The index represents the cumulative value of ordinary dividends paid by the stock components of the 30-member benchmark index, the Straits Times Index, and will pave the way for “creating products like derivatives, tracker funds, exchange-traded funds and other structured products,” according to a statement sent to the exchange.

The benchmark has gained 10% this year.

The dividend index will run on a calendar year basis with reviews in March and September to take into account any changes in the index components, according to the statement.

Well, this is very likely that it will pave the way for a Singapore Dividend Select ETF which would be good for investors who are fans of low cost ETFs. If its local ETFs priced in SGD it will be best, but it will depend on the aggregate dividend yield of the basket of stocks.

Some of the best criterias would be:

1. Dividend growing for the last 5 years
2. Dividend with less than a fixed payout ratio

This would be very similar to the SGX list dividend ETF DJ STOXX Global Select Dividend 100 index. But I struggle to find a lot of Singapore Companies that fit that criteria.

Nevertheless, it is interesting to see how this develops.

I thought i will put this up as well. Its a good article that its not all about saving and not having fun. its finding the right balance in life.

From Portfolio.com:

A reader writes:

As a “younger investor” myself looking for ways to
retire with millions (we can all dream), I’ve been trying to start
early and doing my research to figure out ways to gain an advantage in
the long run. Starting young is always helpful. But the idea of timing
the market makes me nervous. At the same time, with the market in the
dumps – isn’t this the best time, as a 20-something, to jump in and
fill my retirement portfolio exclusively with stocks? Maybe if I close
my eyes and look away for a year, when I look back there will be a nice
ROI.

She wrote this in response to my blog entry in June about research saying that if you’re young and investing for retirement, it’s a good idea to take a lot of risk — perhaps even more
risk than putting everything in stocks. But do read the comments on
that blog entry: they’re all very smart, and there are indeed good
reasons not to borrow the money you’re saving for retirement.

What that means is that the first thing you do, if you’re in your
20s, is pay off your credit cards and all your other debt, with the
possible exception of any low-interest-rate student loans you might
have. Only once you’ve done that should you even think about saving for retirement.

But the second thing you should do, frankly, is think seriously
about spending your income rather than saving it. People in their 20s
get more value out of every marginal dollar than they will in their
30s, 40s, or 50s. Steve Levitt puts it really well:

The right reason to save is so you can even out your
consumption. When times are good, you should save, and when times are
bad, borrow.
Most likely, I would never be as poor again as I was starting out. That meant I should have been borrowing, not saving.

There’s a reason why it’s commonplace for parents to give or loan
money to their children, while flows in the other direction are rare
indeed: older people, as a rule, have more money — which means that
one dollar is worth less to them than it is to their kids. When you’re
in your 20s, a couple of hundred dollars can significantly change your
standard of living; when you’re in your 40s, it probably won’t. (And if
you do find yourself, in your 40s, at a point in your life
where a couple of hundred dollars will significantly change your
standard of living, I can assure you that having saved more in your 20s
wouldn’t have changed anything.)

If it hurts to save, then, don’t. You’re only young once: enjoy it.
No matter what the financial-services industry would have you believe,
now’s not the time to worry about your income when you’re 80.

Okay, now we’ve got that out of the way, let’s say you’re in your
20s and you do have some excess cash you want to use for retirement –
maybe you’re in the fortunate position of having an employer who’ll
match your retirement savings, or something like that, in which case
it’s a much better idea to try and maximize those 401(k) contributions.

In that situation, then yes, putting your savings 100% into stocks
makes sense. The worst that can happen is that your retirement savings
go down — but since you weren’t going to touch this money until you
were in your 60s anyway, that makes zero difference to your present
standard of living. Meanwhile, if your investments go up, as stocks
usually do, then you’re precisely where you want to be: leveraging the
magic of compounding for decades.

The key insight here is that you’re making relatively small regular
contributions to your retirement account. As you earn more money in the
future, those contributions will increase in size. The contributions
you make at the beginning of your career are small enough that only a
long period of good returns will turn them into something you can live
off in retirement. If those small initial contributions are wiped out,
you haven’t lost that much, by the standards of your 70-year-old self:
remember, older people are richer. On the other hand, if they do well,
then you’ll feel great.

So yes, if you’re saving for retirement, put 100% of your
contributions into stocks. (If you want to start getting sophisticated,
then maybe buy ETFs of other asset classes like real estate and
commodities, but let’s keep things simple for the time being.) You’re
not timing the market, you’re just giving yourself the maximum amount
of time to see that investment blossom over the decades into something
really substantial.

But if you’re not saving for retirement, don’t let the
financial services industry guilt-trip you into thinking that you’re
doing something horribly wrong. Retiring with millions is all well and
good, but don’t let it prevent you from going out and having fun today.

Here in an audio interview at financial sense, the author explains

• What are ETFs
• What are active ETFs
• How does ETFs work
• What are the advantages of ETFs

I find that this is a really good primer to know more about ETFs when you are relaxing. Do listen to it.

[Podcast: All you need to know about Exchange-Traded Funds]

The best way to describe my feeling after reading this second article is like buying that candy and realise it didn’t taste that well to awful.Here George Nichols outline that in truth, timber investing is but a myth for the average investors. The ETFs and the REITs out there are not pure play in these sector and thus, will not take advantage off the benefits that we have stated in the previous article.

