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Timberland Investments in an Institutional Portfolio

Timberland Investments in an Institutional Portfolio -...

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Copenhagen, August 17, 2006 Timberland Investments in an Institutional Portfolio
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Copenhagen, August 17, 2006 Contents Executive Summary 2 1 Introduction 4 2 Timberland Return Characteristics 4 2.1 Return Drivers 4 2.2 Return Structure 6 2.3 Distribution of Timberland Returns 8 3 Institutional Asset Allocation with Timberland 9 3.1 Timberland Return 10 3.2 Timberland Volatility 12 3.3 Timberland Correlations 13 3.4 IWC’s Asset Allocation Model 14 3.5 Threshold Analysis 15 References 17
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2 Executive Summary Due to a range of attractive performance characteristics and diversification opportunities from including timberland in a diversified portfolio, institutional timberland investments, especially in the USA, have grown significantly in the last 25 years. Timberland investment returns can be described as a function of three drivers: Biological tree growth – main driver of attractive and stable returns Timber product price change Changes in land value. Ownership of timberland and the adherent biological growth and flexibility in connection with timing of entry/exit and timing of harvests provides investors with an attractive re- turn structure. Biological growth and utilization of the timing options reduces the risk of negative returns and results in a higher upside potential and a reduced downside risk compared to investments without these characteristics. Returns between professional managed timberland investment funds are evenly distrib- uted. This indicates that when investing in timberland funds, the number of investments which needs to be made is limited in order to achieve a mean return. For asset allocation purposes, timberland investment return characteristics are attractive: According to an industry index, timberland in the USA has for the period 1987 – 2005 yielded 15.3% p.a. nominal before asset management fee. For an interna- tional diversified timberland portfolio, The International Woodland Company A/S (IWC) assumes for the future an average annual rate of return of 10% - 12% before asset management fee. Historical standard deviation has been 8.9% p.a. IWC assumes an annual stan- dard deviation of 8% - 12% for a timberland portfolio. Timberland returns have historically shown low correlations with returns from traditional asset classes in an institutional portfolio. The benefits of including timberland in an investment portfolio have been analysed through an efficient frontier analysis. Based on IWC’s asset allocation model, which con- strains a maximum allocation to real estate to 25%, European stocks to 75%, Global stocks to 50%, and European bonds to 75%, two efficient frontiers have been produced: one that allows allocations to timberland investments, and another where timberland is not al- lowed in the portfolio. The result is shown in the figure below.
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3 Timberland European Stocks Global Stocks European Bonds Real Estate 5% 7% 9% 11% 0% 5% 10% 15% 20% Risk (Std.dev) Annual Return Including Timberland Without Timberland From the figure it is evident that including timberland in a portfolio is highly beneficial.
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