Benchmarking provides a useful, and often necessary, tool for evaluating the performance of alternative investments (such as private timberlands), alternative investment managers (such as timberland investment management organizations – TIMOs), and timberland investment ideas (such as the ability to hedge inflation). Unfortunately, benchmarks often serve as incomplete indicators for alternative investments and unusual investment strategies. This can prove problematic for institutions that seek guidance when making investment decisions and evaluating asset managers.
Timberland Investment Indices
In 2015, Forisk published research on benchmarking timberland investment performance (“Best Practices and Existing Indices for Privately Held Timber Assets”). The article lays out criteria for evaluating existing timberland indices and recommends proper applications of these tools. The National Council of Real Estate Investment Fiduciaries (NCREIF; pronounced “nay-creef”) publishes the two most widely referenced indices for private timberland investment performance in the U.S. These indices include the Timberland Index (TI), which reports returns derived from individual properties, and the Timber Fund and Separate Account Index (TFSAI), which reports returns from managed funds and accounts.
While NCREIF’s two timberland indices capture meaningful samples of underlying data in helpful formats, they suffer from practical and unavoidable limitations. For example, while NCREIF covers four distinct U.S. regions, it is primarily a U.S. South index. In addition, this coverage is specific to a certain class of investors and managers. While NCREIF has data for over 13 million acres of institutional timberland, it has zero coverage of, for example, the 35 million timberland acres owned by forest industry firms and publicly traded REITs, and no acres owned by non-industrial private landowners.
That said, the NCREIF Indices have and continue to serve as powerful tools for educating investors, improving transparency and communication within the timberland investment community, and providing a baseline for assessing timberland investments relative to other asset classes.
Timberland Investment Performance and Inflation
How have private timberland investments performed relative to other asset classes? While this question opens the door to a series of follow-ups and potential binge drinking, we can leverage readily available data sets – including the NCREIF Timberland Indices – to introduce timberland’s relative performance for specific questions. For example, one of the most common attributes tagged to timber relates to its ability to hedge inflation. Given that inflation in the U.S. has been below 4% for 23 of the past 27 years (1988 through 2014), what have we learned?
To answer this question, we compare timberlands with investments in the S&P 500 (equities) and 10-Year U.S. Treasuries (bonds). For private timberland investments, we will apply annual data from NCREIF). The figure below highlights the relative performance of these three asset classes in different inflationary buckets. Overall, timberland outperformed the other assets on a relative basis in higher inflationary environments based on this data set. [“Net timber” refers to estimated returns net of asset management fees.]
Inflation & Annual Returns – Period: 1988-2014
The concept of hedging inflation with timber deserves attention. Remember that inflation is an indicator of something else: prices, values, costs and returns are rising somewhere for someone; somebody makes money when inflation rises. So, if some seek timber to hedge rising inflation, does the corollary apply? Should we leave timber when inflation remains low? Ultimately, the relative performance confirms the academic literature, which finds that timberland performs well for hedging “unexpected” inflation.
Two themes remain constant in evaluating benchmarks and criteria. First, data quality dictates what is possible. Regardless the methodology or technology involved, confidence and clarity in the underlying data, where it came from, and how it’s managed drives the utility of benchmarks and indices. Second, objectives matter. How will the benchmark be used relative to the investment objectives? Benchmarks designed to track asset-level or sector performance can differ from those used to evaluate manager performance and investment strategies.
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