This is comparable to investing in a energy fund and realise that hey, its got a sort of problem that the underlying oil does not have! We been here a few times wih Gold and Oil at record prices yet the funds don’t perform up to expectation and this seem to be an excellent primer from us investing in another one of those situation.

How to invest in timber

by George Nichols | June 22, 2008

Introduction

As noted in my previous article, timber has delivered high risk-adjusted returns while serving as an excellent portfolio diversifier and a partial hedge against inflation.

Despite the compelling case for this asset class, the world of timber investments is fraught with peril. I’ve been disturbed by the misleading statements made by product marketers — and troubled by the misconceptions perpetuated by media outlets — regarding this asset class. I hope this article will debunk the myths that are leading investors to make costly mistakes. Before I elaborate, let me review the ways investors access this asset class.

The most direct option is to buy your own forest, which is as impractical as stuffing your basement with oil barrels in order to gain commodities exposure. Instead, what ultra-wealthy individuals and large institutions usually do is invest through timber investment management organizations (TIMOs). TIMOs typically require a minimum investment of several million dollars, putting them beyond the reach of virtually all individual investors, as well as many institutions.

Ordinary investors seeking timber exposure have instead turned to specialized ETFs or real estate investment trusts (REITs), whose pros and cons I’ll review.

Timber ETFs: A sector bet disguised as an “asset class”

In November 2007, the Claymore/Clear Global Timber Index ETF (CUT) became the first American timber ETF to hit the market. On June 25, 2008, it was joined by the iShares S&P Global Timber & Forestry Index Fund ETF (WOOD), which had already been trading in Europe (WOOD.L) since October 2007.

Promoters have suggested these ETFs provide smaller investors with an excellent way to access the asset class of timber. Perpetuating such myths, numerous media articles have provided favorable or uncritical portrayals of these vehicles, which have attracted many investors.

But the conventional wisdom is wrong. Timber ETFs actually do not provide investors with direct access to this asset class.

These ETFs are broadly focused on forestry/paper stocks, which lack most of the benefits associated with timber investing. CUT’s top holdings include International Paper (IP), a manufacturer that derived only 2.1% of its revenue in 2007 from timberlands. CUT shareholders who think they’re diversifying into an attractive asset class are actually making a questionable sector bet.

Timber ETF Correlations

To gauge whether CUT is an effective proxy for timber, I calculated the correlation coefficient of its annual returns (using its backtested results since 2002) relative to an established timber benchmark, the NCREIF Timberland Index.

(As a cautionary note, let me emphasize that the statistics I present throughout this article are historical rather than predictive, and based on a very limited time sample, reflecting what little data is available.)

So, what is a correlation coefficient? In a nutshell, a score of -1.0 indicates one investment has tended to go up while the other asset has gone down, 0.0 indicates the two move independently of each other, and 1.0 indicates both investments tend to move in unison. I’d say a decent timber proxy would score at least 0.80.

My calculation indicates CUT isn’t even close to being a timber proxy, registering a -0.23.

However, this calculation is based on a short time period, and I suspect longer-term correlations aren’t quite so negative. So, I tested CUT’s self-selected benchmark, the Dow Jones World Forestry & Paper Products Index, using available historical returns from Jan. 1991 thru Dec. 2007. The DJ-WFPPI index scored just -0.03, indicating no correlation with timber. Granted, CUT has somewhat less exposure to manufacturing than this benchmark does, but the variance isn’t nearly enough to make CUT resemble a timber proxy.

To put these figures into perspective, investors would do a much better job (albeit still a poor one) of tracking timber by buying an S&P 500 index fund. Ultimately, CUT shareholders need to ask themselves why they are making a bet on the paper/forestry products industry.

(click on any graphic to see all graphics in full size)

Comparing the timber ETFs

Timber assets significantly increased in value during the recent stock market downturn, however the market has not been so kind to paper/forestry stocks. Since CUT’s launch, the ETF has plunged around 20% (through June 20th) while WOOD has fallen “only” around 10%. So far, WOOD’s returns have tracked the S&P 500 somewhat closely, implying low diversification benefits.

Based on my assessment of the ETFs’ underlying portfolios, I’d say WOOD boasts somewhat greater timber exposure, which may explain why it suffered a milder decline during the recent market downturn. Most notably, WOOD’s exposure to timber REITs (24%) is double that of CUT’s (12%). Nonetheless, as with CUT, WOOD’s fatal flaw is its heavy exposure to wood manufacturing and distribution businesses. I’d say timberland-related sales account for less than 20% of total revenue among the combined holdings of these timber ETFs. And this exposure is indirect via equities, rather than directly through ownership of trees.

Timber vs Manufacturing

In my view, the costliest error that investors make is lumping together the unrelated industries of timberland management and wood manufacturing. Both markets deal with wood; however, there’s a dramatic difference in their underlying economics.

In addition to high labor and energy costs, wood manufacturers are burdened with heavy capital expenditures for equipment and facilities. In fact, academic research suggests the pulp & paper industry may be twice as capital intensive as any other major US industry [1]. All told, mill operators are notorious for poor operating margins, highly cyclical results, capacity problems, depreciating assets, high debt loads, and much higher tax rates compared to what REITs pay for their timber harvests.

