Timberland investing with Manulife Investment Management

Nimar Bangash (00:02)

Hello, my name is Nimar. I'm the CEO of Obsiido, the alternative investments platform. Welcome to our new series where we provide a rapid fire overview of distinct asset classes within alternative investments. Today, we're chatting about investing in Timberland with our special guest, Michael Strzelecki, Managing Director, Business Development and Senior Timberland Portfolio Manager at Manulife Investment Management. Welcome, Michael. Thanks for your time.

Mike Strzelecki (00:28)

Thanks, and we're happy to be here, and I appreciate the opportunity.

Nimar Bangash (00:32)

Awesome. All right, let's dive right in with a bit of background on yourself and Manulife Investment Management. Can you tell us a little bit about your role, your firm, and how you ended up getting involved in timberland?

Mike Strzelecki (00:47)

Yeah, absolutely. So as you mentioned, I'm a senior portfolio manager and also part of the senior leadership team at Manulife Investment Management's timberland business. That means I'm responsible for capital formation across both our fund strategy as well as our separately managed account business. And I'll come back and talk more about the platform in a bit. But how did I end up in the Timber space? It's quite a niche space.

I actually started my career at Merrill Lynch as a rotational analyst and actually by chance ended up covering the forest product sector as a sell side equity research analyst. That was back before the global financial crisis. And then in about 2009, I actually joined a boutique timberland investment firm. So I had the opportunity to move from the public side and focus on the private side. I came in as an acquisitions analyst and being a small firm that was an opportunity to wear a lot of different hats and ultimately ended up being a partner and portfolio manager for two of the firm's large flagship funds. And then back in 2017, I had the opportunity to join Manulife Investment Management, which is the world's largest timberland investment manager and have been with the company now for about seven years.¹

Nimar Bangash (02:25)

Perfect. Thanks for the background there. Let's maybe double click on Manulife's investment expertise within sort of the real assets arena with Timberland as a part of the real asset sort of ecosystem. But maybe you can speak to the platform at Manulife for real assets. And as you just mentioned, large player in the timberland space.

Mike Strzelecki (02:47)

Yeah, so just to provide a bit of context here, the timberland platform sits within Manulife Investment Management, which is the wealth and asset management arm of Manulife Financial Corp. And as listeners may be aware, that's the largest insurance provider in Canada, a publicly traded company. Within Manulife Investment Management, that's a platform that is across about $450 billion including public and private markets. And the private markets has two verticals. So the timberland strategy sits within the real assets vertical alongside farmland, real estate and infrastructure. And altogether, that's about a $50 billion business. And then the other vertical within private markets is private equity and credit, which is another $25 billion.

As we drill down into the timber platform. I mentioned earlier that we're the world's largest investment manager of timberland with nearly 40 years of experience in approximately 12 billion US in assets under management across the US, Canada, Australia, New Zealand, Chile, and Brazil.¹ And what we do is we specialize in developing and sustainably managing diversified portfolios in this asset class on behalf of our clients. One of the key differentiators about our platform is the fact that we have a vertically integrated operations team. So a big employee base around the world that lives and works in the communities where we invest. And that allows us to have both a global reach with our strategy as well as a local presence and expertise. And with this approach, we're the stewards of nearly five and a half million acres around the world. 100% of that is certified to third party sustainability standards.

Nimar Bangash (04:55)

Helpful background and that certainly sounds like an important distinction being vertically integrated in that way and having that local presence. I imagine that is a significant value creator for your platform. But maybe we can maybe take a step back now Michael and just start from the basics with respect to investing in timberland. You know, as you pointed out it's a niche asset class lesser known to a lot of listeners of our podcast.

So maybe you can start by providing an overview of Timberland investing and the different approaches or strategies that are associated with the space.

