Prudence. We harvest the biological “income” and don’t touch the “principal.”
Tropical timberland is a unique, undervalued, and disappearing asset class. Through Sustainable Forest Systems investment vehicles, it can provide true portfolio diversification, strong cash flow generation, and substantial environmental and social benefits.
There are no good substitutes for tropical timber in many commercial uses, and most tropical timber species native to rainforests cannot be grown on plantations. As a result, 300 years of felling tropical timber has reduced the world’s rainforest acreage by about 40 percent, with unacceptable consequences for forests, communities, and climates.
But there is another way: Use classical forestry practices to selectively cull tropical timber while simultaneously preserving forests. That’s what SFS, whose operations have been certified by the Forest Stewardship Council (FSC), has been doing in South America since 1991.
Principles & Approach
Together for decades, our multi-cultural team members have a deep collective expertise in forest management, ecology, markets, sustainable development, community work, and operations.
Long before sustainability became a universal buzzword, SFS was founded on the principles of sustainability in three areas – the environment, social relationships, and investor returns.
Our work principles are best expressed by the Golden Rule applied to people, planet, and profits: Treat others as one would like others to treat oneself.
Applied to tropical forests, this means that we only harvest the biological growth. That typically means harvesting between five to ten trees per hectare every 25 years. In financial terms, we harvest the interest (biological growth) while keeping the principal (main forest structure) untouched or improved.
Harvesting only biological growth means we need an extensive forest, which we protect as a functioning nature reserve maintaining biodiversity, ecosystem functions, and wildlife corridors. And, because there are many species, we also need a lot of land to be able to offer commercially important volumes of forest products. In Bolivia, our land base was a little smaller than the state of Delaware in USA.
The Golden Rule applied to local residents provides the basis for sustainable communities, which have long term forest access, ability to create value within the forest, and long-term relationships based on economic opportunity, mutual respect, and transparency. These aren’t just words; we’ve been operating for over 20 years based on these principles.
The application of the Golden Rule to investors and customers means treating people well, keeping our word, and being transparent in all of our dealings. We seek long-term relationships with those as committed to the forest as we are.
We prize our trustworthy and transparent relationships with customers, vendors, and investors who believe as we do that tropical forests are too valuable to disappear.
With the myriad global investment opportunities available, why invest in sustainably managed tropical timberlands in natural forests?
Sustainable Forest Systems’ investment thesis is simple: Investing in high value resources in low value environments creates the opportunity for excess returns.
While timber has a well-deserved place in portfolios, it’s typically softwood timber grown in industrial forests. Both softwood timber and industrial forests are low value resources and have been planted to excess. But tropical forests and sustainably managed timberlands are high value resources and are both globally in short and decreasing supply and therefore, when combined, provide superior returns.
After clear-cutting, tropical high-grade hardwood rainforests cannot be regenerated; only sustainable forest management provides the hardwood commodity long-term. A bull market in tropical timber species has been in effect for at least two decades; some experts say it has been intact for centuries.
Typical Plantation Investments
In contrast to high value tropical timberlands, softwood plantation investments exhibit almost the exact opposite characteristics of tropical hardwoods including:
Increasing supply and planting.
No barriers to entry.
High volatility compared to natural hardwoods.
Long-term real price decreases.
Low operational flexibility.
High correlation with traditional investing assets
High Value Tropical Timber
The fundamentals of tropical hardwoods are very strong and include: Huge biological barriers to entry erected over millions of years of evolution.
Dwindling amount of the timberland asset.
Robust and increasing product demand for certain uses where tropical hardwoods are the low-cost and most favored material.
Low volatility compared to softwood stumpage.
Long-term real price increases.
Operational flexibility through a wide range of diverse species and cutting cycles.
True diversification for portfolios composed of more traditional investing assets.
Moreover, current and long term supply, demand, and inventory dynamics of tropical forests are all very constructive for a continued long-term bull market.
