OTPP Boosts its US Timberland Holdings
Ontario Teachers’ Pension Plan Board (Ontario Teachers’) is pleased to announce it has completed a redemption transaction, whereby Tamarack Timberlands LLC, an investment vehicle owned by Ontario Teachers’, has assumed the direct ownership of approximately 870,000 acres of timberland.
The unique, large-scale timberland portfolio of high-quality Loblolly pine is spread throughout the U.S. South and is third-party certified to the Sustainable Forestry Initiative standards, one of the leading sustainable forest management standards worldwide. The timberland portfolio provides significant diversification benefits to Ontario Teachers’, including diversity of locations, customers and tree age classes.
Ontario Teachers’ has invested in these timberland assets indirectly since 2006 through a material ownership interest in a larger timberland investment vehicle. The transaction will give Tamarack Timberlands LLC full control and governance of the assets and create greater opportunities to implement long-term value creation initiatives. Resource Management Service, LLC (RMS), one of the world's largest providers of timberland investment services, will continue to act as the timberland investment manager for the asset.
The assets will continue to be operated using best-in-class management practices to ensure the sustainability of the forest over a long-term horizon, and to preserve the ecosystems and biodiversity of the forest.
“A responsible, sustainable and long-term approach to forestry has value beyond timber production,” said Christopher Metrakos, Managing Director, Natural Resources at Ontario Teachers’. “These assets will continue to provide Ontario Teachers’ with stable and robust cash yields as well as long-term capital appreciation, while also acting as a natural climate solution to help mitigate the impacts of climate change.”
Ontario Teachers’ Natural Resources department has a global, diversified portfolio of private natural resource investments in energy, metals, timberland, agriculture, aquaculture, and natural climate solutions, with timberland assets across the U.S., Canada and New Zealand.
Ontario Teachers’ recently committed to having net-zero greenhouse gas emissions across its portfolio by 2050. In September last year, it set industry-leading interim reduction targets: to reduce portfolio carbon emissions intensity by 45% by 2025 and two-thirds (67%) by 2030, compared to a 2019 baseline.
About Ontario Teachers’
Ontario Teachers' Pension Plan Board (Ontario Teachers') is the administrator of Canada's largest single-profession pension plan, with C$227.7 billion in net assets (all figures at June 30, 2021 unless noted). It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an annual total-fund net return of 9.6% since the plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region offices are located in Hong Kong and Singapore, and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded as at January 1, 2021, invests and administers the pensions of the province of Ontario's 331,000 active and retired teachers. For more information, visit otpp.com.
So, Tamarack Timberlands LLC, an investment vehicle owned by Ontario Teachers’, has assumed the direct ownership of approximately 870,000 acres of timberland.
The press release states this unique, large-scale timberland portfolio of high-quality Loblolly pine is spread throughout the US South and is third-party certified to the Sustainable Forestry Initiative standards, one of the leading sustainable forest management standards worldwide.
A full discussion on timberland as an asset class is beyond the scope of this post but I highly recommend you read this Meketa Investment Group white paper on timberland written in August 2020.
There you will read institutional interest in timberland started maturing in early 2000s.
I believe Yale, Harvard and other endowments were early entrants but OTPP was definitely among the first pension plans to invest in the asset class around that time.
From the Meketa white paper:
Timberland returns stem from four distinct sources: biological growth; timber prices; land values; and management strategy. Timber managers have control over biological growth and management strategies, but are also subject to market conditions for timber prices and appraisal values.
Timberland as an asset class is unique in that it experiences biological growth ranging from 2% to 8% per annum. That is, the volume of the timber on a parcel of land grows as the trees grow. Generally, the larger a tree’s volume, the more valuable it becomes. Even more importantly, this volume growth can be stored “on the stump” for long periods, which provides timberland owners with the option to wait for better prices in an unfavorable market environment. Biological growth is the main driver of value for timberland investments
Timber pricing is the most volatile return component, and is influenced by such specific factors as the economic cycle, rainfall patterns, interest rates, currency exchange rates, consumer demand, the environmental/political climate, and various other factors. More broadly speaking, prices are influenced by the twin factors of supply and demand. Demand for timber is a direct function of global economic activity, which is generally expected to increase with world population growth and a global increase in per capita income. In particular, the growing wealth of emerging nations is translating into increased demand for wood-dependent products such as housing, furniture, containerboard, and boxes for shipping. Furthermore, despite secular changes in demand, arising from such factors as increases in paper recycling rates (now close to 50%) and e-commerce activity, demand for paper and pulpwood continues to grow.
