A key goal for plan sponsors is to align the duration of a portfolio with its liabilities—in general, strive to mitigate the risk of pension plan assets being insufficient to meet the plan’s obligations. Farmland and timberland investments help institutional investors offset address that concern.
For many plans, duration-liability alignment means gradually increasing allocations to long-duration fixed income securities. If bond yields should decrease, for example, resulting in increased liability values, a plan needs to offset the imbalance by having corresponding increases in asset values.
With assets typical of long lives and predictable long-term income flows, timberland and farmland have duration characteristics that can be a good match for long-dated liabilities.
Timberland is a long-term investment vehicle with long-tailed cash flows from timber harvesting. Farmland, with proper management, has an infinite productive life. Both assets can provide institutional investors with steady income returns.
In fact, the income landowners receive from leasing farmland to tenant operators, for example, is similar to the interest payment investors receive from a fixed income product. Instead of clipping a coupon, however, farmland investors receive rental income from row crop assets such as corn, soybeans, cotton, rice, vegetables and wheat.
For this reason, some institutional investors view farmland as a replacement for fixed income and manage their farmland allocation within their fixed income portfolio. Farmland and timberland investments have a growing history of being valued by institutional investors for appropriate long-term liability-matching needs.
Growing investor demand
Direct investing in timberland and farmland is not new; both are fast- growing institutional asset classes. In the 16 years through 2011, portfolio investment in U.S. timberland grew at an annualized rate of 15% to US$35 billion. Farmland portfolio investment has also grown—21% a year in the five years through March 2012 to US$3.2 billion, according to growth in the NCREIF Farmland Index total market value.
Direct investment should not be confused with indirect investment. Indirect investment in farmland or timberland through a publicly listed company or one of the newer public funds has shown a weak link to private timberland or farmland and the benefits these direct investments offer. A direct investment in timberland or farmland is one that is held in private ownership in either a separate or commingled fund and typically requires substantial upfront costs and committed capital for the long time horizon. These barriers to entry are generally only accessible to institutional investors such as pension plans with the necessary large pools of available capital.
Investors are increasingly shifting their attention to real assets because of the uncertain outlook of traditional equity and fixed income investments. Timberland and farmland investments are particularly appealing because they provide exposure to rising economic growth in emerging market economies. They can also offer strong, risk-adjusted returns, including a regular income stream, while offering low correlation with financial assets to provide an attractive alternative investment option.