Heather Davis, Senior Managing Director, Global Private Markets
The economic relationship between China and America became one of the defining global economic themes before the 2007-08 financial crisis, when trade between the two nations was a busy but mostly one-way-street: China made things and America bought them in large quantities, with cheap credit fueling growing consumption. But the dynamic between the two nations — which historian Niall Ferguson has dubbed “Chimerica” — is shifting. As China’s affluence has grown, many people there are not only seeking opportunities to store wealth but also to show their rising affluence. And since any demographic change has enormous implications in China because of the size of its population and economy, these developments will likely have an impact on investment strategies in many unforeseen ways.
One reversal of the Chimerica narrative that has enormous potential for investment is in timberland. Timberland is a mature asset class for institutional investors, and finding new sources of alpha or diversification opportunities has proven challenging in recent years. But rising affluence in China has created an enormous appetite for hardwood timber, which is used for upscale home furnishings and flooring. This has led to a boost in timber exports from the U.S. to China — a trend that has many implications for timberland investors.
A new way to diversify timberland holdings
Timber has produced attractive investment returns at relatively low levels of volatility over the past quarter-century, and its future demand also looks promising. Timberland has performed well versus traditional asset classes on a risk-adjusted basis over the last 25 years, with an average annual return of 12.8%, while also simultaneously offering strong downside risk protection, inflation protection, and low volatility.1 Another appealing aspect of timberland investing has been its diversification potential, due to historically low correlation with those traditional asset classes.2 While there are no guarantees that past performance will be repeated, the rapid economic expansion and population growth, plus the long-term build-up of infrastructure in emerging markets, are creating strong, long-term global demand for timber.
In emerging markets, this demand is being driven particularly by the burgeoning middle class, with its substantial and increasing consumption of resources, including timber products. This is especially true in China, where much of the population saves voraciously and stockpiles much of their savings in residential real estate. Property investment has been a winning approach for individual investors, since the Chinese housing market has offered consistent price appreciation over many years, and most Chinese lack access to traditional stocks and bonds. As a result, many Chinese savers buy second and even third homes as investment properties to store their wealth and to set aside as places to live for other family members, including children or parents. To many, owning property is a status symbol, and upscale hardwood furnishings only add to the appeal.
This new market for hardwood offers diversification opportunities for timberland investors who have traditionally focused on softwoods, such as pine, which are heavily used in the construction of new homes. Having a balanced timberland investment approach may lower correlation with the U.S. housing market. The growing desire for hardwood timber among China’s wealthier classes, however, has presented investors like us with a new and compelling opportunity to diversify their timberland holdings while accessing China’s fast-growing wealth.
Hardwood demand: Seeing China’s property obsession up close
Serving the needs of people halfway around the world can be challenging, which is why an on-the-ground presence in key markets is so critical. TIAA acquired a majority stake last year in Portland, Oregon-based GreenWood Resources, which has a strong and established presence in Asia, to strengthen and diversify our $1.5 billion timberland investment portfolio. During a trip to China last year, members of our U.S. investment team met with GreenWood’s management team to learn more about GreenWood’s approach to timber management in Asia and to see the Chinese property obsession firsthand.
Although the real estate boom in China is well-known, burgeoning demand for timber is driven not only by the sheer volume of residential construction, but also by the ubiquitous use of hardwoods in the decorations, flooring and furniture of many apartments. It is also not uncommon for homes in many residential complexes to be stripped almost every five years and refinished with new hardwood flooring and decorations. The timber industry in Asia mostly has softwood stock, which is one reason why there is such large demand for imported hardwood timber, which is abundant in the U.S.
We returned with a deeper cultural appreciation for the extent of growing affluence in China, and how the affluent population is dedicated to buying, renovating and furnishing apartments. This is why GreenWood is a critical partner for us on several fronts. It is first and foremost a leading timberland investment management organization with an ample supply of quality hardwoods. Second, it has an established office in China, which gives us a deep local connection to the market and a firsthand view of the consumer trends that are driving the demand for hardwood timber.