By contrast, trees are relatively low-maintenance assets. After all, trees have grown successfully for nearly 400 million years without human assistance. The key ingredients for tree growth — soil, sunlight, air, and water — are readily provided by Mother Nature at no cost. Timber may be the only asset in existence that reliably exhibits physical growth for decades with little involvement from the owner. [2]

Nevertheless, there is a widespread misconception that timber and manufacturing assets are comparable. I was disappointed by a recent Barron’s article [3] that used an invalid data point to support their assertion that timber REIT Plum Creek was overvalued:

“…Plum Creek shares also trade at 3.8 times book value — compared with 2.6 for Potlatch and 1.4 for forest-products companies.”

In this case, book value isn’t meaningful because accounting practices understate the value of timber assets relative to manufacturing assets, as these authors from Hancock Timber Resource Group explain (emphasis added by me) [4]:

US Generally Accepted Accounting Principles (GAAP) consistently understate the returns from timberland — book values cannot be written up as trees grow; and a noncash cost, “depletion” (similar to depreciation) is deducted from operating EBITDA to compute GAAP net income, despite the fact that the forest asset may be accreting in value [...]

The return to shareholders, whether measured by return on capital employed or return on equity, for integrated forests products companies has been comparatively low (5% to 7%), while returns from timberland have been far higher (as we will see below, the returns from US timberland have averaged 15.3% since 1987). Since integrated forest products companies are nothing more than a collection of timberland and manufacturing assets, the disparity of returns highlights the comparatively poor operating performance of the manufacturing assets.

In an email conversation with me, Daniel Rohr, an equity analyst for Morningstar, agreed with my opinion on book value. Rohr, who covers the paper and forestry industry, added: “In many cases, timberlands were purchased several decades ago, so not only does their book value fail to capture biological growth, but the power of plain ol’ compounded inflation as well. I can think of examples where certain parcels are held on the books at $10 or less per acre, when the current market value is well in excess of $1,000.” [5]

Timber REITs: How much timber do they really have?

There are three timber REITs: Plum Creek Timber (PCL), Rayonier (RYN), and Potlatch (PCH). Plum Creek stands out from the pack — it was the first timber firm to become a REIT, and its 8 million acres of American forests makes it the country’s largest non-government owner of timberlands.

Unfortunately, none of these REITs are pure-play timber firms. Rather than divest their manufacturing operations, the REITs have merely reorganized them into taxable subsidiaries. Thus, REIT shareholders are stuck with significant exposure to sawmills and paper mills.

This is why it’s important for investors to examine corporate SEC filings to figure out what they own. My reading of 10-K filing data indicates Potlatch shareholders have basically owned a manufacturer packaged to them in a “timber REIT” wrapper. As my graph shows, timberland-related sales (which I define as timber harvesting revenue plus real estate gains from the sale of timberlands) made up less than 17% of total revenue in 2007, while the other 83% came from manufacturing. Timber makes up a slightly greater proportion (28%) of revenue for RYN. Plum Creek has, by far, the highest timber exposure (71%), and is the only REIT that I’d have no reservations calling a timber company. (Pope Resources and Deltic Timber, also depicted in the graph, are non-REITs I’ll mention later in this article.)

Will Potlatch really become a pureplay REIT?

In April 2008, PCH announced that it was evaluating a potential spin-off of its pulp-based businesses. After those businesses are divested, the residual company will become “essentially a pure-play timber REIT,” exclaimed the company’s CEO in a press release. Excited investors sent the stock skyrocketing on this news. However, I came away underwhelmed after calculating some numbers for this hypothetical company.

Based on 10-K data, I determined that only 45% of the residual company’s revenue in 2007 would’ve been timber-related. That figure rises to 49.6% if I conservatively subtract revenue (based on my estimates) from a recently closed mill. Thus, the proposed Potlatch is shaping up to be a “half-timber play” (the other half being mills retained in its Wood Products segment). While that figure represents a big boost from its current 17%, it is well short of 100%, or even Plum Creek’s 71%.

REITs: Not a pure timber proxy

As a group, the three REITs exhibited fairly low correlations (ranging from .04 to .33) to timber during my sampled period [6]. (Deltic Timber (DEL), a non-REIT firm heavily involved in manufacturing and non-timberland real estate development, showed similar results.) While I anticipated these results for RYN and PCH, I was suprised that PCL — the sole near-pureplay timber REIT — exhibited such low correlation.

So, why haven’t these REITs shown greater correlations to timber?

Manufacturing operations may be the biggest culprit, as I’ve already explained. Hypothetically, manufacturing also gives rise to conflicts of interest. Unlike the TIMOs constituting the NCREIF Timberland Index, REITs may be tempted to prematurely harvest timber — or sell trees at deflated prices — in order to subsidize their mills.

REITs are also publicly-traded entities that are susceptible to the various economic factors affecting all equities. As a corollary to this point, TIMOs can afford to defer harvesting for years, but REITs may face shareholder pressure to cut trees prematurely in order to meet quarterly dividends or other short-term financial targets.

The REITs are unlikely to resolve this manufacturing-versus-timber tug of war anytime soon. In fact, Congress recently passed legislation (The “TREE Act” of 2008) that, in my opinion, strongly reduces the incentive for REITs or forestry companies (like Weyerhaeuser, which lobbied aggressively for this bill) to ever become pure-play timber REITs.

Also, REITs derive some of their timberland revenue from real estate rather timber harvesting. For instance, while 71% of Plum Creek’s sales is timberlands-related, 47% came directly from timber harvesting, while 24% was derived from the land that the trees are sitting on (e.g. selling forests to conservation organizations, or developing forestland for sale to residential property managers).

Lastly, it’s worth noting this data is merely a snapshot of the past decade, and I suspect correlations will increase in the future as these firms continue to divest manufacturing assets in order to focus more on timber.