Mike Strzelecki (05:32)

Yeah, happy to. So maybe just a bit of a history lesson too. Institutional investment in timberland was really prompted back in the 1980s as a result of a change in the tax code and treatment for timberland assets in the US. And that stimulated really a reassessment on the part of the large vertically integrated forest companies to look at the financial role of those timberlands on their balance sheet. And over the course of the subsequent years through the 90s and even the first half of the 2000s, there was a process of disposition of those assets for the most part from the integrated forest companies and those large timberland holdings eventually found their way into new ownership under institutional investment and several institutional investors have now been invested in the space for 20, 30 years. And many of those are still clients of ours. Our in -house economic research team estimates that the investable universe for Timberland globally is about 420 billion, which we said it's a niche asset class. It's very small compared to other asset classes, right?

And it's fairly concentrated too. So about two thirds of the investable universe by our estimates is in the US and about two thirds of that is in the southeastern US and that's comprised primarily of softwood pine plantations. know, timberland investing generally involves the acquisition and management of large existing working forests as well as properties for potential greenfield, afforestation, and reforestation projects. Sustainably managed timber investments ultimately provide integral inputs for basic human needs, and that includes wood products for building shelter, as well as fiber products for paper packaging and absorbent materials. So it's really a tangible source of product for investors to wrap their heads around. And timberland also provides investors with portfolio diversification, having a long track record now of attractive risk adjusted returns, as well as a positive environmental and social impacts when managed sustainably.

Nimar Bangash (08:15)

Super-helpful color on the space and you know, obviously clearly an important raw material for a lot of essential goods consumed by people all around the world. Maybe we can kind of continue down this path on understanding timberland investing and talk a little bit more about underwriting or evaluating investment opportunities in this ecosystem, you maybe you can speak to the way in which manual life evaluates opportunities in the space and some of the key factors involved in underwriting timberland assets.

Mike Strzelecki (08:52)

Yep, so as mentioned, we do have a long history and expertise evaluating and managing these types of assets. Our process is informed by the work that our in -house economic research team does, dedicated forestry economists. It starts with defining that investable universe that I talked about. They're also looking at trends in supply, demand dynamics, and price forecasting for various products.

We also have a dedicated sustainability team that's integrated into our investment process and they're there to ensure that we evaluate the ESG risks and opportunities in addition to the forestry and financial due diligence that we have to conduct when we're looking at new investment opportunities. Our acquisitions team sources opportunities through both competitive sale processes and has quite a successful track record also originating deals that are privately negotiated in one -to -one transactions. And ultimately, we're seeking to align the investment opportunities with the objectives of the portfolios that we're investing on behalf of. So that could be looking at different jurisdictions or geographies to build out portfolios or perhaps different product and market exposure. And once we identify an opportunity, what we're tasked with is to try to figure out how much that forest is worth. So generally speaking, the forests that we're looking at do not come with a price tag. There's no exchange with a bid and ask as there are in other markets. So that involves evaluating the forest inventory data that a seller might provide and or conducting inventory analysis on our own and conducting property inspections to actually confirm that the volume that the seller is representing is actually there and in the forest and in the field. And that gives us basically a starting point from which we can build. And then we need to develop growth and yield models to forecast the volume that the property could produce over the long term. So we're generally developing long term 50 -year type models that will optimize the wood flow coming out of the forest. And as a result, the cash flows too, once we apply the price and cost associated with those volumes. There again, is a benefit of having that vertically integrated team and our ability to leverage real -time on -the -ground property intelligence to say, the model says we can Cut X and deliver that to the market. But in reality, you know based on our experience in the local market we can only Deliver Y and it's going to cost you know A B and C to make that happen. And so there's a lot of moving parts that go into it And again having that team on the ground creates that value opportunity that you mentioned And then once we develop the 50 year cash flow model, we have to apply a discount based on the specific characteristics of that property. So we're looking at it very much on a property by property basis. We have a proprietary risk matrix that we look through at every property that we're evaluating. We're looking at the risks around the markets, the volume, the growth and yield, historical price volatility, climate, and et cetera, all types of risk associated with those types of investments in that specific market to develop what we believe is the appropriate risk-adjusted required rate of return. And then we apply that to that 50 year cash flow model to arrive at the value that we think that properties were..