Managing timberland risks and concerns
The opportunities to access growing wealth in China are compelling, but we should be mindful that there are always risks to consider with investing, particularly in emerging markets. These are a few areas that the TIAA-CREF timberland team will continue to watch closely as we continue to diversify further into new areas.
1 – Emerging-market economies can be volatile. Rapid economic growth in developing markets can be bumpy. We’ve seen stellar growth in China for many years, though there is evidence that the fast rate of expansion has slowed and will continue to do so in the near term. TIAA-CREF appreciates the growth opportunities associated with emerging markets as well as the importance of not relying on them too heavily. In the case of China and its growing demand for hardwood’s exposure to any future volatility can be tempered by greater ties to the U.S. housing industry’s consumption of softwood.
2 - Energy markets can be fickle. Exposure to energy supply and demand — even indirectly through biomass energy, as is the case with timber management — exposes investors to an additional source of volatility as well as pricing risks. However, having a relatively small exposure to the variations of energy demand and market developments in alternative fuels, specifically, makes this a minor consideration.
3 - China is far from transparent. As attractive as China is as a rapidly growing market with a population of 1.2 billion, its government is not known for being transparent with economic data. Because of the potential for unreliable information, it can be difficult to say with conviction what is really happening there. There have been concerns, for example, that reports of China’s real estate market’s growth have been overestimated. By having an on-the-ground presence in China through GreenWood, we benefit from an independent reading of key trends, as well as valuable local insight and market color that is generally not available from government sources.
4 - Declining opportunities. Part of the performance history for timberland covers a period when it was undervalued and ripe for opportunistic investment. Returns in recent years (8.5% average annual return for 2004-2011) have moderated substantially from the roaring returns of 1987-2003, when timberland yielded a 15.8% average annual return.3 Going forward, with more efficient markets, it’s unlikely that such robust returns will be easily attainable. This is important to recognize, as the best plans are based on realistic expectations.
TIAA-CREF’s response: Long-term opportunity
Investing in timberland is a long-term proposition, though what we’ve seen in recent years is how the dynamics of an asset class — even a well-established one like timber — can quickly change as a result of powerful trends taking shape in markets around the globe, such as the thirst for hardwood floors in emerging economies like China.
Timberland offers excellent opportunities for strong returns, potential for inflation protection and broad portfolio diversification. In an increasingly complex and challenging world, investing in real assets such as timberland can enhance risk-adjusted returns and provide attractive growth, which is why TIAA-CREF believes the asset class has such an important role for investors like us with long-term horizons.
1 As measured by the National Council of Real Estate Fiduciaries (“NCREIF”) Timberland Index, timberland’s standard deviation of returns was of 11.0% over the last 25 years, (as of 12/31/12), compared to 17.9% for the S&P 500, 17.6% for the Russell 3000, 20.3% for the MSCI EAFE Index, 7.3% for the U.S. Treasury Index, and 7.3% for the Citigroup Long-term High-Grade Corporate Bond Index. Average returns for the same period were: S&P 500 11.3%, Russell 3000, 11.6%, MSCI EAFE, 7.3%, Citigroup Long-term High-Grade Corporate Bonds 9.3%, U.S. Treasury Index 7.2%. Sharpe ratios for the same period were: Timberland, 1.16, S&P 500 0.63, Russell 3000, 0.66, MSCI EAFE,0.36, Citigroup Long-term High-Grade Corporate Bonds 1.25, U.S. Treasury Index 0.99.
2 Correlations of the NCREIF Timber index from 1987-2013, for example, were 0.25 with U.S. equities, 0.01 with long-term corporate bonds and 0.13 with Treasuries.
3 As measured by the National Council of Real Estate Fiduciaries (“NCREIF”) Timberland Index.
The material is for informational purposes only and is not intended, and should not be regarded, as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Past performance does not guarantee future results.
It is not possible to invest in an index. Performance for indices does not reflect investment fees or transactions costs.
TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, TIAA-CREF Alternatives Advisors, LLC and Teachers Insurance and Annuity Association® (TIAA®). Each such entity is a registered investment adviser and wholly owned subsidiary of Teachers Insurance and Annuity Association of America (TIAA).