Tropical forest quantity is dropping worldwide at a rate of 0.50% – 1.0% per annum. Quality of existing forest continues to degrade at higher rates.
Worldwide, government data on natural forest extent has been seriously overestimated by approximately 40%.
For readers who are interested in USA domestic timberland we suggest contacting Dr. Jack Lutz at Forest Research Group, who authors a terrific quarterly newsletter.
One of the questions we hear most often is “How can you make money for investors if you harvest so few trees so infrequently?” The answer is that the trees are relatively valuable and the land is relatively inexpensive.
For example: We harvest the biological growth only. That biological growth might be one cubic meter per hectare (2.47 acres) per year. Although this growth is expressed as cubic meters per hectare per year, it is important to remember that we harvest this growth on any particular hectare only once every 25 years, or after approximately 25 cubic meters of timber has regrown on that particular hectare.
Assume that one cubic meter of mature timber is worth approximately $50 as a standing tree.
Assume a hectare of tropical forest is worth $400. Current yield is calculated by dividing value of timber by the cost of the land required to produce that timber, or $50/$400 or about 12.5%.
However, that calculation applies only to standing timber. Manufacturing in the tropics is an essential activity to capture fully the arbitrage between relatively inexpensive tropical trees and high value international forest products markets. Typically, adding manufacturing will generate significantly higher returns than timber only.
SFS does its own manufacturing, typically primary forest products that will be used by other forest products manufacturers to complete their products. Examples of such products include lumber, rotary veneer, and plywood. Manufacturing in the tropics is an essential activity to capture fully the arbitrage between inexpensive tropical trees and high value international forest products markets. That’s because most governments in the tropics ban the export of logs. With access to manufacturing facilities timberland owners can fully capture the complete range of value that tropical hardwood markets provide.
Tropical hardwoods play an essential role in manufacturing for the global forest products markets. That’s because these hardwoods are frequently the low-cost components for many forest products manufactured from both softwood and hardwood resources. Tropical hardwoods also have some unusual working characteristics that make them prized, and in some cases, indispensable, for forest products.
This is not a new trend. Since the 1600s tropical hardwoods have filled supply voids created by the absence of both quantity and quality of accepted temperate species. For example, in the 1600s mahogany from British Guyana supplied British markets lacking suitable native oak.
SFS focuses mostly on primary manufacturing such as plywood, veneer, and lumber products.
We typically use North American and European plant managers in manufacturing operations to guarantee product quality and delivery schedules. The remainder of manufacturing operations are staffed by local experts and team members.
We founded Sustainable Forest Systems in 1991 to generate financial, social, and environmental returns through sustainable management of native tropical forests.
Although our investment thesis is rooted in the fundamental analysis of tropical forest and hardwood supply/demand, the constraints of managing species diverse, tropical forests within a long-term framework require us to use a sustainable business model that puts the forest first. ”Putting the forest first” means only taking the biological growth (dividends) and not touching the principal. The SFS forestry team ensures that we don’t exceed biological limits and we voluntarily have third parties confirm our work by operating under Forest Stewardship Council (FSC) certification. Sustainable forest management creates an organizational mindset that encourages us to look at our business from the perspectives of our employees, our investors, and the communities we work in.
We are fortunate to operate with three structural advantages:
The basic resource is diminishing in extent and quality. We want to be long-term investors so that we can provide reliable fiber supply for customers, improve forest utilization by introducing lesser known species to customers, and capture real price increases as well as quality difference as our forest increases in quality while other forests decrease. We operate in relatively inefficient markets and can generate excess return from both efficient operations as well as market inefficiencies.
Sensible business design allows us to have a large positive social and environmental impact without trading off returns. We could produce higher returns by over cutting or converting the forest to farmland; that isn’t our model, nor is it where our values lie.
Our approach to impact investing is first to create business units that are self-sufficient and profitable enough that investors will fund them. Second, we look for investors who share our values of long-term investing and sustainable management. Third, we work to involve our local partners, employees, vendors, and communities in as much wealth creation as possible