Why I love Timber as an Asset Class

I found this article on the Motley Fool this week called “Is Lumber the New Gold“, and it reminded me why Timber might be my favorite asset class of all.

I was first introduced to Timber as an asset class at Harvard Business School, in one of my classes on Venture Capital & Private Equity. Dave Swensen, who managed the Yale endowment for over 20 years, discussed the strategy that led Yale to incredible outperformance in the 1980s and 1990s. He took the endowment from $1.3 Billion to $14 Billion, using a strategy very different than his colleagues.

It would be a whole different post to sing the praises of Mr. Swensen, and his philosophy on investing has now become public knowledge since he released a book on the subject. In his discussion with the class, I remember his specific comments on assets that had extremely attractive risk/reward ratios. Private Equity is one, to be sure, but he also allocated over 20% of his funds to “real assets”, which included Timber.

Timber is fascinating as an asset class. Here is a summary, cribbed from a recent post on Seeking Alpha:

  • Excellent Returns. Annual returns of 14.5% since 1972. Better returns than any common asset class (stocks, bonds, real estate, commodities)
  • Less Volatility than Stocks. What? More reward with less risk? It shouldn’t be true, but it here at least empirically.
  • Timber is counter-cyclical with Stocks. Especially nice to have an asset that zigs when the stock market zags.
  • Money grows on Trees. Fundamentally, you have to like the fact that 6% growth every year comes from the fact that trees just grow bigger with natural sun & water. The value of trees is also non-linear, in that growers can just “not cut” in weak years for timber prices, and make even more in subsequent years.

Here’s a nice post from Seeking Alpha in July on why Timber should outperform in an inflationary market. It even features my personal favorite REIT stock in the sector, Plum Creek Lumber (PCL), which I’ve owned since 2002.

You have to love the web. I found this fantastic blog post from 2005 on Timber. Couldn’t have said it better myself.

Until recently, it was very hard to invest in timber without a portfolio allocation in the millions of dollars. However, now, there are several ways to add timber to your portfolio. My favorite are the REIT stocks, like PCL & RYN, which allow you to own companies who have a primary business in owning & maintaining timber land. Given the regulations around managing timber land, and the tax-advantages of the REIT structure, it’s hard to get better direct exposure.

It’s interesting, but as the trend continues towards development & environmental protection, these firms should have an even more compelling advantage as the supply of quality timber dwindles, and the regulatory environment grows more arduous. Even the sleepy paper companies are starting to look more valuable for the timber land that they own, rather than the product they produce.

It’s so interesting that money, in some cases, really can grow on trees.

Update (6/13/2007): A commenter forwarded me to a webpage that had a link to one of my favorite articles on timber as an ivnestment, from a 2001 issue of Smart Money magazine.  Check it out here.

Dow 12000? Could have been 22000! Berkshire Hathaway in the Dow Jones Industrial Average.

Big news this week. The Dow has closed over 12,000. Whoopee.
Sometimes, I am amazed at how incredibly stable certain staples of culture can be, even in the face of overwhelming logic & reason.

One example of this is the continued fascination that people have with the Dow Industrials index. This group of 30 stocks has changed over the years, but dates back over 100 years (1896), ever since Dow & the Wall Street Journal attempted to capture a measure of the “Industrial Strength” of the US Economy.

The problem is, the equation they used to calculate it is nonsensical. Literally.

The Dow Jones Industrial Average is a “price-weighted” index. This means that a $1 move in a $25 stock is worth more than a $1 move in a $10 stock.

This, of course, makes absolutely, positively no sense.

Now, a “market-capitalization-weighted” index, like the S&P 500, makes sense. An “even-weighted” index makes sense. Even some of the cool new “fundamental-weighted” indexes, based on figures like the revenues or cash flows of companies makes sense.

But a price weighted index makes no sense. If a stock in the Dow Jones splits 2:1, it’s future impact on the average will be lower than if it never split at all.

This, compounded with the incredible unpredictable and poor timing that the index owners have used to add & remove stocks from the index has led to extremely unpredictable performance.

There is a really great piece in Business Week that illustrates how ridiculous this index is.

As you may have heard, Berkshire Hathaway, Warren Buffet’s company, hit its own milestone lately by trading at $100,000 per share. Yes, that’s right. The reason it is so high is that they have never split their stock, and it has compounded at extremely high rates since the 1960s.

Can you imagine what the Dow would be like if it had included Berkshire Hathaway as one of its stocks (which would be easy to justify)?

The answer is: if they had added it in 2000, the index would now be at 22000!

Buffett’s Baby: Too Big for the Dow

Despite this, every newspaper and television show seems to highlight this milestone for this nonsensical financial metric. And it really does influence investor behavior. I have family members who have told me they are reluctant to buy stocks right now because “the Dow is so high”.

For the 20 or so readers of this blog, hopefully now you know the truth. Spread the word. The DIA is meaningless.