Stockholm (HedgeNordic) – The World Bank has projected a fourfold increase in global timber demand by 2050, driven by anticipated worldwide economic and population growth. The surge in demand for timber is expected to result from various factors, such as increased construction activities, infrastructure development, and the growing need for wood products in industries such as furniture, paper, and packaging. With the launch of its fifth forest fund, structured as an evergreen fund, Finnish asset manager United Bankers aims to provide investors with an opportunity to tap into the growing demand for timber products while offering access to the attractive characteristics of timberland investments.
Characteristics of Timberland Investments
Diversification and Inflation Hedge. “Diversification is one of the main reasons for adding exposure to timberland investments,” states Kari Kangas, forestry-focused fund manager at United Bankers. Timberland investments offer unique diversification benefits derived from the biological growth of trees, which adds a ‘natural’ element of diversification to investment portfolios. “Forests and trees grow every year, so the value of your assets in terms of biological growth increases every year,” explains Kangas.
“Diversification is one of the main reasons for adding exposure to timberland investments.”
Another key advantage of timberland investments is their potential to serve as a hedge against inflation. The inflation-hedging properties of forestry investments arise from the many uses of wood in the real economy, including fuel, building materials, furniture, paper, tool, and more.
Carbon Sink. Timberland investments are often considered ‘impact’ investments due to their positive environmental attributes, emphasizes United Bankers fund manager Jyri Hietala, who also focuses on forestry. Investing in sustainably managed forests contributes to the preservation and conservation of forests, promoting biodiversity and mitigating climate change.
As forests act as carbon sinks – absorbing more carbon from the atmosphere than releasing – institutional investors aiming to reduce portfolio emissions to net zero must consider forestry investments in their portfolios. “Forestry investments are a necessary component in a portfolio as most, if not all, other asset classes generate some emissions,” explains Hietala. “You can neutralize emissions in the portfolio by investing in forestry investments; all our funds are carbon sinks.”
Similar to the three previous vintages, the new fund – UB Nordic Forest Fund IV – will also be classified as an Article 9 fund under SFDR. “Our aim is to mitigate climate change, that’s our objective,” says Hietala. “Our forests, first of all, act as carbon sinks, but we are trying to do something additional compared to an average forest owner,” he elaborates. “We also manage our forests sustainably, with most of our forests being double-certified with PEFC and FSC,” both of which have the same goal of creating and implementing sustainable forestry policy.
Steady Cash Flows. Forestry investments provide access to a steady stream of returns and predictable cash flows derived from carefully planned and sustainably managed timber harvesting. “We typically create a budget for harvesting for the whole year based on an assessment of harvesting possibilities, the type of forest we own, and the expected market development for the next year or two,” explains Hietala. “If the prices are high, we can increase the amount of harvesting depending on the harvesting possibilities. We don’t want to deplete our yield or the future value growth by cutting too early.”
Buy and Build Premium. In addition to the direct cash flow return generated from forestry activities, the return on forestry investments consists of an additional component: asset value growth determined by supply and demand for forestry assets, changes in the growing stock, and its composition, among other factors. The forestry team at United Bankers has employed the strategy of buying individual properties or small pools of properties to drive asset value growth through the ‘buy and build’ premium created when acquiring nearby properties to achieve operational synergies.
“Whereas many of our competitors are buying very large packages through a few transactions annually, we conduct 200 or 300 transactions annually, almost one transaction per day,” explains Hietala. “This is a fairly different strategy, but we see that this buy and build strategy adds value in this acquisition process and we have been quite successful following this strategy with our previous funds.” he elaborates.
New Fund, Similar Strategy, Wider Focus, and Different Structure
United Bankers manages approximately 150,000 hectares of timberland in the Nordic and Baltic Rim countries, with around 131,100 hectares in Finland, approximately 6,500 hectares in Estonia, 10,600 hectares in Latvia, and about 1,800 hectares in Lithuania. While its first two forest funds fully focused on the Finnish market, its third fund began broadening its geographical exposure into the Baltic countries. With the upcoming launch, United Bankers will place more emphasis on the Baltic Rim countries and expand its geographical reach to new markets in Europe.
“One of the main differences between the new fund and the previous vintages is the broadening of the geographical scope in this new fund.”
“One of the main differences between the new fund and the previous vintages is the broadening of the geographical scope in this new fund,” says Hietala. “This fund will operate and focus on the Nordics and Baltics in addition to seeking new markets elsewhere in Europe such as Spain, Portugal, UK, and Ireland, among others,” he explains. The expansion of focus is driven by the desire to allocate capital more efficiently in a significantly larger timberland market.
“The size of our investable universe in the timberland market will be much larger, allowing us to invest capital more efficiently and achieve higher diversification due to different markets and species,” elaborates Kari Kangas. This diversity in markets and species serves as an additional risk management tool, according to Kangas. “Expanding the geographical focus enhances diversification across natural risks, which we consider the most severe risk in our line of work due to climate change,” he elaborates. “When you go south to the Mediterranean, you encounter different natural risks, especially fires, and insects, so you must be prepared for these kinds of issues.”
“The size of our investable universe in the timberland market will be much larger, allowing us to invest capital more efficiently and achieve higher diversification due to different markets and species.”
The forestry team at United Bankers does not blindly seek to expand its geographical reach. Instead, the team has a range of criteria that the new markets must meet before venturing into them. All of the forestry funds at United Bankers aim to generate an investment return of a minimum of four percent after all costs, considering that the expected timberland returns are between 4-5 percent in Finland and slightly higher in the Baltics. The new markets United Bankers plans to invest in need to meet the minimum return targets set by the UB team.
“We have conducted a preliminary screening of new markets and have already identified a few areas that seem quite attractive and meet our targets and criteria,” says Hietala. First and foremost, every new market must meet the minimum yield target of four percent after all costs. But there are other criteria as well. “The roundwood markets need to be well-developed to ensure stable demand, and the forest market and the timberland market should be fairly liquid,” he continues. “We also want to see other institutional investors investing in timberland in these markets, which indicates an actual market for timberland if we ever decide to realize some returns by selling properties.”
Unlike the previous vintages of UB’s forest funds, which utilize a closed-ended fund structure with a predetermined lifespan, the upcoming UB Nordic Forest Fund IV will be an evergreen fund with an open-ended structure and no termination date, similar to UB Timberland Fund (AIF). This different structure will also lead to minor changes in the team’s investment approach, particularly regarding the sale of properties. “Since we don’t have a pre-defined term for exiting our investments to realize the ‘buy and build’ premium, we will opportunistically buy and sell properties to capture the premium,” explains Hietala.
While the team can rely on the return stream from timber harvesting on a frequent basis, the return stream from the appreciation of forest properties can be captured only by periodically selling some properties and acquiring new ones. “The ‘buy and build’ premium and the appreciation of land value appreciation are not factors incorporated into the net asset value calculation for our investors,” says Hietala. “If the land value increases, we will occasionally sell properties to realize the appreciation.” This evergreen structure allows for a more opportunistic approach to capturing land value and ‘buy and build’ appreciation.