1. Chapter 13 The Role of Real Assets
Portfolio Construction, Management, & Protection, 5e, Robert A. Strong
Copyright ©2009 by South-Western, a division of Thomson Business & Economics. All rights reserved.

2. Gold still represents the ultimate form of payment in the world.
Alan Greenspan

3. Introduction Real assets:
Are assuming an increased role in some of the country’s largest pension funds and in private investor portfolios
Include timberland and gold
Do not have a corresponding liability unless one is created to finance the purchase of the real asset
Most portfolio investments are real assets
Stocks
Bonds
Bank certificates of deposit

4. Real Estate Investment Characteristics
Immobile
Land cannot be moved
Indestructible
Land cannot be destroyed
Nonfungible
Every plot of land is unique

5. Real Estate Investment Characteristics (cont’d)
Characteristics of land (cont’d):
Land is typically a long-term investment
Especially for institutional timberland owners
Land can be a short-term investment
e.g., timberland may be used for development or the extraction of minerals

6. Real Estate Categories
Residential
Commercial
Industrial
Farm
Special Purpose
Owner occupied
Office buildings
Light manufacturing
Timberland
Cemeteries
Rental
Store properties
Heavy manufacturing
Pastureland
Churches
Lofts
Mining
Ranches
Government properties
Theaters
Orchards
Golf courses
Garages
Farmland
Parks
Hotels and motels
Public bldgs. and streets

7. Developed and Undeveloped Property
Developed property is land with improvements on it
e.g., shopping malls and apartment complexes
Purchased by investors for:
Income-producing characteristics
The tax advantage from depreciation of buildings

8. Developed and Undeveloped Property (cont’d)
Undeveloped (raw) property has no improvements
e.g., undeveloped lots
Investors purchase undeveloped property:
To speculate
For timber, crop, or livestock production
For the production of subdivided lots for resale or development

9. Pension Fund Investment in Real Estate
U.S. pension funds have over $170 billion invested in real estate
Office buildings (33%) and malls (30%) account for most of pension funds’ allocation to real estate
Real estate investment trusts (REITs) are popular and convenient to purchase real estate
Ownership, and cost, is divided into many shares

10. Timberland
Timberland is a very viable investment form of real estate for large portfolios
The U.S. encompasses about 2.27 billion acres, of which about 20.9 percent are timberland

11. Institutional Interest in Timberland
Innovative forms of ownership in timberland have been developed:
Public limited partnerships
Closed-end investment companies in timberland
Securitized units of timberlands or forest product companies

12. Institutional Interest in Timberland (cont’d)
Examples of institutional interest:
In 2001, Harvard Management put 6 percent of its portfolio into timberland
In 2008, California Teachers’ Retirement System increased its real estate percentage to 10 percent, or $17.4 billion
Timberland investment management organizations (TIMOs) managed about $16 billion in timberland near the end of 2006

13. Portfolio Aspects of Timberland
Loans are routinely secured with timberland by life insurance companies
Timberland serves as a strategic investment when owning it:
Helps ensure the long-term viability of a company or
Reduces the volatility of a company’s cash flows

14. Timberland as a Pure Investment
Portfolio managers hold timberland as a pure investment:
The property is held for its own investment merits
The property is not held as part of a strategic plan or to assist in project financing

15. Timberland Investors
The largest current owners of timberland for pure investment purposes are:
California Public Employees Retirement System
John Hancock Financial Services
New Hampshire State Employees Retirement System

16. Timberland Ownership in the United States (thousands of acres)
Owner Class
1952
1970
2002
Federal
103,124
107,108
147,278
State, County, and Municipal
27,216
29,010
37,559
Forest Industry, Farmer Owned, and Other Private
358,269
363,576
356,261
Total Timberland
488,609
499,697
541,098
Total Forestland
664,194
753,549
748,923
Source: Agricultural Statistics” 1956, 1976, 2004, United States Department of Agriculture, U.S. Government Printing Office.

17. Timberland Returns Timber grows on the land and is sold and renewed
Growing timber is stumpage
The value of a stand of timber depends on:
The volume of wood on the acreage
The size and quality of the trees
The market price of the species of forest products

18. Timberland Returns (cont’d)
A timberland investor’s return is a function of:
The acquisition cost and selling price
Site productivity
The ability of a site to grow timber depends on weather, soil conditions, etc.
Management competence
Silvicultural practices and management strategies can affect return

19. Timberland Returns (cont’d)
A timberland investor’s return is a function of (cont’d):
Market price
Investors have substantial discretion in regard to time of harvest
Price is influenced by the relative size of trees on the land

20. Biological & Productivity Risks
Biological risk is the risk of loss due to natural events:
Fire
Insects
Disease
Wind
Productivity risk refers to the possibility that a stand of timber will not produce the anticipated volume of wood due to:
Species competition
Drought

21. Economic Risks Price Demand Liquidity Management risk means that
poor management practices can erode the value of timberland
Liquidity risk
relatively limited market for timber and timberland
Regulatory risk
statutes and ordinances limit forest management and land use options

22. Problem of Lack of Information
Problems with constructing a standard timber index:
Must consider the growth in timber volume
Must consider the low volatility associated with land
Focusing on timber prices alone biases the return downward and biases volatility upward
Timberland is nonfungible

23. Problem of Lack of Information (cont’d)
Examples of timber indexes:
Wachovia’s Timberland Performance Index (TPI)
The Warnell School’s Timber Mart South
Log Lines
National Council of Real Estate Investment Fiduciaries

24. Timberland as A Portfolio Component
Virtually all studies of timberland find very low or negative correlation between timberland and other investment alternatives

25. Timberland Correlation Coefficients (1960–2002)
0.39
Inflation
–0.32
Long-term corporate bonds
0.04
Treasury bills
–0.14
International equities
–0.10
Small cap equities
–0.17
S&P 500 index
–0.08
Commercial real estate
1.00
Timberland
Correlation Coefficient
Investment
Source: Data from Hancock Timber Resource Group. “Timberland as a Portfolio Diversifier,” Research Notes, 2003.

