Acorns of interest in foresty funds develop into oaks

As investors have been lamenting the performance of equities, commercial property and bonds over the past year, some may have missed the impressive growth of a rarer asset class: forestry.

The IPD UK Forestry Index generated a return in excess of 30 per cent last year, eclipsing returns from all the other main asset types.

The market has recovered well after a difficult period in the late 1990s, when sterling was strong and wood could be imported cheaply from eastern Europe. Returns have doubled since 2005 and last year reached their highest level since the IPD index was launched in 1992.

The success is rooted in rapidly rising timber prices, as well as growing demand. Timber prices jumped 46 per cent in the year to March 2008, having already grown rapidly the previous year.

One factor in the recovery is new demand for sustainable energy production.

“Wood as a fuel is taking off very fast,” says James Hepburne Scott, representative of the Confederation of Forest Industries. “This frees up the lower value timber market, which in turn helps the higher end.”

Timber is also increasingly being used in construction as a greener alternative to concrete and steel. As demand has recovered and the timber price started to improve, providers have seen an increase in interest from wealthy private investors.

Alastair Sandels, director of forestry at Fountains, one of the sponsors of the IPD index, says investment in forestry tends to be counter-cyclical to other markets, and less volatile, so has attracted investors looking to diversify away from standard assets.

IPD says the market has seen increasing interest from overseas and corporate investors, keen to take advantage of the rise in commodity prices. The group says there is growing awareness of sustainable forestry as a provider of raw materials.

Investors have also been attracted by the tax breaks. Forestry investment is not liable for income or capital gains tax so has increasingly caught the eye of high net worth investors, especially as other tax-efficient investments have been closed.

“The drivers are not the same as other investments,” says Sandels. “There are property drivers, tax drivers as well as the timber price and the biological factors of investing in trees.”

Investment in forestry also provides an element of security as trees are more sustainable than other commodities, and advisers say investors like the tangibility. Sandels believes some have been drawn by the chance to “own a bit of England” and to play a part in conservation.

Returns are likely to slow this year but a number of factors underpin performance over the longer term.

“Existing forests will become more valuable as demand for food, fuel and fibre continues to increase,” says Sandels. “The amount of new natural timber is going to fall away.”

Colin Lees-Millais, director at FIM, a specialist investment provider, believes timber prices still have much further to rise. “It will become much more expensive to import timber as the pound is not as competitive and transport and shipping costs are rising,” he says.

FIM runs forestry funds for private investors, which typically have minimum investment levels of around £50,000. Providers are restricted as to how they promote these types of investment schemes so prospective investors must go via a financial adviser.

Investors can also access forestry through exchange traded funds. iShares offers a S&P Global Timber and Forestry fund that provides diversified exposure. Investors can buy as little as one share in the fund, currently priced at around £9.50.

Individuals with substantial capital can also buy woodland directly. Companies such as FIM seek out woodland on behalf of private investors. Direct entry typically needs a minimum of £100,000-£500,000. Hepburne Scott says some investors are even buying bare plots of land to plant woodland themselves.

Advisers say investors need clear objectives before they go into this area as different types of forests will suit different people, depending on whether they want to generate income quickly or go for longer-term returns.

Investors are warned against going into forestry purely for the tax advantages. “Forestry investment should be a small part of a portfolio and intended for the longer term,” says Sandels.