POPE: a timber pure-play but not a timber proxy

More than 97% of Pope Resources’ (POPE) revenue is timberlands-related, so it is a pure-play. Pope exhibited a moderately high correlation coefficient of 0.67 during the sampled period. However correlation statistics fail to convey the high volatility of this micro-cap vehicle. During the 11-year span from 1997 to 2007, POPE either gained or lost more than 20% annually seven times, versus zero times for the steady NCREIF index.

POPE is a timber Master Limited Partnership. I’m not a big fan of MLPs, due to their tax complexity, including IRS K-1 forms and unfavorable tax rules for IRA accounts. Investors considering POPE may want to consult a tax advisor.

Wells Timberland REIT

At a glance, the Wells Timberland REIT looks like the real deal: a timber vehicle for small investors. This non-traded REIT, which began raising public funds in May 2007, requires a minimum purchase of only $5,000 and has moderate net income requirements. Another big plus: its portfolio is actually 100% timber-related. As with CUT, several stories from media outlets — including BusinessWeek, CNBC, and the New York Times — have mentioned this REIT in stories about timber investing.

However, my examination of its SEC filings uncovered many red flags. For starters, Wells levies huge upfront costs — up to 10% of the initial investment. There are also onerous redemption constraints — investors currently can’t sell shares unless they die or become disabled.

Shareholders will earn the privilege of selling out — for an additional cost of 9% — only after the fund pays down enough debt to meet the financial criteria set by its lenders. That may take a while, given the REIT’s dangerously high leverage, as measured by its debt-to-equity ratio. Generally speaking, a ratio of 0.5 or less is considered reasonable, while a ratio above 2.0 is poor. This REIT’s ratio of 33 is downright scary.

While the high commissions generated by this REIT make it extraordinarily popular among the financial advisors who sell it, I think it’s a terrible deal for investors. You can read more about the dangers of non-traded REITs in this discussion at the Bogleheads Investment Forum .

UK Timber Funds

Those seeking a viable publicly-traded timber fund have to look to the UK, which has multiple timber investment vehicles unavailable to Americans.

Phaunos Timber Fund Limited (PTF.L), which launched in Dec. 2006, is a closed-end investment company trading on the London Stock Exchange. The fund charges investors a management fee of 1.50% and a 20% cut of any returns exceeding 8% annually, plus administrative expenses. Recent performance has been excellent relative to its peers, as illustrated below.

Cambium Global Timberland Limited (TREE.L) is a closed-end investment company trading on the AIM market of the London Stock Exchange. It’s still too early to assess the performance of the fund, which launched in March 2007. Cambium manages timber on an environmentally and socially sustainable basis, which should appeal to socially responsible investors, as well as investors seeking returns from carbon credits. The fund charges management fees of 1% and 20% of any returns above 8%, plus administrative expenses.

Like Cambium, the Quadris Environmental Investment Fund manages timber on an environmentally and socially sustainable basis. The fund, which owns fast-growing teak plantations in Panama, does not trade on a public exchange. The minimum investment is 1,000 British pounds. The primary share class has delivered solid results since launching in late 2004, however fees are fairly high. The total expense ratio is 2.16%, which includes an annual management fee of approximately 1.3%. Purchases must be made through a financial advisor, who may charge additional fees. Shares may be sold with a 30-day notice, and there is a small redemption charge if shares are sold within five years.

Huge pent-up demand for timber investment vehicles

While few investors are aware of timber’s superior historical performance, those in the know tend to be extremely eager to invest their money.

The three investment products I’ve panned as being non-timber or financially dangerous have attracted tons of money. As of June 2008, investors have forked over roughly $80 million to the Wells Timberland REIT, while CUT’s assets have reached nearly $60 million (as of June 2008). In Europe, WOOD.L’s assets are around $12 million (USD), a figure that will increase after its debut in America. It’s quite remarkable that these flawed vehicles can raise so much money amidst poor market conditions.

In Europe, Cambium raised over $200 million (USD) for its initial offering. That’s impressive, but Phaunos has attracted a comparative tidal wave of assets. Its latest fundraising round will boost total funding to as much as $2.1 billion (!). This includes up to $600 million in an unsolicited offer from a European investment group loosely affiliated with Deutsche Bank.

So, in a span of 1.5 years, this fund has emerged from obscurity and is now on pace to become among the most profitable publicly-traded funds around. Will Phaunos become a victim of its own success? Its asset base may get so bloated that it’ll be difficult for the fund manager to find good deals in a market characterized by limited capacity.

Ironically, Cambium’s and Phaunos’ portfolio managers, as well as some of the funds’ holdings, are based in America. This begs the question: Why haven’t financial institutions rushed to offer the first bona fide timber fund in America, thereby reaping enormous profits from pent-up investor demand for this asset class? Instead, these providers have been more focused on issuing me-too products, or gimmicky ETFs (like the ones that narrowly track stocks of Wal-Mart suppliers or “gastrointestinal/gender health” companies). Though, in their defense, SEC regulations make it extraordinarily difficult to launch a timber product for the American retail market.

Conclusion

In theory, timber is an attractive asset class that merits consideration for a small slice (such as 5%) of an investor’s portfolio. But in practice, a genuine investment vehicle for the masses doesn’t exist, and I think investors are better off without timber rather than buying a quasi-timber vehicle.