Nimar Bangash (13:03)

Obviously extremely comprehensive and to I think like a great extent given the real nature of this asset class, lot of on the ground work in terms of the evaluation, the site visits and the inventory. Is there any, I guess, you know, kind of going off script here for a second, but in terms of technology or potential use cases of artificial intelligence and terms of inventory and mapping, your teams applying any of those capabilities - is this still very much kind of an on the ground effort with your local teams when it comes to doing some of the diligence on an acquisition?

Mike Strzelecki (13:42)

Yeah, absolutely. Technology has played a major part and has really increased the level of precision and accuracy with which we can evaluate and plan over the long term for these assets. And just to give you an example, we historically would collect timber inventory by deploying a team on the ground doing measurements, setting up plots in the forest, counting the trees and the plots, and basically extrapolating that across tens of thousands of acres across the landscape. And that's the way it's been done for decades, right? More recently, we've been able to invest and move to a LIDAR -based approach where we're collecting data from an aircraft and running that through the models and tools and essentially coming out the other end with a detailed view of the forest where we're able to count effectively every tree that we have standing out there. So it's kind of moving from a sampling approach to more of a specific data point.

Nimar Bangash (14:57)

Interesting, that makes a ton of sense, and are you applying kind of some of that cutting-edge technology to make it much more detailed and at the same time save a lot of time and cost I imagine. So, maybe let's kind of continue going here and now talk from the perspective of you know, why investors should consider allocating part of their portfolio to Timberland. You touched on the long track record and attractive track record of this asset class but perhaps you can go a little bit deeper on the reasons, the benefits, the risks, and some of the typical investment characteristics of Timberland in terms of return and risk.

Mike Strzelecki (15:45)

Yep, so I mentioned earlier that timberland can provide portfolio diversification and more specifically a source of stability for investor portfolios. There is an established track record of generating quite attractive total returns in the mid to high single digit range with relatively lower volatility compared to other asset classes. So, including timberland in a portfolio can provide higher returns for any given level of risk or in contrast, they also lower risk for any level of return, which effectively increases the Sharpe ratio and helps optimize risk-adjusted returns for investors. I mentioned total returns generally comprised of about one third income two -thirds appreciation, and generally uncorrelated, or perhaps even negatively correlated in some cases with other asset classes, which goes to that point I made earlier about the ability to provide stability and resilience to investor portfolios, particularly during periods of high volatility and uncertainty. And we've seen that play out across multiple market cycles in the past.

Nimar Bangash (16:44)

Okay.

Mike Strzelecki (17:13)

Another important aspect of timberland investing is that historically there's been a positive correlation with inflation and that's been particularly true during periods of moderate to high prices like we've seen the last couple of years. So there's been also an ability to act as an inflation hedge. So I'll pause there and see if there are any follow -ups on that one.

Nimar Bangash (17:39)

Yeah, I think like a lot of what you're saying intuitively, at least to me, certainly makes a lot of sense. It's interesting to understand the breakdown or the underlying aspects of the return of this asset class. Maybe adding on to that, more recently as we've started to see a kind of a maturing of a carbon market globally, and you have now projects and sort of initiatives underway to find ways to either use timberland for purposes other than just delivering timberland as raw material into other of economic reasons. So can you maybe talk about some of the more near term sources of return that are coming online for timberland and given Manulife's position in this market as the largest timberland investor globally, I have to imagine you're either already involved in this or have looked at it extensively and may have some comment on that market.

Mike Strzelecki (18:40)