And as far as sources of returns:
The above drivers result in two primary sources of timberland returns readily observable by investors: income and appreciation. As shown in Exhibit 5, historically income returns have exhibited more stable returns ranging from 2.5% to 4.0%, annually, relative to land values. Timberland investors who favor income over appreciation potential tend to focus their investments toward mature forests that are generating income.
Investing in natural forests can create multiple avenues of revenue to provide income over the holding period. Harvesting trees is the primary source of income from natural forests, and may be conducted with an eye toward thinning the forest or converting a section to HBU. Thinning a forest consists of the removal of selected trees in order to enhance growth, health, and quality of the remaining trees. HBU would often take the form of converting the land so that it would be attractive for a real estate developer (e.g., for residences, golf courses). By limiting the harvest, a sustainable wood supply can be developed while preserving native vegetation and wildlife habitat and encouraging natural regrowth.
After the housing market downturn in 2008, timberland managers turned to alternative revenue sources to supplement harvesting income from residential activities. In a challenging market environment, timber managers can reduce or suspend harvesting, depending on minimum harvesting contract obligations, and let the trees continue to grow. The trees will gain additional value as larger trees can be sold at a premium price. Natural forests can generate some income through recreational and hunting leases that allow clubs or organizations use of the forest. Additionally, conservation-related uses can create revenue early in the investment period or when managers delay harvesting. The supplemental income sources help in maintaining consistent revenue when operators elect to store on the stump in low commodity price environments. In years such as 2008 and 2009 when new housing starts decreased from 1.5 million to 0.5 million and remodeling activity slowed, income remained at 1.5% to 2.0% primarily from these alternative sources.
Capital appreciation/depreciation of timberland consists of the change in value of both the underlying land and inventory of trees. Timberland valuations are based on discounted future cash flows, which themselves are based on projections for biological growth, cash flows from harvest, and interest rates.
With the exception of the high rates of appreciation in the mid-to-late 2000s, timberland has exhibited returns and volatility between that of public stocks and bonds:
The critical thing to realize is that timberland offers important diversification benefits, especially in an inflationary environment like the one we are living through now.
This is why timberland is part of OTPP's inflation sensitive portfolio, making up roughly 4% of assets as at the end of last year:
“A responsible, sustainable and long-term approach to forestry has value beyond timber production. These assets will continue to provide Ontario Teachers’ with stable and robust cash yields as well as long-term capital appreciation, while also acting as a natural climate solution to help mitigate the impacts of climate change.”
OTPP has committed to reduce its portfolio carbon emissions intensity by 45% by 2025 and two-thirds (67%) by 2030, compared to a 2019 baseline.
Investing in timberland will bring it that much closer to this goal, albeit only marginally since it's a small part of the overall portfolio.
Still, along with BCI and other large Canadian pensions, OTPP is committed to reducing its carbon footprint and it's committed to timberland as part of its overall diversified portfolio strategy.
Are there risks to timberland? You bet, a downturn in global demand, climate change, forest fires, pests and insects, etc.
But these assets will continue to be operated using best-in-class management practices to ensure the sustainability of the forest over a long-term horizon, and to preserve the ecosystems and biodiversity of the forest, mitigating some of these risks.
Lastly, today is the Bell Let's Talk Day and OTPP shared this important message from Jeff Davis, Chief Legal & Corporate Affairs Officer:
Below, an interesting panel of carbon emission buyers, sellers, and intermediaries discuss how carbon markets can contribute to timberland returns (October 2021). The panel explored the motivations to enter the carbon-offset market, the challenges associated with developing carbon offset projects on timberland, successful and unsuccessful projects, and the controversies surrounding forest-based carbon offsets. Take the time to view this.
And it's Bell Let’s Talk Day. Every time this video is watched, Bell will donate 5¢ to mental health initiatives.