LaBaugh

We recently held a conversation with members of the timberland investing team at TIAA-CREF and GreenWood Resources. We discussed the past present and future of timberland investing. Participants were: José Minaya, Managing Director and Head of Global Natural Resources and Infrastructure Investments at TIAA-CREF; Clark Binkley, Ph.D., Managing Director and Chief Investment Officer, GreenWood Resources; Sandy LaBaugh, Senior Director, Portfolio Manager – Global Timberland at TIAA-CREF; Jeff Nuss, President and Chief Executive Officer, GreenWood Resources.

aiCIO: Let’s begin with an overview of institutional investing in timberland. When did it begin to find its way into investors’ portfolios?Binkley: Institutional investing in timberland started in the late 1970s. Eastern Air Lines, British Coal Board, MetLife, and a few others were early investors. It started off very small but grew about 20% per year from the early 1980s through around 2005 when asset flow plateaued a bit. That history developed prin-cipally from the disintegration of the forest products industry. The integrated forest products companies such as International Paper, who owned manufacturing facilities and timberlands, sold their timberlands.

aiCIO: What specifically about timberland do owners/investors find attractive? Public plans for instance, may have a different need than endowments. What’s the business reason behind an investment in timberland? Binkley: Broadly speaking there are three reasons why insti-tutions acquire timberland. The first is to generate good risk-adjusted total returns, including reasonable cash flow. Secondly is diversification. Timberland returns have historically been poorly correlated with returns from other assets.1 Finally, timberland is a real asset. It has been, historically, a good hedge against inflation — especially against unexpected inflation.

aiCIO: That’s the business case. Then there’s the question of access. It’s not like you or I could personally go and buy a forest. How are these institutions accessing the timberland?

LaBaugh: Institutional investors have access to timberland through separate accounts, in which they set up a mandate for the timberland managers to help them source and manage the timberland. They also have the opportunity to invest in specific assets with other institutions or commit to timber funds, which typically have a specific strategy. It’s also possible to access timberland exposure through public REITs, although this option will be more highly correlated with public equity market dynamics.

aiCIO: I assume that choosing the right vehicle depends on a lot of things, allocation size being one of them. An institutional investor with a billion dollars in assets will likely do it a lot differently than a sovereign wealth fund with one hundred billion dollars in assets. LaBaugh: The allocation size certainly makes a difference in investors’ ability to establish separate accounts and ultimately build a diversified portfolio. But having the staff to review the opportunities in detail and make the decisions necessary to invest and manage is a key factor in the vehicle determination.

Minaya: The infrastructure and resources that an institution has will determine whether it builds its own team and goes out and make these investments itself, versus a more passive route of outsourcing to others and diversifying across managers. It comes down to how you are set up internally and how large an allocation to timber your organization has in order to merit additional resources.

LOCATION, SUSTAINABILITY, GROWING TREES

Minaya Binkley Nuss

1. Based on 25-year correlations of the NCREIF Timberland Index vs. S&P 500®, Russell 3000, MSCI EAFE, Long-Term Corporate Bonds, U.S. Treasury Total Return, and NCREIF Commercial Real Estate

Photography by Stephen Mallon

SPONSORED SECTIONReprinted from aiCIO February 2013.

aiCIO: What’s has been the progression in investment vehicles since the 1970s? Let’s talk about what it started at and what it is now. What is the current way to enter this market?Binkley: Separate accounts dominated the early history of the asset class. Tax issues were a main cause. Institutional inves-tors had difficulty owning timberland because of unrelated busi-ness taxable income issues, and the solutions frequently were tailored to the needs of individual investors.

Most of those tax problems have been resolved by now. Funds emerged pretty much at the same time as Goldman Gold funds. The first ones were quite small, on the order of $10 million — the first Hancock Fund, for example. Since the early 1980s both funds and separate accounts have grown in size and number.

Since the financial crisis, investors want more transparency and control over their investments. But at the same time, they don’t want to, or can’t, put the staff resources into this sector to do it directly, as the very large investors can.

