The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Friday, June 01, 2007

Timber! Money Can Grow on Trees

A few years ago, I came across an alternative asset class that institutional investors -- especially university endowments -- that struck me as being really out-of-the-box: timberland. At the time, I asked myself, "Why are sophisticated investors investing in trees and forests?"

A recent New York Times article, For Some Investors, Money Grows on Trees (May 27, 2007), answered many of the questions I had about this alternative investment. In a nutshell, investors are counting on revenues from sales of timberland products to lumber, paper, and other companies, along with potential gains from the underlying real estate. Rather than investing in individual lots (which would make little sense for large institutional investors like pension funds and university endowments), investors invest through TIMOs (timber investment management organizations) and timber REITs (real estate investment trusts).

Historically, investing in timber has done well. An index of returns on timberland investments since 1986 (when the index was created) to the first quarter of this year rose at an annualized rate of 15.09%. In the last three years, the return was 14.63%, which is higher than the returns on the S&P 500 over that period (12.25%).

The most appealing aspect of this asset class is that it has had low correlation with the performance of stocks and bonds. 'Low correlation' is important to risk management under conventional financial economics portfolio theory. I should note that that I am usually highly skeptical and suspicious of claims of 'low correlation' between asset classes and markets since 'correlations' are (a) dynamic, and (b) there might be less obvious links between investments that simple measures of correlation don't pick up. However, in this case, this idea does seem to pan out at this point in time.

Note: The best books I'm aware of dealing with the role that alternative assets can play in managing an investment portfolio are the two books written (thus far) by David Swensen. I'm not sure if Yale's endowment invests in timberland, but I would be shocked if they didn't. I am aware of other university endowments that do invest in timberland, e.g., Caltech.

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