation easements may in some cases protect socially sensitive properties from development while preserving their ability to produce timber and potentially create a revenue or tax benefit. While the number of properties that might have these ancillary opportunities is relatively low, the active identification of ancillary return drivers can create meaningful benefits to portfolio returns while also meeting desirable social goals.

The sustainability of U.S. forestlands depends greatly on current laws and voluntary state-adopted forestry best management practices (BMPs). These industry guidelines help mitigate risks and negative impacts on the environment that result from human disturbances, including harvesting and recreational activities.12 For instance, BMPs provide techniques and directions for forest soil protection, reforestation, silviculture and harvest activities.

IIn addition to BMPs, there are several forest certification programs that incorporate further standards for sustainable forest management in the U.S. The Sustainable Forest Initiative (SFI), the Forest Stewardship Council (FSC) and the American Tree Farm System (ATFS) are a few well-recognized certification programs in the industry. Nevertheless, there is currently no consensuspreferred program and the premium market for certified wood products is still limited.

REFORESTATION — SUSTAINABLE TIMBER MANAGEMENT

Reforestation — Reforestation is the natural or intentional replanting of existing forests and woodlands that have been depleted, either through harvest or natural events.

U.S. Trust strives to manage timber resources in line with natural processes. Appropriate forest management activities are utilized to help keep the forest healthy and reduce risk from catastrophic events. Also used are various forest management techniques to reduce risk of fire and disease, managing the ingredients that can lead to diminished financial performance and reduced social benefit.

Reforestation begins with selecting tree species that are indigenous to the area. Reforestation is designed in such a way as to match the land's contour and protect the natural features on the site including streams, wetlands and other unique land features. As the forest matures, natural differentiation occurs between the most vigorous healthy trees and the less vigorous trees. This helps guide thinning decisions. By removing the less healthy trees and concentrating growing space on the most vigorous, we help ensure forest health and soil and water resources can be preserved. As the trees become over-mature, we use even-age harvests, group selection techniques or uneven-age management to re-establish younger healthier forests. We can also use conservation easements, wetlands mitigation and habitat protection to further provide long-term forest and resource protection.

The U.S. Trust timberland team is comprised of experienced forestry professionals. With expertise in forest operations, investment analytics, economics and advanced silvicultural techniques, we believe our team is uniquely positioned in the financial services industry to provide timberland investment management, and we are committed to doing so with the ultimate regard to land ethics.

For more information on timberland as a sustainable investment, please contact your advisor today.

1 Diversification does not ensure a profit or protect against loss in declining markets.

2 Source: Hancock Timber Research Group – Research Notes 2003 (latest data available).

3 Source: National Council of Real Estate Investment Fiduciaries (NCREIF), 3Q 2016.

4 Source: The Potential of U.S. Forest Soils to Sequester Carbon and Mitigate the Greenhouse Effect, 2003 (latest data available).

5 Source: American Forest Foundation, January 2016.

6 Source: American Wood Council: Wood and Carbon Footprint: North American Wood products reduce the carbon footprint of buildings, March 2011.

7 Source: American Forest and Paper Association: Climate Change and Green Buildings: The Forest Products Industry Perspective, January 2008 (latest data available).

8 Source: American Forest Foundation, January 2016.

9 Source: Wood Bioenergy U.S.: Forisk Research Quarterly Q2 2015.

10 Source: United States Department of Agriculture: Science Supporting the Economic and Environmental Benefits of Using Wood and Wood Products in Green Building Construction, December 2011 (latest data available).

11 Source: Intech: Application of Cellulose and Cellulose Derivatives in Pharmaceutical Industries, August 2013 (latest data available).

12 Source: United States Department of Agriculture: National Best Management Practices for Water Quality Management on National Forest System Lands, April 2012 (latest data available).

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