I think PCL is the most attractive of the available options, even though it’s not a proxy for the NCREIF Timberland Index. Nevertheless, PCL reaps many of the benefits of this asset class, is an accessible and transparent large-cap vehicle, and boasts reasonable tax efficiency (unlike most REITs). While micro-cap vehicle POPE is a purer play, it is nonetheless much more volatile than timber is. It also happens to be an MLP, which has tax implications that are confusing and/or adverse for average investors.

In the past decade, several inaccessible asset categories have been made available to ordinary investors, including commodities, inflation-protected bonds, and managed futures. I think something similar will eventually happen for timber. In the meantime, desperate investors will have to move to the UK!

Summary

PCL: closest thing to a pure-play timber REIT
RYN, PCH, DEL: manufacturers with low timber exposure
POPE: timber pureplay, but a volatile micro-cap, and MLP-related tax headaches
CUT, WOOD: unattractive quasi-timber vehicles
Wells Timberland: many problems make it a terrible option
Phaunos: successful timber vehicle in UK
Cambium: new SRI timber vehicle in UK
Quadris: non-traded SRI timber fund in UK, solid record but high fees and illiquid

Here we at Investment Moats, we hope to to discover good asset classes or instruments that are obscure to most investors, especially Singaporean Investors.I first heard about timber sometime back but didn’t really follow up on this since I thought this is just another agriculture. Little did i know it is very wrong. In this first article by Index Universe, the author outline the historical returns of timber as an asset class that by itself, have a lower volatility, higher measurable long term returns then equities.

Most of all in potentially higher inflation times like this, timber does have a higher correlation to it then other asset classes.

Why the focus now? I think as Singaporean investors, we can expose to this asset class through ETFs. iShares S&P Global Timber & Forestry Index Fund ETF was recently listed and together with Claymore/Clear Global Timber Index ETF, they present viable option.

The question we ask ourself is whether it makes sense to invest in timber ETFs as a long term allocation in your portfolio.

Timber: Introduction To The Asset Class
Written by George Nichols

Timber products touch our lives on a daily basis, though few people have ever considered timber as a potential investment. That is gradually changing, however, as more investors discover the little-known fact that timber investments have generally outperformed stocks, bonds, and commodities over the long run.

How Timber Makes Money

The defining attribute of timber is its steady, long-term biological growth. A tree’s wood volume tends to increase 2% to 8% annually (varying by climate, species, and age). Compounding the effect of this biological growth, trees yield price gains when they grow into bigger product classes. For instance, a small tree that is only suitable for paper products may eventually grow into sawtimber, where it can fetch dramatically higher prices per ton and be used for products such as plywood or telephone poles.

An academic study found that biological growth drives more than 60% of total returns, while timber price changes and land appreciation account for the remainder of returns.

Returns And Volatility

The NCREIF Timberland Index, the standard benchmark for this asset class, increased 18.4% in 2007, versus a 5.5% rise for the S&P 500. Longer term, the Timberland Index has outpaced all the major asset classes depicted in the above graph (from Forest Investment Associates), except small-cap stocks. After factoring in volatility (as reflected in the Sharpe Ratio), timber has exhibited the highest risk-adjusted returns of the group. Timber returns have been particularly high over the past couple of decades, as illustrated in the second graph.

Relative to the S&P 500, timber has exhibited low downside risk. Since its 1987 inception, the NCREIF Timberland Index has declined only in one year: -5.25% in 2001. By contrast, the S&P 500 has fallen four times, including -22.10% in 2002.

Diversification, Correlations And Inflation Hedges

Timber can also improve a portfolio’s risk-adjusted returns by virtue of its fairly low correlation to most asset classes. This low correlation reflects the fact that the primary driver of returns�biological growth�is unaffected by economic cycles.

Correlation statistics have varied greatly depending on the time period, as you can see from the graphs below by Jack Lutz of the Forest Research Group. While the 1960-2006 numbers give an idea of long-term results, pre-1987 returns are based on a simulated index rather than actual returns, so post-1987 figures may give a better indication of what to expect in the future.[3]

Timber also exhibits a moderate correlation to inflation, and research indicates timber assets may serve as a good long-term hedge against unanticipated inflation.

More Tax Efficient Than Other Portfolio Diversifiers

Like stock gains, timber gains are generally taxed at the capital gains rate (usually 15%) rather than the ordinary rate (typically 25%), so investors in taxable accounts take home a greater proportion of gains. By contrast, much of the typical returns from bonds, non-timber real estate investment trusts (REITs), and commodities futures contracts are taxed at ordinary rates.

Risks

Physical risks�such as damage from fire or insects�can inflict significant losses, but not to the extent that many investors fear. Such losses usually erode returns by 0.1% annually, for timberland holdings that are well-diversified by geography, age, and species.[4]

In my view, the greatest risks are: 1) overpaying for timber assets, and 2) illiquidity (inability to readily sell assets).

Overpayment/Valuation Risk

No longer a “well-kept secret,” timber has been attracting plenty of assets from large institutions and ultra-wealthy investors.

This influx of money is chasing after a limited number of forests. This is particularly the case in the U.S.�American forest-product conglomerates largely finished divesting millions of acres of forests in the past decade. Thus, investors are increasingly looking overseas for deals.

