Does money grow on trees?

A tree-mendous way to prepare for retirement is to focus on alternative investments such as forestry, as Edward Daniels explains

With the double ­whammy of ­inflation and rock-bottom ­interest rates ­hammering the income of the retired ­population, the minds of many investors wishing to plan for their post-working lives are turning towards alternative investment vehicles.

As asset classes go, alternatives are a fascinating area. Their returns have a low correlation with standard asset classes (equities and bonds) and they are a good way to diversify a portfolio.

Alternative investments can range from property and commodities to private equity and hedge funds. You could be investing in tin mines or in a seed fund for entrepreneurs.

But one alternative asset class pricking the interest of investors, particularly those heading towards retirement age, is forestry.

Compared to the recurring ­volatility in the equity markets and the steadfastness of the returns in gilts, ­timber investments have proved to be exciting. The ten-year ­annualised rate of ­return is now 10.4% for forestry, compared to 3.7% in equities, 5.9% in gilts and 6.8% in commercial property.

For many investors with fingers burned by the equity markets and the burst commercial ­property ­bubble, trees could provide a ­welcome alternative. As an asset class, woodland is low risk and more akin to bonds than stocks, and so a more comfortable option for more risk-adverse retirees.

Timber also tends to perform best when stocks and bonds head south, so it makes a good balance to an investor's portfolio.

The merits of timber

One of the best - and obvious - ­reasons to buy timber is the simple fact that trees grow. It is this very truth that underpins the value of a forest investment. Unlike a crop of wheat, it is not necessary to harvest on a falling timber price.

As the trees grow, so the volume of timber increases, ensuring an increase in value throughout the ­period of the investment. Crop value is 85% to 90% of the value of a forest at maturity.

Though timber prices go up and down, research has shown the ­timber price has demonstrated better performance than any other commodity in the past 100 years.

Why is this? Unlike oil or a mined resource, there are no sudden discoveries of new timber reserves, which can affect the elasticity of supply.

Demand is strong and people will always need wood and paper. The global price of timber is on an upwards spiral, primarily driven by demand from BRIC nations (China, in particular).

Timber consumption is directly correlated with GDP growth, mostly due to its expanding use in house building for the burgeoning middle classes.

Therefore, inflation bodes well for the timber investor, due to the upward pressure this global demand puts on the price of wood. In this particular investment case, inflation is not a bad thing.

Another factor influencing ­supply is constraints on the global ­production of timber. A significant proportion of the world's supply comes from illegally logged and unsustainable regions, such as the Amazon in Brazil and various parts of south east Asia.

 Increasing levels of control and regulation will lead to a gradual decline in the supply of timber from these sources, which will in turn continue to push prices upwards.

Tax benefits

Despite the good returns and the benefits from rocketing ­commodity prices, the main appeal of UK forestry ­investment (­particularly for investors heading towards ­retirement) is the tax benefits.

Once a commercial forest has been owned for two years, it qualifies for 100% business property relief, meaning that there is no ­inheritance tax payable on the asset. The rise in the timber value is exempt from capital gains tax.

This is particularly ­advantageous for investors who buy a young ­plantation and later receive ­substantial income when the mature trees are harvested.

Income generated from the ­growing timber in commercial ­forestry is also exempt from both corporation and income tax.

A ­forestry investment is ­flexible in that returns can be planned (through timber harvesting ­schedules) around specific future events, such as paying for school or university fees.

For people heading towards their retirement, forestry is definitely a secret worth discovering. From the tax breaks through to the healthy returns (especially when compared against bonds and equities), timber has a proven track record.

Compared to brasher, more exciting asset classes, timber keeps a lower profile. But in terms of ­demonstrating a sound investment case, trees are hard to beat.

Edward Daniels is investment director at FIM Sustainable Timber & Energy LP