Yeah, absolutely. And so you're exactly right. In addition to those traditional portfolio diversification benefits, investors are increasingly looking at sustainably managed timberland to generate positive social and environmental impacts and help contribute to sustainability goals, help contribute to climate change mitigation and biodiversity loss. And with those trends come certain opportunities. You touched on carbon, that's been something that has been evolving in the marketplace for quite a bit, but more recently has become more popular and a focus of Timberland Investing. And you're right, we do have experience managing carbon projects on behalf of our clients across the existing portfolio base that we manage and we see that being increasingly a source of revenue and value going forward. The asset class, as I mentioned, is quite uniquely positioned to serve as a nature-based solution and so we can manage the forest on a spectrum. We can manage it purely for commercial wood and sustainable wood production and or we can manage for carbon sequestration. As you might imagine, there would be a trade -off there and we have to evaluate the economics between timber and carbon. But when we move toward that end of the spectrum with carbon sequestration, we have to demonstrate the concept of additionality to ensure high quality, high integrity of the carbon credits that we're generating to ensure that there's a real climate benefit. And when we do that, we increase the optionality of the, terminal and asset. We see opportunities for that already in certain markets. And as the carbon price continues to increase as many out there are predicting it will, we see that as potentially increasing the optionality on other parts of the portfolio that we manage on behalf of clients because as I mentioned, you do have to look at that trade -off between timber and carbon economics. The carbon is really just one of the additional value sources that we see. We also see opportunities for mitigation banking, whether that's for wetlands or wildlife. We also see opportunities for renewable energy siting with wind and solar opportunities for underground carbon capture and storage. And so what is really happening the last couple of years and what we expect to continue to happen as we look in the medium to long term is that these additional sources of value will become increasingly recognized as these markets develop and will provide new sources of return for investors that are invested in space.

Nimar Bangash (22:03)

Very interesting. Maybe we can kind of continue on just the sustainability climate change theme for a second. Just given the nature of the space, there is obviously direct exposure to a changing climate. And I think specifically what we've seen, at least in parts of the world, Canada, you know, is in the news these days with Western Canada's wildfires that have been raging. How do you take into consideration some of the climate change impacts on timberland as it relates to valuing these assets or using them for different purposes? What is the thinking on climate change?

Mike Strzelecki (22:41)

Yeah, it's one of the top questions we get from investors that are looking at the space. The asset class comes with a laundry list of risks that could potentially impact their investments that are not necessarily exposed to in other parts of their portfolio. The main one, of course, would be wildfire risk. But there are also lots of other ones that could be hurricanes, ice storms, pest and disease. So there being a natural biological asset, there are certain of these inherent risks that are quite unique to the investment strategy. And that being said, we've been quite successful in managing these risks and mitigating losses from these risks to near de minimis levels. And our approach is really three pronged.

On the front end, make sure that we understand the risks that are associated with particular timberland property before we bring it into the portfolio. And so that goes to your question about climate risk. We actually are using climate risk tools to understand the risks in the current state, as well as under various climate change scenarios to assess how that risk will change and whether we feel that we are able to effectively manage that over the long term. If we feel that we're not, then we're actually not going to bring that investment opportunity into the portfolio for our clients. But in the case that we do, we then seek to develop a diversified portfolio. So I mentioned some of the geographies we're invested in around the world. We generally would not expect a single risk event to impact a globally diversified portfolio. So that also helps significantly mitigate the risk. And then ultimately, in the event that a risk event does occur, that's where the importance of having an integrated team on the ground comes in to, is very important because A, we're actually able to identify risks early and react quickly with appropriate treatments. And in the event of a catastrophic, a natural catastrophe, for instance, then we're able to respond quickly to help salvage the value and we're often able to salvage in excess of 50%. So taken all together, we've been tracking losses from all types of these risks over the long term for over 30 years now. And on average, we found that the loss to our investors based on a percentage of asset value has been in the range of approximately 10 to 12 basis points annually. as I mentioned, we can never completely eliminate these risks. They are inherent and natural to the asset class. However, we've been quite effective in significantly mitigating them over the long term.

Nimar Bangash (26:07)

Yeah, no, mean, that's sort of a nice hard number in terms of just quantifying the impact of some of these risks to the portfolio and 30 years is obviously a long period of time to make that assessment. Really interesting, kind of continuing maybe in a slightly different direction now to talk a little bit about the current economic environment. You know, we've come out of a fairly low for long kind of interest rate environment and there's been just a general change in the market regime now now in some parts of the world We are seeing some moderation and inflation and interest rates, but it's mixed right Canada You know cut rates twice over the last couple of quarters the U.S. is still looking at this other parts of the world are increasing interest rates so What is the relationship between  timberland and macroeconomic know, factors and how is the asset class kind of position for the current market environment?

