Investing in timber could disprove the old adage that money doesn’t grow on trees.

Gaining exposure to the timber industry doesn’t mean buying a patch of forest in a distant location. A far more accessible way to tap into this trade is by investing in the shares of companies which produce pulp or lumber, businesses which supply the construction industry, or paper and packaging firms. Not only are company shares easier to buy, they are more liquid than real estate or land.

And many investors will prefer to buy a fund which invests in a basket of stocks operating in this space.

Timber is a so-called soft commodity – one which is grown such as coffee or soybeans, rather than mined or extracted such as ‘hard’ metal commodities such as copper or nickel. ‘Crucially, unlike most commodities which are finite resources, trees grow,’ says Nathan Sweeney, investment manager at Architas.

Driven by housing sector

Also unlike hard commodities, the primary driver for the timber industry is the housing sector, with its fortunes heavily tied to the number of construction starts. As a result, the timber industry was hit hard during the global financial crisis when building work dried up and construction volumes fell as much as 75%.

When demand drops commodity companies typically rein in their spending on exploration and, for metal miners, that means there is usually a dearth of supply when demand picks up again. The same is not true for timber and lumber producers, of course, because trees will keep on growing regardless of the economy.

The price of lumber is up more than 25% over the past year. And that price could keep rising as the number of new home starts climbs. It is estimated that the US needs to increase construction of single homes by 80% to sustain long-term trend needs. Currently there are around 1.2m housing starts a year – well below historical averages.

David Heyl is an analyst on the Investec Enhanced Natural Resources (GB00B2QVX896) fund, which has 20% of its assets in soft commodities. He says: ‘Growing trees requires very little ongoing running costs so, even though there weren’t necessarily new plantations started, the natural growth from 2008 to 2013 meant that more wood and fibre was available once demand returned.’

The role of technology

But Heyl is concerned that the abundant supply could drag prices lower in the coming years. He adds: ‘This additional supply is still far from being absorbed by demand growth’.

You can offset this by tapping into other parts of the supply chain. Heyl, for example, prefers companies such as Toronto-based Norbord, which is focused on other building products such as oriented strand board and plywood. The fund has returned 12.2% over the past year.

Gary Greenberg, head of emerging markets at Hermes Investment Management, likes Klabin, which is the largest paper producer and exporter in Brazil, where steady rainfall through the year allows eucalyptus and pine trees to thrive.

While in the US the average individual uses almost 300 kilos of paper a year, the global average is just 55 kilos, suggesting there is plenty of latent demand. Meanwhile, demand for wood fibre from China is expected to increase by 30% between 2015 and 2020, and new technologies mean the material can now be put to use in much larger building projects.

Christoph Butz, co-manager of the Pictet Timber (LU0448837087) fund, says: ‘Timber is used in far more applications than you might think.’ He says the trend towards internet shopping is supportive of the industry as retailers need strong packaging, such as corrugated cardboard wrap, in which to post their products.

His fund, which has returned 21.4% over the past year, invests across the entire supply chain with investments in timber land owners Weyerhaeuser, UK paper supplier Mondi (MNDI) and US packaging manufacturer WestRock.

Risk warning

Investing in timber is not without its risks. This is a small, concentrated investment universe, with only around 160 companies in the supply chain; the top four packaging providers have a market share of 75% between them.

And while timber might grow regardless of the economic environment, it is not immune to its surroundings – in Canada, it is feared up to 50% of this year’s timber crop may have been damaged by a beetle infestation.

Other risks for the industry include US president Trump’s protectionist trade policies which could impact the amount of lumber being imported – typically the US has imported around 30% of its lumber from British Columbia. There are also sustainability issues, with some managers avoiding investments in countries such as Indonesia where there is not a strong focus on sustainable growing practices.

Sweeney says: ‘Demographics and growing populations support the case for investing in timber, particularly at times such as now where a major natural disaster can lead to an uptick in building work. But there are challenges for this industry over the long-term too and investors should not put more than a small amount of their money into these assets.’

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