WOOD - WOOD: Targeted Exposure To Forestry Sector But Highly Correlated To Equity Markets

2023-11-01 09:00:00 ET

Summary

• The iShares Global Timber & Forestry ETF provides targeted exposure to companies in the timber and forestry sector.
• Looking at the WOOD ETF's historical performance, it does not appear to have any portfolio diversification benefits as it is highly correlated to equity markets.
• Investors should monitor developments in the carbon credit space, as timberland operators are exploring new sources of revenue.

While academic papers have extolled the virtue of timberlands as a portfolio diversifier, the evidence suggests the iShares Global Timber & Forestry ETF (WOOD) is not. Historically, the WOOD ETF is highly correlated to the equity markets and does not provide any diversification benefits.

Broadly speaking, the WOOD ETF tracks the price of lumber. With no near-term catalysts to drive the price of lumber and forestry products higher, I rate the WOOD ETF a hold .

Fund Overview

The iShares Global Timber & Forestry ETF provides targeted exposure to global companies operating in the timber and forestry industry. The WOOD ETF tracks the S&P Global Timber & Forestry Index ("Timber Index"), an index that measures the performance of companies engaged in the ownership, management, or upstream supply chain of forests and timberlands. These include forest product companies, timber REITs, paper packaging companies, and agricultural product companies.

The Timber Index is very concentrated and only contains 29 constituents. The WOOD ETF uses a 'representative sampling' methodology to manage the fund, so it does not replicate the full holdings of the index.

The WOOD ETF has $190 million in AUM and charges a 0.42% expense ratio.

Portfolio Holdings

Figure 1 shows the sector allocation of the WOOD ETF. The WOOD ETF's largest sector weight is Paper & Forestry Products at 55.6%, Containers & Packaging at 22.4%, and Specialized REITs at 16.2%.

Geographically, the WOOD ETF has exposure to companies located in multiple jurisdictions, with the United States being the largest at 29.4%, followed by Sweden at 13.1%, Brazil at 11.4%, Finland at 9.3%, and Japan at 8.3%(Figure 2).

Distribution & Yield

The WOOD ETF pays a modest semi-annual distribution with a trailing 12-month distribution of $1.44 or 2.0% yield (Figure 3).

Returns

Historically, the WOOD ETF has delivered modest returns, with 3/5/10Yr average annual returns of 6.5%/1.5%/5.9% respectively to September 30, 2023 (Figure 4).

The WOOD ETF had a strong 2020 and 2021 performance as the price of lumber skyrocketed on COVID-induced supply shortages (Figure 5). However, as lumber prices have come back to earth, so has the WOOD ETF.

Timberlands May Be A Diversifier, But WOOD May Not

Historically, there is a thought that timberland investments can be a way for investors to diversify their portfolios, as it offers biological growth (as trees grow, they become more valuable), land appreciation (the underlying lands can become valuable real estate assets), and price appreciation of the timber harvests.

For example, according to Forisk Consulting , an investment in Timberlands actually outperformed the S&P 500 from 1990 to 2019 (Figure 6).

However, the same may not be true for an equity ETF like the WOOD ETF. Using data from Portfolio Visualizer, since inception in 2008, the WOOD ETF has only returned a CAGR of 4.9% compared to the SPDR S&P 500 ETF Trust's (SPY) 10.4% CAGR returns while having an 85% correlation with the equity markets (Figure 7).

In fact, a 54/36/10 allocation to a SPY/TLT/WOOD portfolio would lead to lower overall CAGR returns and higher volatility compared to a simple 60/40 SPY/TLT portfolio, so it appears WOOD does not act as a portfolio diversifier (Figure 8).

Carbon Credits A Potential Source Of Revenue

Recently, I came upon some interesting developments with respect to timberland companies that may improve the economics of owning these equities.

Specifically, while reviewing the financial results of Acadian Timber Corp ( ADN:CA ), I noticed that the company began talking about the value of carbon capture credits from a trial project.

In its latest Q2/2023 report, ADN reported that the company registered 770,071 carbon credits on the American Carbon Registry and made them available for sale. This is a trial project associated with ADN's Maine timberlands that is subject to a working forest conservation easement.

On ADN's balance sheet, these carbon credits are recorded as inventory with a value of C$14.1 million, or roughly C$18 / credit (Figure 9).

According to Manulife Investment Management , carbon credit pricing may have to increase to as high as $75 / ton in order to incentivize timberland operators not to harvest their forests (Figure 10).

Overall, Acadian expects this Maine project to generate 1.6 to 1.9 million carbon credits over the 10-year life of this project. Actual credit issuances will be adjusted in each reporting period depending on actual harvesting and other factors, but Acadian believes if this project is successful, the company can replicate the project's learnings into additional carbon credit projects in the future.

For context, Acadian as a company generated C$35.5 million in net income in 2022, so if these carbon credit projects are successful, it can materially improve the profitability of the timberland asset class and so is worth monitoring for investors (Figure 11).

Conclusion

The WOOD ETF provides targeted exposure to companies operating in the global timber and forestry sector. While timberlands may provide portfolio diversification benefits, the WOOD ETF does not, as it is highly correlated to equity markets.

Looking forward, investors should pay attention to developments in the carbon credit space, as more and more timberland operators are trialing carbon credit projects that could provide a new source of revenue.

Overall, I do not see any near-term catalysts to drive the price of lumber and forestry products higher, so I rate the WOOD ETF a hold .

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