26. Future Timberland Prospects
An increasing number of portfolio managers may discover timberland as an investment:
Asset allocation strategies are in vogue
Pension funds will probably continue to be the principal private investors

27. Index Problems
The lack of a consistent timberland index is the single biggest barrier to increased investment by pension funds:
Continuous pricing by the market is difficult due to:
Lack of liquidity
Timberland is not an exchange-traded product
Regional variations
The appraisal-based nature of timberland

28. Social Risk
The timber industry considers forestland to be a renewable resource
Many environmentalists do not consider forestland to be a renewable resource
The length of reforestation depends on the species

29. Real Estate Investment Trusts
A real estate investment trust is a convenient means of investing in a portfolio of real estate properties
It is essentially a closed-end investment company including real estate
It usually owns and operates a variety of forms of income-producing real estate

30. REIT Distribution Rules
As long as a REIT distributes at least 90 percent of its taxable income to its shareholders, the firm is able to deduct the dividends from its corporate taxable income
Most REITs distribute all their income and pay no federal taxes

31. Types of REITs
Equity REITs own and operate income-producing real estate
Probably the most popular and common type
Mortgage REITs buy mortgages or lend money directly to property purchasers
Hybrid REITs own and operate properties as well as engage in the financing of property

32. Types of Real Estate Value
Market value is “the most probable price which a property would bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller acting prudently, knowledgeably and assuming the price is not affected by undue stimulus”

33. Types of Real Estate Value (cont’d)
Fee simple value is a measure of what a property would be worth if there were no leases encumbering it
Leased fee value is the value of the property given its existing leases
Leasehold value is basically the value of the lease

34. Types of Real Estate Value (cont’d)
Investment value is the value of a property to a particular investor and may be more or less than market value
Assessed value is the basis on which the city levies property taxes

35. Motivation for Gold Investment
People often buy gold because of the security it is expected to provide during times of trouble
An insurance policy against inflation
Particularly pronounced in Europe
A currency without a country

36. Motivation for Gold Investment (cont’d)
Gold can be an attractive investment because:
Gold has demonstrated returns that are unrelated or even opposite to those of the stock market
The correlation between the Philadelphia Stock Exchange’s gold and silver index and the S&P 500 index since 1986 has been –0.04

37. Determinants of the Price of Gold
The strength of the U.S. dollar
Influenced by trade balances and protectionism concerns
The strength of foreign currencies
Stronger foreign currencies decrease the value of gold measured in the home currency for foreign investors

38. Determinants of the Price of Gold (cont’d)
Inflation and rising oil prices
An increase in the price of oil raises fears of inflation and an increased price for gold
International finance uncertainty
Investors turn to gold as a result of mounting debt, third-world loans, etc.

39. The London Fix
The London fix is the price of gold that reflects the relative buy and sell orders that have been placed with member firms of the London Gold Market
The fix is determined twice each day at 10:30 a.m. and 3:00 p.m. London time

40. Gold Bullion Gold bars are bullion
There are different sizes of gold bars (see next slide)
Investors can acquire smaller quantities of gold:
1-ounce bars
Nuggets
Gold dust

41. Equivalent Troy Ounces
Gold Bullion (cont’d)
Unit of Weight
Region Where Used
Equivalent Troy Ounces
One Troy Ounce
USA, UK, Australia —
100 Grams
Globally
3.2151
10 Tola
India, Pakistan, Middle East, Singapore
3.75
5 Tael
Hong Kong, Taiwan, China
6.017
10 Baht
Thailand
4.901
5 Chi
Vietnam
0.603
10 Dons
Korea
1.206

42. Gold Bullion (cont’d) Shortcomings of bullion: Subject to theft
No income productivity
Lack marketability

43. Gold Certificates Gold certificates are:
Obligations of the issuer to deliver gold upon demand
Issued by banks
Registered in your name
Readily sold back to the dealer
Gold certificates have the risk that there is no gold backing them

44. Shares in Mining Companies
Purchasing shares in mining companies is the most popular form of gold ownership in the U.S.
South African mining companies
Some mutual funds specialize in gold or other precious metals

45. Shares in Mining Companies (cont’d)
Owning shares in mining companies or mutual funds has advantages:
Shares are instantly marketable
Shares can generate some income through dividends

46. Coins Gold coins are popular with investors and gold speculators
A coin’s intrinsic value is the higher of:
Its bullion value
Its fiat value
The value assigned by the issuing government

47. Popular Coins for Investment
American Eagles
Australian Nugget
Austrian Philharmonic
Canadian Maple Leaf
Mexican Peso
South African Krugerrand