Steve Holland, portfolio manager for the Campbell Group, told me in an e-mail interview that while there are opportunities overseas, they involve “political, currency, and tax risks.” Holland, who also serves as the NCREIF Timberland committee chair, says that currently “the U.S. is still the best place to invest, but over time institutional ownership of timberland on a global basis will become more prevalent.”[5]

Illiquidity Risk

Timber is strictly an asset class for long-term investors rather than speculators seeking a quick buck. Trees generate most of their returns through steady biological growth, and harvesting cycles are typically 15 to 40 years. Also, timber assets are difficult to sell quickly. As I’ll explain in my next article, some pure-play timber investment vehicles limit the timing or amount of sales by shareholders.

In the debate over active vs passive investing, the base-case assumption is that a passive investment involves tracking a stock-market index, normally the S&P 500. But of course stock-market indices are actively managed, with listing requirements and changing components and survivorship bias and that kind of thing. And according to a fascinating paper by Angelo Ranaldo and Rainer H�berle, actively-managed indices significantly outperform a genuinely passive buy-and-hold strategy.

More precisely, actively-managed indices outperform a passive buy-and-hold approach in up markets, and they underperform in down markets. But since the whole point of investing in stocks is that they tend to go up over long periods of time, one can conclude that there is a real outperformance here over the long term.

I’m not sure how the efficient markets hypothesis deals with this: as you can see from the table above, the degree of outperformance is large. And I don’t think it’s a self-fulfilling phenomenon, either, where the very fact of being included in an index causes a stock to outperform: the same phenomenon is seen in relatively unpopular indices which aren’t benchmarked.

But this is yet another reason to buy index funds rather than individual stocks. If you buy and hold your stocks like any good long-term investor should, you have to outperform substantially just to keep up with the index, let alone beat it.

More accurately, the fund-which invests in commodity futures contracts-has reached its position limits in some of its commodities. 

The commodity exchanges and the Commodity Futures Trading Commission set maximum amounts that certain investors can hold in individual commodities. DBA’s assets have soared recently, adding nearly $1 billion in assets in February alone (to hit $2.8 billion), and that asset growth has pushed the fund against CFTC position limits. As a result, as PowerShares DB said in this filing with the SEC, DBA has started trying to replicate the returns of the index by investing in futures that are similar … but not identical … to those in the index itself.

Right now, here’s the split between what the index tracks and what the fund actually holds.

First, it has started buying contracts with different expiration dates. For instance, the index tracks the performance of the corn futures contract expiring in December 2008. But the fund includes both that contract and a separate contract expiring in July 2008. Historically, those two have tracked very close to one another, but of course, that doesn’t have to be the case.

The second thing the fund has done is buy contracts on different exchanges. In the wheat markets, the fund has diversified beyond Chicago wheat contracts to buy contracts in both Kansas City and Minneapolis. But these contracts don’t just trade on different exchanges, they are actually different kinds of wheat: Soft Red Winter Wheat (Chicago), Hard Red Winter Wheat (Kansas City) and Hard Red Spring Wheat (Minneapolis).

These different varieties tend to perform in similar ways, but not always. They serve different kinds of markets and, because the harvests come due at different times, they can be impacted by different seasonal and weather patterns. Minneapolis wheat, for instance, has seen extraordinary gains recently due to near-term crop shortages.

Finally, the index has diversified into alternate or "derivative" contracts for soybeans, buying not just the beans themselves but soybean meal as well. These two products are related, but of course, they do not track perfectly.

Should any of this worry investors? Not necessarily. This fund still offers strong exposure to the agricultural futures market.

But it does raise some concerns. Deutsche Bank, for instance, claims that the underlying index is designed to pick the most profitable contracts for each commodity based on the expected roll yield. Simple logic, then, suggests that alternate contracts could be suboptimal. And the addition of different types of contracts raises some tracking risk against the index.

The CFTC is reconsidering the limits it places on investors, and may increase them in the future. If they don’t, we may see more funds adopt the model of DBA and using alternate contracts to try to approximate the returns of the index itself.

This may in the long term give an advantage to the exchange-traded note structure, as notes won’t be directly limited in size.

Everyone expects to be above average. And those helpers – bless their hearts – will certainly encourage their clients in this belief. But, as a class, the helper-aided group must be below average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs they incur; 2) Passive and index investors, through their very inactivity, will earn that average minus costs that are very low; 3) With that group earning average returns, so must the remaining group – the active investors. But this group will incur high transaction, management, and advisory costs. Therefore, the active investors will have their returns diminished by a far greater percentage than will their inactive brethren. That means that the passive group – the "know-nothings" – must win.

So do we quit active investing? I think not. Low Cost in funds are important, but being in the right asset class in the future is also another important determining factor.

One of the top endowment managers in US gives his tips on the decisions one should take in the current financial situation:

• Don’t try anything fancy
• Stick to a simple diversified portfolio
• Keep your costs down
• Rebalance periodically to keep your asset allocations in line with your long-term goals

Investment Building Blocks Recommended:

• Index Funds
• Exchange Traded Funds
• Other Low-Cost Instruments

Swenson’s Proposed Allocation:

• 30% Domestic Stocks
• 15% Foreign Stocks
• 5% Emerging Market Stocks
• 20% Real Estate
• 15% Bonds
• 15% TIPS

On Diversification:

Diversification will buffer a portfolio from declines in specific asset classes. For example, he said: “If the dollar declines dramatically, you have foreign and emerging-market equities. And a declining dollar may well be associated with inflation, but a diversified portfolio would include TIPS,” to provide a hedge. “That means if any of these scenarios play out, an investor has sizable chunks of his portfolio that protect against them,” Mr. Swensen said.

