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Chapter 14 The Role of Real Assets: 

Chapter 14 The Role of Real Assets


Though wisdom cannot be gotten for gold, still les can it be gotten without it. - Samuel Butler


Outline Introduction Real estate in general Timberland in particular Gold


Introduction Most portfolio investments are financial assets, such as: Common stock Corporate bonds Bank CDs

Introduction (cont’d): 

Introduction (cont’d) Real assets: Are assuming an increased role in some of the country’s largest pension funds and in private investor portfolios Include timberland and gold Do not have a corresponding liability unless one is created to finance the purchase of the real asset

Real Estate in General: 

Real Estate in General Investment characteristics Developed and undeveloped property Pension fund investment in real estate

Investment Characteristics: 

Investment Characteristics Characteristics of land: Immobile Land cannot be moved Indestructible Land cannot be destroyed Nonfungible Ever plot of land is unique

Investment Characteristics (cont’d): 

Investment Characteristics (cont’d) Characteristics of land (cont’d): Land is typically a long-term investment Especially for institutional timberland owners Land can be a short-term investment E.g., timberland may be used for development or the extraction of minerals

Real Estate Categories: 

Real Estate Categories

Developed and Undeveloped Property: 

Developed and Undeveloped Property Developed property is land with improvements on it E.g., shopping malls and apartment complexes Purchased by investors for: Income-producing characteristics The tax advantage from depreciation of buildings

Developed and Undeveloped Property (cont’d): 

Developed and Undeveloped Property (cont’d) Undeveloped (raw) property has no improvements E.g., undeveloped lots Investors purchase undeveloped property: To speculate For the production of subdivided lots for resale or development

Pension Fund Investment in Real Estate: 

Pension Fund Investment in Real Estate U.S. pension funds have nearly $100 billion invested in real estate In 2000, the average pension fund had about 20 percent of assets invested in real estate Real estate investment can be convenient through a real estate investment trust (REIT)

Timberland in Particular: 

Timberland in Particular Introduction Institutional interest in timberland A timberland investment primer


Introduction Timberland is a very viable investment form of real estate for large portfolios The U.S. encompasses about 468 million acres of timberland

Institutional Interest in Timberland: 

Institutional Interest in Timberland Innovative forms of ownership in timberland have been developed: Public limited partnerships Closed-end investment companies in timberland Securitized units of timberlands of forest product companies

Institutional Interest in Timberland (cont’d): 

Institutional Interest in Timberland (cont’d) Examples of institutional interest: Timberland investment management organizations (TIMOs) managed about $9 billion in timberland near the end of 2001 In 2001, Harvard Management put 6 percent of its $18.3 billion portfolio into timberland

A Timberland Investment Primer: 

A Timberland Investment Primer Timberland as an asset Timberland investors Timberland returns Timberland risks Problem of lack of information Timberland as a portfolio component Future prospects

Timberland as An Asset: 

Timberland as An Asset Timberland as collateral Timberland as a strategic investment Timberland as a pure investment

Timberland as Collateral: 

Timberland as Collateral Loans are routinely secured with timberland by: Life insurance companies The Federal Land Bank

Timberland as A Strategic Investment: 

Timberland as A Strategic Investment Timberland serves as a strategic investment when owning it: Helps ensure the long-term viability of a company or Reduces the volatility of a company’s cash flows

Timberland as A Pure Investment: 

Timberland as A Pure Investment Portfolio managers hold timberland as a pure investment: The property is held for its own investment merits The property is not held as part of a strategic plan or to assist in project financing

Timberland Investors: 

Timberland Investors The largest current owners of timberland for pure investment purposes are: CALPERS John Hancock Financial Services New Hampshire State Employees Retirement System

Timberland Investors (cont’d): 

Timberland Investors (cont’d)

Timberland Returns: 

Timberland Returns Timber grows on the land and is sold and renewed Growing timber is stumpage The value of a stand of timber depends on: The volume of wood on the acreage The size and quality of the trees The market price of the species of forest products

Timberland Returns (cont’d): 

Timberland Returns (cont’d) A timberland investor’s return is a function of: The acquisition cost and selling price Site productivity The ability of a site to grow timber, depends on weather, soil conditions, etc. Management competence Silvicultural practices and management strategies can affect return

Timberland Returns (cont’d): 

Timberland Returns (cont’d) A timberland investor’s return is a function of (cont’d): Market price Investors have substantial discretion in regard to time of harvest Price is influenced by the relative size of trees on the land

Timberland Risks: 

Timberland Risks Biological risks Economic risks

Biological Risks: 

Biological Risks Biological risk is the risk of loss due to natural events: Fire Insects Disease Productivity Wind

Biological Risks (cont’d): 

Biological Risks (cont’d) Productivity risk refers to the possibility that a stand of timber will not produce the anticipated volume of wood due to: Species competition Drought Disease