That’s the conundrum the investment management community is trying to resolve for investors these days.

aiCIO: You entered the market in 1998. Let’s hear about the progression of your firm in this market and how you think about it.LaBaugh: We started investing in timberland in 1998, with a sepa-rate account focused on the Southeast U.S. and a single manager. Over time, we built up our expertise and understanding of the asset class and have taken a very active role diversifying our portfolio. We’ve tried to add exposure where we can unite attrac-tive property characteristics with a growing or resilient market and a management strategy that can drive value in a unique way.

We’ve added timberland exposure across nine other countries outside the U.S. We continue to want to increase our exposure outside the U.S. due to the fundamentals that we see there.

aiCIO: Is there a breakdown of the assets, U.S./non-U.S. percentage?LaBaugh: It’s roughly 75% in the U.S., currently. That percentage is going to decrease over time if we continue to build out our non-U.S. strategy.

There are some interesting opportunities in South America given the increased processing capacity and competitive cost dynamics. Specifically, we’re focused on countries such as Chile, Brazil, Uruguay and perhaps some other areas of Central America. There are also attractive opportunities in Europe given the need for renewable energy. There’s a lot of conversion into renewable energy taking place there, and wood biomass will play a significant role in the transition. We’re also seeing strong growth in demand for wood products in Asia, particularly in China. Supplying that demand from countries located within a convenient transport distance for use in China is also an area of interest.

aiCIO: How does timber fit into TIAA-CREF’s overall invest-ment portfolio?Minaya: Timber fits into the segment that we call natural resources. We created a natural resources allocation partly for the reasons that you’ve heard earlier on in our discussions

around correlation, diversification, etc.; but also because of the fundamentals that we see in that sector. We look at the natural resources sector, of which timber is part of, and we like the demand trends we are seeing. From a demographic point of view, we continue to see a trend toward population growth and faster growth in emerging markets across the middle class.

The other side is that these natural resources usually have a finite supply. As you get this pull on the demand side, coming from population growth and a growing middle class, it tends to increase the value of our assets because you’re dealing with finite resources. Assets like timber, or energy, or agricul-ture provide essential needs for society. Timber helps provide shelter for individuals and it also helps provide fuel. That’s where it fits in our overall portfolio and the kind of exposure that we’re looking to get from assets like timber.

aiCIO: Tell us about GreenWood Resources. Nuss: The company started in 1998, focused on a narrow niche of assets within timberland, such as high-yield fast-growing tree farms. We initially provided expertise in forest manage-ment and today we have evolved to working with institutional investors like TIAA-CREF that are interested in investing into a diversified timberland strategy. Improving how we grow trees is core to our beliefs and central to our strategy.

We do this through an integrated approach, bringing together investment analysis and management, development and deploy-ment of better plant material, and having our own people on the ground managing the tree farms. This is critical in order to provide investors with what we believe are the best opportuni-ties for returns.

By applying this approach, we believe this can lead to 1% to 3% per year in volume growth and can add material improvements to the assets we manage, providing us the best opportunity to improve the returns long-term.

Early on we knew our strategy was a global strategy, so we began to expand to locations where we saw the need and a growing demand for our expertise. Today we have operations in North America, Latin America, Europe, and Asia.

From our past working relationship with TIAA-CREF, we real-ized the shared visions we have for timberland investing and the synergies of the two organizations, which lead us to complete a transaction where TIAA-CREF took a majority ownership in GWR along with key managers owning the rest of the company. We believe the combined strengths of the two organizations are very important for the future of timberland investing.

aiCIO: I assume timberland management is getting more and more sophisticated and scientific; that it is no longer simply about cutting down trees?Nuss: It is. Forest technology, particularly the effort to improve the plant material planted, was a focus of the integrated forest products companies. They usually had a very strong science program, but they were doing it primarily for themselves. As those companies moved away from the integrated model, some of that science didn’t continue to move forward.