On Timing the Market:

Mr. Swensen says investors should forget market timing entirely. Once an individual sets up a program, it should be rebalanced quarterly or semiannually, he said, “but it should be disciplined.”

When the markets decline, try not to pay attention, he said. “Let yourself off the hook,” he said. “If you pursue the sensible long-term policy, look at it over a 5- to 10-year period. Don’t look at five months.”

Article

IT has been a time to worry even the savviest investors. The credit markets have been in a crisis, the domestic stock market has been shaky and overseas markets haven’t been much better.

What should an individual investor do?

Don’t try anything fancy. Stick to a simple diversified portfolio, keep your costs down and rebalance periodically to keep your asset allocations in line with your long-term goals. That is the advice of David F. Swensen, who has run the Yale endowment since 1988, relying on a complex strategy that includes investments in hedge funds and other esoteric vehicles. The endowment earned 28 percent in its last fiscal year, which ended June 30, beating all other endowments. It finished the year with $22.5 billion.

For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.

Don’t be distracted by market forecasts, he said. “You have to diversify against the collective ignorance,” he said. “I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.”

[Read More | New York Times ]

Sun Tzu is an honorific title bestowed upon S?n W?. Tzu, who lived from 544 to 496 BCE, authored The Art of War, an immensely influential ancient Chinese book on military strategy. The book, composed of thirteen chapters, each devoted to one aspect of military warfare, has long been considered one of the definitive works on military strategies. It has also had a huge influence on business tactics. Investors can also benefit from its wisdom. They can particular benefit from the insight provided by one its most often cited phrases: “Every battle is won before it is ever fought.”

On July 19, 2007, the S&P 500 Index closed at 1553. By August 15, it had fallen to 1407, a drop of almost 10 percent in less than a month. The drop was fueled by a flight-to-quality, or what might be called a flight-to-liquidity. Headlines from the financial media reported huge losses in hedge funds as investors fled all risky assets, the kind of assets hedge funds often buy.

The media (and not just the financial media) also commented about how this was an unprecedented event. The following statement is a good example. It was made by Matthew Rothman, global head of quantitative equity strategies for Lehman Holdings Inc. and a University of Chicago Ph.D. After three days of huge losses for equities all around the globe Rothman stated: “Wednesday is the type of day people will remember in quant-land for a very long time. Events that models only predicted would happen once in 10,000 years happened every day for three days.”(Wall Street Journal, “One ‘Quant’ Sees Shakeout For the Ages—’10,000 Years,’ August 11-12, 2007.)

Lehman’s models (as well as the models of many other hedge funds) may have made such a forecast, but all that proved was that the models were wrong. These events have occurred in the past, and they have done so with a fair amount of frequency. In fact, we had a very similar crisis in the summer of 1998, just ten years earlier.

The hedge fund Long-Term Capital Management [LTCM] was founded in 1994 by John Meriwether (former vice-chairman and head of bond trading at Salomon Brothers). Myron Scholes and Robert Merton who shared the 1997 Nobel Memorial Prize in Economics sat on its board. LTCM had early successes producing annualized returns of over 40 percent in its first years. Then, in 1998, it lost $4.6 billion in less than four months and became the most popular example of the risk that exists in the hedge fund industry. In early 2000, the fund folded. LTCM, failed because its models told them the same thing that Rothman’s model had told him. As Spanish philosopher Santayana warned: “Those that cannot remember the past are doomed to repeat it.”

The Historical Evidence

Professor Eugene Fama (the thesis advisor to LTCM’s Myron Scholes at the University of Chicago) studied the historical distribution of stock returns. Here is what Fama found: “If the population of price changes is strictly normal, on the average for any stock…an observation that is more than five standard deviations from the mean should be observed about once every 7,000 years. In fact such observations seem to occur about once every three or four years.” (Roger Lowenstein, When Genius Failed, Random House (1st edition, September 2000), p.71.) That is a long way from once every 10,000 years.

Consider also the following:

• From 1926–2006, twenty-three out of the eighty-one years produced negative returns. In nine of those years the losses were greater than 10 percent. In five of the years the losses exceeded 20 percent. In two of the years the losses exceeded 30 percent. And in one year the loss exceeded 40 percent.

• During the same period, out of 324 quarters, there were twenty-seven in which losses exceeded 10 percent. There were also seven quarters when losses exceeded 20 percent. And there were two quarters when losses exceeded 30 percent.

What the data is telling us is that stocks are risky assets. And the risks show up fairly frequently. The data also tells us that severe losses are fairly common. In fact, the risk of severe losses is why stocks have provided higher returns historically than have bonds. On average, investors are risk averse. To entice them to take the risks of equity investing, stocks must be priced to provide high expected returns. And it is not a question of if the risks will show up. The only questions (to which no one has the answers) are when the risks will show up, how sharp the declines will be and when they will end.

The Anatomy of a “Crisis”

Some bear markets are caused by specific events such as what occurred on September 11, 2001 or the oil crisis of 1973. These are random events that cannot be forecasted. But others follow a fairly consistent pattern that goes as follows. When economic times are good investors become more willing to take risks. Prices begin to rise. The longer the times remain good, the more confident investors become, and the more risk they become willing to take. Eventually stocks may even become “priced for perfection.” Eventually the risks do show up. Losses appear, credit tightens, margin calls have to be met, and a flight-to-quality ensues. We might say that “the tipping point” was reached. Prices don’t just fall, they often collapse as a vicious cycle develops as selling begets more selling. Some investors are forced to sell to meet margin calls and others simply panic.