Economic Risks: 

Economic Risks Economic risks include: Quality Liquidity Demand Price Management practices Changes in the regulatory environment

Economic Risks (cont’d): 

Economic Risks (cont’d) Management risk means that poor management practices can erode the value of timberland Liquidity risk exists because there is a relatively limited market for timber and timberland Regulatory risk stems from statutes and ordinances that limit forest management and land use options

Problem of Lack of Information: 

Problem of Lack of Information Problems with constructing a standard timber index: Must consider the growth in timber volume Must consider the low volatility associated with land Focusing on timber prices alone biases the return downward and biases volatility upward Timberland is nonfungible

Problem of Lack of Information (cont’d): 

Problem of Lack of Information (cont’d) Examples of timber indexes: Wachovia’s Timberland Performance Index (TPI) The Warnell School’s Timber Mart South and Timber Mart North Log Lines National Council of Real Estate Investment Fiduciaries

Timberland as A Portfolio Component: 

Timberland as A Portfolio Component Virtually all studies of timberland find very low or negative correlation between timberland and other investment alternatives Allows for substantial diversification benefits

Timberland Correlation Coefficients (1960-2000): 

Timberland Correlation Coefficients (1960-2000)

Risk and Return (1981-2000): 

Risk and Return (1981-2000)

Future Prospects: 

Future Prospects Introduction Index problems Social risk


Introduction An increasing number of portfolio managers may discover timberland as an investment: Asset allocation strategies are in vogue Timberland allows for substantial portfolio diversification Pension funds will probably continue to be the principal private investors

Index Problems: 

Index Problems The lack of a consistent timberland index is the single biggest barrier to increased investment by pension funds: Continuous pricing by the market is difficult due to: Lack of liquidity Timberland is not an exchange-traded product Regional variations The appraisal-based nature of timberland

Social Risk: 

Social Risk The timber industry considers forestland to be a renewable resource Many environmentalists do not consider forestland to be a renewable resource The length of reforestation depends on the species


Gold Motivation for gold investment Determinants of the price of gold The London fix Investing in gold

Motivation for Gold Investment: 

Motivation for Gold Investment People often buy gold because of the security it is expected to provide during times of trouble An insurance policy against inflation Particularly pronounced in Europe A currency without a country

Motivation for Gold Investment (cont’d): 

Motivation for Gold Investment (cont’d) Gold can be an attractive investment because: Gold has demonstrated returns that are unrelated or even opposite to those of the stock market The correlation between the Philadelphia Stock Exchange’s gold and silver index and the S&P 500 index since 1986 has been 0.14 The relationship is tenuous

Determinants of the Price of Gold: 

Determinants of the Price of Gold Strength of the U.S. dollar Influenced by trade balances and protectionism concerns The strength of foreign currencies Stronger foreign currencies decrease the value of gold measured in the home currency for foreign investors

Determinants of the Price of Gold (cont’d): 

Determinants of the Price of Gold (cont’d) Inflation and rising oil prices An increase in the price of oil raises fears of inflation and an increased price for gold International finance uncertainty Investors turn to gold as a result of mounting debt, third-world loans, etc.

The London Fix: 

The London Fix The London fix is the price of gold that reflects the relative buy and sell orders that have been placed with member firms of the London Gold Market The fix is determined twice each day at 10:30 a.m. and 3:00 p.m. London time

The London Fix (cont’d): 

The London Fix (cont’d) Gold prices also change in response to: Continuous exchange trading Economic news Political news

Investing in Gold: 

Investing in Gold Bullion Gold certificates Shares in mining companies Coins


Bullion Gold bars are bullion There are different sizes of gold bars (see next slide) Investors can acquire smaller quantities of gold: 1-ounce bars Nuggets Gold dust

Bullion (cont’d): 

Bullion (cont’d)

Bullion (cont’d): 

Bullion (cont’d) Shortcomings of bullion: Subject to theft No income productivity Lack marketability

Gold Certificates: 

Gold Certificates Gold certificates are: Obligations of the issuer to deliver gold upon demand Issued by banks Registered in your name Readily sold back to the dealer Gold certificates have the risk that there is no gold backing them

Shares in Mining Companies: 

Shares in Mining Companies Purchasing shares in mining companies is the most popular form of gold ownership in the U.S. E.g., Homestake Mining is the largest U.S. gold-mining company Some mutual funds specialize in gold or other precious metals

Shares in Mining Companies (cont’d): 

Shares in Mining Companies (cont’d) Owning shares in mining companies or mutual funds has advantages: Shares are instantly marketable Shares can generate some income through dividends


Coins Gold coins are popular with investors and speculators A coin’s intrinsic value is the higher of: Its bullion value Its fiat value The value assigned by the issuing government

Popular Coins for Investment: 

Popular Coins for Investment

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