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That’s the uniqueness of GWR. We believe in the science compo-nent of what we do and that this can materially improve the assets that we manage. We put our own money into maintaining that science program — into developing and finding better ways to produce better trees.

aiCIO: You say this is part of a larger resources play. It seems distinctly different than other resources in that you can re-grow trees and you can improve that process, whereas once you take a mineral out of the ground that mineral is gone. How does that play into your thinking? Nuss: Trees are one of the best renewable resources that God has given us. I think most everyone in this industry, and certainly the people at GWR and TIAA-CREF, take their job very seri-ously regarding the nature of sustainably managing the assets and the land that we’re responsible for. It is a combination of working with our clients and doing the right thing with respect to investing capital and managing money wisely and managing the resource in a way that doesn’t just generate cash flow, but generates and maintains long-term value.

aiCIO: What are the trends of the institutional investors with regard to timberland in the last three to five years?Binkley: The total amount invested in the asset class is continuing to grow, particularly outside the United States. However, there have been shifts within the asset class as well. The Harvard endowment is a notable one. They sold their entire U.S. portfolio in the early part of the last decade. Then they bought and subsequently sold down their holdings in the Kain-garoa Forest in New Zealand and have made other investments. It’s a case where they’ve been selling assets that they think are fully priced and buying ones that they think are less fully priced. That’s exactly the way we look at the world.

A large part of our focus is on greenfield plantation develop-ment and that has several implications. One of them is that you can put the plantations more or less wherever you want them. You aren’t constrained by where trees exist today. That means you can put the plantations close to growing markets. You can put them in places where the transportation infrastructure is favorable, or where the land prices are favorable. It also means you can leverage the science that Jeff talked about more imme-diately because a lot of the benefit of the science comes in the plant material that you use when you develop a plantation.

LaBaugh: Institutions operating in today’s low-yield environment are increasing their interest in real assets, which can provide both current income and capital appreciation. We’re seeing more institutions going into timberland. There also appears to be a shift from U.S. holdings to more non-U.S. exposure.

Minaya: At the end of the day, we’re dealing with a commodity.

When you’re investing in a commodity, you want to be the lowest-cost producer. You want to be, as Clark pointed out, where the markets are from a logistical point of view. You want to deploy practices in technology and in areas that are going to make you that lowest-cost producer.

aiCIO: Is there still a political element to owning a timber resource that people are concerned with? Is that causing any shift in the business? At one point, this was a highly visible issue.Nuss: The value of forests and the use of wood are very impor-tant to society. I think if anything there is a stronger focus on the management of the resource and its sustainability. For GWR and TIAA-CREF that’s an important component of who we are. We take pride in being good managers of our assets and look to certify our trees farms under the appropriate third-party certifications.

Binkley: The controversy around forestry has mostly to do with natural forest. Clayquot Sound on the West Coast of Vancouver Island in British Columbia is a great example of that. That’s a natural old-growth forest containing values that people cher-ished. When it was logged people got very upset, protested, and ultimately greatly reduced harvest levels. But it’s a lot easier for people to accept the idea of logging trees that someone has planted.

Our focus on greenfield plantations is much more like agricul-ture. You’re much more able to put forests in places that are less politically controversial. That’s another means of risk control in this setting.

aiCIO: Are there governing bodies for certification of timber harvesting?Nuss: There are a lot of different certification methods that you can deploy. All of them have their value. We have certified our tree farms under the Forest Stewardship Council Certifica-tion, which might be considered the gold standard for forest management. We may look to certify under others as well and we are familiar with Sustainable Forest Initiative and a pan-European certification.

Binkley: These are independent third parties. The Sustainable Forest Initiative has a board composed of industry and envi-ronmental stakeholders. The Forest Stewardship Council has a similar board. They have standards for certification and proto-cols to follow. This is true, third-party certification.

aiCIO: Managed correctly, as Jeff said, this is a perfect resource because it’s not gone and spent in one generation; this can be a boon for a local economy in perpetuity. Second, this can be a perfect asset class for the institutional investors who are supposed to have long-term views that line up with this type of investment.

“ At the end of the day, we’re dealing with a commodity. When you’re investing in a commodity, you want to be the lowest cost producer.”—José Minaya, Managing Director and Head of Global Natural Resources and Infrastructure Investments

SPONSORED SECTIONReprinted from aiCIO February 2013.

