Olly Hughes, managing director of forestry at Gresham House, highlights the uncorrelated nature and ESG credentials of commercial forestry assets
The decade of seemingly limitless growth for global equities has finally come to an end, with the sudden and severe stock slump on the spreading covid-19 pandemic once again underlining the need for a diversified portfolio.
While ESG-oriented funds have fared relatively well through the recent volatility – largely owing to the absence of energy and a bias towards quality – this space still does not provide investors with real diversification. For a truly differentiated asset class – and one which also benefits the environment – investors should look no further than out of the window.
Commercial forestry assets provide returns largely uncorrelated to stock or bond market movements, with correspondingly low volatility. Moreover, the outlook for timber and forestry values looks very promising.
Housing shortage to drive consumption
Forestry returns are reinforced by rising demand for timber products, which is driven by housebuilding and underpinned by long-term macroeconomic forces, such as urbanisation and decarbonisation. Over the past 20 years, global industrial roundwood timber consumption has risen 28%, at a compound annual growth rate of 1.2%.
In the face of a global housing shortage, we estimate timber consumption will rise 2.7 times by 2050, at an annual rate of 3.1%. In the UK, housing starts are at 201,990 – well below the annual target of 300,000. With roughly 60% of timber consumption coming from the construction sector, housebuilding is expected to be the dominant demand driver for timber. While housing starts may be affected in the short term by the covid-19 pandemic, they remain crucial to our society over the long term.
Moreover, the global urban population is forecast to rise from 4.4 to 5.2 billion over the next 10 years – reaching 6.7 billion over the next 30 years. China, which experienced a 96% increase in urban dwellers over the past 20 years, saw timber consumption increase 96% over that period.
In addition to the urbanisation trend, the subsequent increase in wealth leads to a follow-on ‘suburbanisation’ movement from public housing into single-family homes. Timber consumption then rises further, as larger single-family homes use about three times more timber than multi-family units.
Sustainable solution to secular trends
While construction will have to increase to meet the global housing challenge, this is at odds with the decarbonisation imperative. The construction industry contributes about 36% of global CO2 emissions, and the EU has set a target to reduce emissions from the sector by 90% by 2050. The clearest way to achieve this goal is through the use of timber.
In the UK, achieving net-zero carbon emissions from construction could be done through a 72% increase in the use of timber. Timber permits off-site prefabrication, which lowers operating emissions. Wood is also an insulating material, which reduces energy consumption in completed buildings and locks up CO2.
To combat climate change, wood products can also be used to generate carbon neutral energy. Biomass wood pellets are created from sawdust and other residual wood materials, which can be burned in boilers – often former coal boilers – to generate heat and electricity.
As the use of intermittent renewable energy increases, low-carbon baseload generation will be required to meet lower emissions targets. Consequently, global demand for wood pellets is expected to double by 2025.
Multiple demand, limited supply
In contrast to the multiple demand drivers, the supply of timber is limited. Softwood timber, which is easier to work with and represents about 80% of timber consumption, can only be sourced from temperate forests in Canada, the US, Northern Europe, Russia and Oceania. This puts upward pressure on the price of timber.
Due to growing demand for the ubiquitous material and rising timber prices, UK forestry investments have outperformed all other asset classes over a 25-year period, delivering an annualised return of 9.2%. While construction projects are temporarily being halted due to social distancing efforts to curb the coronavirus outbreak, demand should rebound once the measures can safely be lifted.
The appeal of forestry assets lies in the flexibility of the harvest window. It takes a tree about 40 years to reach full maturity. Unlike most agricultural crops, however, trees can be left in the ground for about 15 years without impacting the quality of the end-product. This means the timber harvest can be timed to match demand and higher prices, without losing precious output. This flexibility ensures consistency in long-term forestry returns.
At a time of whipsawing markets, it pays for investors to have exposure to a proven uncorrelated asset class with firmly entrenched roots.
This article first appeared on ESG Clarity’s sister title Portfolio Adviser.