The other week, I wrote an article for MoneyWeek on timber investing, looking at some of the interesting properties of timber as an asset class and what drives returns. It’s probably behind the paywall right now, but will be free in a few weeks – or you can get a free trial to read it now.
In the article, I focused on well-established investments such as the US timber real estate investment trusts (Reits) but I subsequently received questions about unregulated timber investments that promise retail investors rather eye-popping returns. I don’t want to comment on specific schemes, but here are some general points to bear in mind about arrangements of this type, which I’ll post here as a brief addendum to the article.
Regulation of these schemes
The crucial difference between these arrangements and the established listed timber companies such as the US timber reits is that the most reputable listed firms generally have a long track record, good transparency, experienced management and are a known quantity. These unlisted schemes aimed at retail investors typically have none of these aspects.
The only significant information available is usually provided by the firm and/or marketing/research/consultancy sources paid by them. Consequently, any claims they make should be treated with immense caution.
Importantly, such arrangements are not regulated by the Financial Services Authority or – in general – any other credible regulatory body. This means that you will have no recourse to the regulator or the Financial Services Compensation Scheme in the event that you invest and something goes wrong.
It also means that there is no regulator scrutinising and approving their marketing material to ensure that it is accurate and complete. Some such arrangements are fond of claiming that they are permitted for investment within a self-invested personal pension (SIPP), implying some stamp of regulatory approval. This is entirely misleading since there is no approval process for SIPP investments – anything can in theory be held in a SIPP, although HMRC will levy penal rates of tax on certain assets.
This does not imply that all unregulated schemes are necessarily fraudulent, but for those that are not, there are still usually significant risks in the management of the investment, over and above the usual business risks related to the product. For example, in the case of a regulated investment from a reputable firm, the investment should hopefully be wound up in an orderly manner in the event that the management firm ceases trading. But if the manager of a small unregulated scheme ceases trading, this would not necessarily be the case.
Given the long investment period envisaged in timber investments, the question of whether the promoters and managers will still be around in a decade or two is very relevant. And in the event that they are not, it is unlikely that it would be easy or even possible for an individual investor to sell a small ownership stake in an overseas timber plantation at anything close to its supposed value.
Marketing of these schemes
The FSA has warned against the increasing promotion of unregulated investment schemes to retail investors.
This does not mean that any particular scheme is necessarily breaking the law – certain assets are exempt from the rules on investment promotions. But it does reflect the fact that there is significant concern that the low interest rate environment is increasingly encouraging investors to turn to unregulated schemes that promise better returns.
Owing to a few recent scandals (notably Keydata and Arch Cru), few UK financial advisers will recommend unregulated investment schemes to retail investors. Consequently, any firms that actively promote these schemes – especially by cold calling or other direct approaches – are highly likely to be commission-driven sales agents rather than genuine financial advisers. Hence, again, all claims they make should be treated with great caution.
Claimed returns on these schemes
There are many unregulated investments being promoted across a wide variety of assets, not just timber. Some of these are undoubtedly fraudulent (I am aware of at least one widely advertised one that does not seem to own the land it claims to own in South America). Others may not be explicitly designed to defraud, but may be improperly managed, run by people with limited experience in the area and have worse prospects than claimed, even if there is no underlying criminal intent.
An experienced institutional investor looking to invest in direct timber schemes should be able to assure itself that the timberlands exist and that title to them is secure, as well as making sure that the returns promised by the scheme are realistic. But it is extremely difficult for the individual investor to do similar due diligence on schemes of this kind.
However, while they can often do little in terms of confirming the existence and security of the land, individual investors can assess whether the claimed returns are possible. As noted in my article, historically well-managed US timberlands have delivered double-digit returns with low risk, but specialists believe that a real return of 6-7% per year looking forward would be a very attractive result.
These more exotic timber investment schemes typically promise returns of two or three times that. These returns are not completely impossible in certain parts of the world (as some of the figures in my article indicate), but sustained returns like this inevitably come with significant risk. If they don’t, the market will rapidly by swamped by other investors entering the same business, increasing supply and driving down returns.
However, these schemes often typically also indicate that they are low risk, often implying that returns are guaranteed or almost certain. The claimed returns and risk levels are generally not consistent with each other, suggesting that either long term returns will be very significantly lower or risks are higher. This risk/reward mismatch is of course the best case outcome, with the alternative being that the arrangement turns out to be a Ponzi scheme.