Minaya: Exactly. What’s unique about natural resources, and specifically timber, is that sustainable practices are directly correlated to the returns we’re expecting. That makes perfect sense because we have a long-term view. Sustainability is about the integrity of that asset. We’re buying something that we hope to get better value from in the future. Sustainability is an impor-tant piece to the return profile.

aiCIO: What gets you most excited about this space now — is it a region, advances in the science? What is the thing that would be most catching to institutional investors with timberland?Minaya: We think about tree growth as something that’s completely uncorrelated to anything else in the markets. If you think about the science component, consider what has been accomplished on the agricultural side with corn, for example, where you’ve seen yields increase significantly over the last couple of decades. You haven’t seen those kinds of resources and development on the timber side. It’s an untapped area to explore.

LaBaugh: We’re very interested in going to areas where increased demand will help our returns. Diversifying more into developing markets is a key theme for us. We see increasing demand for wood in those areas, and in particular short-rotation hardwoods. Also, with the ability to do greenfield establishment with a reasonable rotation length, you can grow a forest close to demand centers. You can implement with the best plant mate-rials to not only increase yields, but also to develop the wood characteristics important to the specific end markets targeted.

Nuss: I’m convinced that the recognition of the value of what these types of assets can provide to the environment, to markets, and to society is broadening. Wood isn’t just about growing a log to cut into lumber or chip up to make pulp and paper. There is an increased interest in the world today on how growing and managing trees can combat global warming through carbon sequestration, meet the needs of a growing population’s demand for products produced from wood, create and maintain sustain-able economies and jobs in rural communities, and even become a renewable resource that can produce energy and fuel for the world. So that’s exciting.

aiCIO: Now, the flip side of that: what are the challenges that this asset class faces?Binkley: The biggest issue for investors these days is the compli-cations of the asset class. Particularly, understanding that the asset class may be fully priced in some regions but not fully priced in other regions. To understand, then, that how you can generate good returns by looking to those other regions takes a lot of thought and a lot of work.

Nuss: It’s a global industry and the need to be able to navigate through its intricacies is clearly one of the bigger challenges. That’s why we believe in the approach we have taken in our organization, that it’s important to have a local presence in the places that we’re making these investments. Having this local presence, along with experienced global leadership and utilizing consistent systems, processes, and risk management, helps with the challenge of navigating through all the obstacles and nuances that you’re faced with in every country that you might be making these investments.

aiCIO: Sustainability is sometimes used as a catchphrase, and is not really implemented. It appears that timberland is different there. Sustainability actually matters because it impacts returns. Is that a fair assessment?Binkley: In timberland, particularly plantation development, you’re generating value in two ways. If you take a piece of land and put trees on it and you grow the trees, you are creating an asset. You’re generating value by creating an asset that wasn’t there before.

Of course, once that asset is built, it generates cash flow and it can generate a lot of cash flow, but you have to maintain the asset base to be able to harvest that cash flow. From that point of view, sustainability is core to the investment pieces related to greenfield plantations. It’s core to building the asset and it’s core to sustaining the cash flows.

aiCIO: Richard Feynman, the physicist, was once asked to sum up in one sentence all of human knowledge about the physical universe. His answer was “everything is made of atoms.” He thought once you knew that, you could figure out everything else. For timberland investing, what is that one sentence that contains the essential concept in relation to institutional investing?LaBaugh: Timberland is a unique asset that provides attractive risk-adjusted returns and several co-benefits to society.

Minaya: It’s about exponential growth on the demand side coupled with a finite resource. The demand will continue to grow in perpetuity, yet the resource of what it could do is limited.

Nuss: Growing trees is fun and is incredibly important to our world.

Binkley: You’ll know that Jeff and I have worked together a long time because my one sentence would be: growing trees can be a reliable source of value creation.

The material is for informational purposes only 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 perfor-mance does not guarantee future results.

Timberland investments may be illiquid and subject to changes in regu-lations, environmental and climatic conditions, macroeconomic and currency fluctuations.

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 Assets, LLC and Teachers Insurance and Annuity Association® (TIAA®). TIAA-CREF Alterna-tives Assets, LLC is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA).

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