When Risks Show Up

It is important to note that during bear markets all risky assets have a strong tendency to become highly correlated. Thus, while global diversification across equity asset classes with low correlation is the prudent strategy because it reduces risk over the long term, during crises this benefit “takes a holiday.” The only safe haven during such periods is fixed income investments of the highest quality (for example, Treasuries, government agency securities). Riskier fixed income assets such as junk bonds and emerging market bonds also suffer from flights-to-quality and liquidity. This is why the prudent strategy is to limit fixed income holdings to securities of the highest credit quality.

It is also important to note that the risks of hedge funds, which supposedly offer the benefit of low correlation, tend to rise during crises. The reason is that many hedge funds attempt to achieve high returns by investing in risky and illiquid assets. Thus, just when you need them to provide their so-called hedge, instead what happens is the risk appears. This is exactly what happened in the summer of 1998, with an encore performance in the summer of 2007. This is just one of the many reasons why investors should avoid hedge funds. (There are many others including their failure to deliver on their “promise” of greater risk-adjusted returns.)

These crises also show the why investors should avoid strategies that employ leverage. Leverage works well until risk shows up. Then the use of leverage often leads to the inability to wait out a bear market because margin calls must be met. Leverage has been the factor leading to the demise of many investment strategies. The perfect example is LTCM. It went belly up despite the fact that many of its trades proved to be correct if only it could have held on to its positions. Unfortunately, margin calls had to be met and LTCM was forced to liquidate.
Let’s now turn to the issue of whether investors can successfully avoid the inevitable periods of sharp losses by timing the market?

Timing the Market

The evidence on efforts to successfully time the market is compelling. For example, one study of one hundred large pension funds and their experience with market timing found that while they all had engaged in at least some market timing, not a single one had improved its rate of return as a result. (The Portable MBA in Investing, Edited by Peter Bernstein.)

Let’s look at some evidence on why market timers get such poor results. Keep in mind that when you try to time the market you have to be right not just once, but twice. You have to sell at the right time and you also have to get back in at the right time. We saw earlier that of the out of 324 quarters from 1926 through 2006 there were twenty-seven in which losses exceeded 10 percent. Out of those twenty-seven quarters, sixteen were followed by quarters when the S&P 500 Index rose at least 5 percent. There was also seven quarters when it rose at least 10 percent, four when it rose at least 20 percent, three when it rose at least 30 percent and two when it rose at least 80 percent. Yes, 80 percent. Thus, following quarters when the market fell at least 10 percent, the next quarter it rose at least 5 percent almost 60 percent of the time. There were also three other quarters when the market rose, though less than 5 percent. Thus, over 70 percent of the time after experiencing a quarter of a sharp decline, the market actually rose. Evidence such as this is why legendary investor Peter Lynch stated: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”(Worth, September 1995). And Warren Buffet’s favorite time frame for holding a stock is forever.

If bear markets cannot be anticipated, what is the prudent strategy?

The Winner’s Game

Napoleon, perhaps history’s greatest general stated: “Most battles are won or lost [in the preparation stage] long before the first shot is fired.” For investors the battle is also won in the planning stage. Successful investors know both that bear markets will happen and that they cannot be predicted with a high degree of accuracy. Thus, they build bear markets into their plans. They begin by determining their ability, willingness, and need to take risk. They make sure that their asset allocation does not cause them to take so much risk that when a bear market inevitably shows up they might sell in a panic. They also make sure that they don’t take so much risk that they lose sleep when emotions caused by bear markets run high.

Summary

Life is just too short for individuals to spend time worrying about their portfolio. If investors make sure that they don’t take too much risk, they will be able to rebalance (buy more of the very investments that have performed the worst) in the face of large losses. Some investors let emotions drive their decisions and they end up buying high and selling low. On the other hand, prudent investors who stay disciplined and rebalance, buying low and selling high, clearly adhere to a superior strategy.

Stocks are risky investments, no matter the time horizon. Smart investors recognize that. They also know that they cannot predict when the bear [market] will emerge from its hibernation or how large the losses will be. They know that just as battles are won in the planning stage, the winning investment strategy is to have a well-developed investment plan in the form of an investment policy statement. However, they also know that having such a plan is only a necessary condition for investment success. The sufficient condition is that they must have the discipline to stick to the plan.

Successful investors know that they must act like a postage stamp. The postage stamp does only one thing, but it does it exceedingly well. It adheres to its package until it reaches its destination. To be successful, investors must have the discipline to avoid having their well-developed plan end up in the trash heap of emotions.

In closing, the next time the emotions caused by a bear market tempt you to sell you should consider the following statement from Stephen Gould. Gould, who died in May 2002, was professor of zoology and geology at Harvard University. He said, “Probably more intellectual energy has been invested in discovering (and exploiting) trends in the stock market than in any other subject—for the obvious reason that stakes are so high, as measured in the currency of our culture. The fact that no one has ever come close to finding a consistent way to beat the system — despite intense efforts by some of the smartest people in the world — probably indicates that such causal trends do not exist, and that sequences are effectively random.” (Stephen Gould, Full House.)

Those interested in learning more about financial history a good read is Charles Kindleberger’s Manias, Panics, and Crashes: A History of Financial Crises. Those interested in learning more about why and how emotions impact an individual’s ability to make rational decisions should read Jason Zweig’s Your Money and Your Brain.