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Alan Brierley: Money grows on trees with Phaunos Timber

Timber has delivered exceptional returns for investors, with a high degree of consistency, over the long term. Given its low volatility, defensive characteristics and low correlation with other investments, we believe timber has a key role to play in improving portfolio diversification.

Since its inception in 1987, the compound annual growth rate of the NCREIF Timberland index is 14.7%, compared with 8.6% for the S&P 500.

The Sharpe ratios of these indices are 1.24 and 0.34 respectively. Over the past 22 years, this index has only fallen in one year, with just five negative quarters out of 90. Underlying returns have been lowly correlated with those of other asset classes.

One of the main characteristic of trees – namely that they grow regardless of underlying economic conditions – has been a key driver of these impressive returns. Meanwhile, when timber prices fall (as they have done in the past year), the manager can simply defer harvesting, with value ‘stored on the stump’. Indeed, returns are compounded by in-growth, the process where trees turn into higher value products as they mature. With recent actions by the authorities likely to reignite inflation, timber has proved to be an effective hedge against inflation over the long term.

Phaunos Timber gives investors exposure to the global timber market. The managers have a rigorous due diligence programme and since the launch of the company at the end of 2006 they have adopted a conservative approach towards new investment. Being a cash buyer in these capital constrained times should work in their favour as they look to become fully invested. At the end of June, the total portfolio commitment was $698 million, of which $212 million had been drawn down.

The aim is to construct a highly diversified portfolio by region, species and age and the focus is on the less developed markets of Latin America, China and Africa, where Phaunos is more likely to access prime properties in a less competitive environment. There has been a bias towards younger plantations, which offer the greatest value in the long term.

Somewhat inexplicably, the market cap is currently less than cash on the balance sheet. Although the fundamentals of this emerging alternative asset class are compelling, an anomalous rating makes Phaunos an even more attractive investment.

Alan Brierley is head of Investment Companies Research Collins Stewart

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