Mike Strzelecki (27:07)

Yeah, so I mean, the biggest impact that we've seen in the way that the sharp rise in interest rates has impacted the market is in terms of housing, right, and specifically housing affordability and construction. So in the US, we've seen housing starts retreat back from the peaks that were reached during COVID. And they still remain much higher compared to the decline that we saw during the global financial crisis. So on a relative basis, the market has been much more resilient. Similarly, finished wood products, the prices for products like lumber and panels kind of went bananas during the COVID pandemic period, reaching multi -year record highs and have since corrected from those highs and leveled out at more sustainable levels. That said, we've not actually seen that type of volatility and value change in the Timberlands that we manage and the underlying raw material pricing that we've seen in other asset classes. So in a sense, timberland has actually done exactly what it's supposed to throughout this market cycle, which is what I mentioned at the outset, provide that stability and resilience to investor portfolios during this period of increased volatility. so, know, Timberland investments tend to be unlevered for the most part, perhaps, you know, modest levels of leverage. I think that's been another factor that's contributed to their resilience during this period of steep rise in interest rates.

Nimar Bangash (28:49)

Great.

Mike Strzelecki (29:00)

And at the same time, we've seen increasing demand for timberland investments while the supply remains relatively limited. So there's a tight supply demand balance and I think that has helped support valuations as well during this most recent period.

Nimar Bangash (29:18)

Yeah, and I mean, that just, again, intuitively makes a ton of sense. Like, you know, I think population growth and other demographic changes globally and urbanization are just generally making forest land less and less. The supply continues to decline. So I would imagine that just based on that alone, you're seeing longer term value appreciation of forest land. Is that fair comment to make?

Mike Strzelecki (29:45)

Yeah, that's right. Yeah, we haven't seen the types of value correction that there's been in other markets like real estate, for example. We've seen valuations continue to hold up and be quite resilient.

Nimar Bangash (29:47)

Okay, so Michael, we're kind of at the bottom of my list of questions and I typically always end off on this note, which is really looking ahead and your view and your firm's view on the opportunities set over the medium to long term. specifically with timberland, what are your views on timberland investing over the next sort of five to 10 years and what are some of the key themes and trends you're paying attention to?

Mike Strzelecki (30:30)

Yeah, so as I mentioned, think Timor -Leste is quite well positioned in the current environment and is benefiting from several tailwinds as we look into the medium and long term. In the US, we see a continued imbalance between housing stock and demand. This has been a result of years of underbuilding following the global financial crisis. At the same time, the demographics are supportive on the demand side, right? So you have the largest cohort of the US population and their prime household formation age, and that is going to be followed not too far behind with another big cohort of the population entering that prime household formation age. So that's a fundamental tailwind. And additionally, you mentioned world population growth. That's absolutely a trend that impacts the fundamentals of the asset class as population grows and per capita income increases, it'll continue to provide demand for all sorts of wood products, including solid wood for building, as well as fiber for everyday products. As I mentioned, paper, packaging, absorbent, and hygiene materials, these are all products that will see higher demand as the population and per capita income grows.

Timberland also stands to benefit as wood products are generally used increasingly as a substitute for higher greenhouse gas intensive materials like steel and concrete in building materials, for example, as well as single use plastic and packaging. So that's another trend that we see and expect to continue in the medium to longer term. And then as investors are increasingly continuing to focus on decarbonization of the global economy, climate change mitigation and nature loss. Sustainably managed timberlands are quite uniquely positioned and offer nature -based solutions that are readily available and investable at scale. So we feel quite optimistic and constructive on the space as we look to the medium and long term.

Nimar Bangash (32:54)

Thanks, Michael, that was really insightful and I think a good way for us to sort of wrap up this episode and this interview. Really appreciate your time, it was a real pleasure to have you join. Thanks again.

Mike Strzelecki (33:08)

Thanks, Nimar. Appreciate the opportunity and look forward to talking with you soon.

1 IPE research, as of January 29, 2024. Ranking is based on total natural capital assets under management (AUM), which include forestry/timberland and agriculture/farmland AUM. Firms were asked to provide AUM and the as of dates vary from December 31, 2022, to December 31, 2023.