Track Record

Timber! Making Money in the Shade

Chris Mayer

Investing is like many of life's other pursuits. There are a select few who are remarkably good at it, as judged by their track record, compiled over many financial seasons.  Financial returns alone, though, never tell the full story. In investing, as in life, it is risks taken that matter immeasurably more. In producing solid returns with only moderate risks, you have what may be the Holy Grail of investing.

Needless to say, role models in the investing world are few in relation to the number of those who pursue it. But, in Jean-Marie Eveillard, the creative mind behind the First Eagle Global Fund, we have a proven winner, and it is instructive to look at some of his ideas and holdings.

So let's take a look at what Jean-Marie Eveillard has cooking at First Eagle. His top holding is right up the alley with one of our recent picks.

Eveillard is a manager with what in an older age was called "moral fiber" -- the strength to stand alone and stay true to your convictions when all around you are doubters. Eveillard has proved his mettle in this area over many years. 

He has been running the show at First Eagle's Global Fund for over 25 years (I should note that the fund has been closed to new investors for the last 10 years). During this time, his fund lost money only twice: in 1990, when it fell by 1.7%, and in 1998, when it lost a miniscule 0.26%. His return since inception has averaged about 15%, compared to 10.9% for the MSCI World Index. He has been a remarkable and steady performer through a variety of markets. As author Maggie Mahar observed in her excellent chronicle of the boom, Bull! A History of the Boom, 1982-1999 , "Eveillard was that rare animal -- an equity fund manager who endured both the late '70s and the crash of 1980-81 and emerged with double-digit returns."

 Lessons From a Great Contrarian

As a testament to his contrarian grit, consider that in 1996 Eveillard began to trim his exposure to U.S. stocks. This move proved unpopular during those boom years, when tech stocks were producing triple-digit annual returns. Suddenly, and predictably, investors began to abandon Eveillard's steady, low-risk approach. By 2000, he had lost over half of his shareholders. But, as Eveillard recalled in Mahar's book, "One of my partners said at the time: 'At least we lost half of our shareholders -- rather than half of our shareholders' money.'"

Eventually, Eveillard's approach prevailed, and he can now count the bear market of the early 21st century among the environments in which he has survived and prospered. Today he is among the most respected of money managers generally, but is particularly best recognized as an international money manager.

The recipe for his success is a common one among the enduring money managers of this age or any other. Eveillard, who frequently cites the father of value investing, Benjamin Graham, as an influence, seeks to acquire securities at attractive prices on an intrinsic value basis, where intrinsic value represents an estimate of what a private buyer would reasonably pay for 100% of the company. Further, Eveillard seeks to maintain a margin of safety, or some difference between his acquisition price and his estimate of intrinsic value.

Eveillard is no blind follower of Graham's techniques and has incorporated elements of his own style into the broader framework Graham began, crafting a durable investment style that has served him well throughout a variety of market conditions.

As an inevitable consequence of this approach, Eveillard finds himself traveling on lightly beaten paths in his quest for "original, obscure, oddball and out-of-the-way" stocks. You won't find the usual blue chips in Eveillard's portfolio. 

An essential part of this approach is digging behind the reported numbers to search for hidden assets or unrealized value that could later result in higher stock prices. Therefore, his hodgepodge of selections shares no single metric of cheapness. It is an eclectic reflection of a contrarian investor.

What is most interesting about the Global Fund's present-day holdings is its concentration in cash. The following table shows the Fund's portfolio composition as of March 31, 2004:

In his annual letter to shareholders, Eveillard explains the rationale for the high cash concentration. The fund was never intended to be 100% invested in stocks -- a refreshing departure from the fully invested style used by many of his benchmark-chasing contemporaries. "Cash with us is a residual," Eveillard notes. If there are few attractive opportunities, as now seems to be the case, then the fund's cash holdings will build up. "It's not that we are timing markets," Eveillard writes. "We are simply pricing securities."

In this light, the cash build-up is viewed positively, as it provides a cushion against a future decline and also provides ammunition when the opportunities do arrive. I agree with Eveillard and would caution investors not to feel rushed to invest simply because idle cash is accumulating in one's brokerage account. 

In addition to holding significant amounts of cash, it is also interesting to note that nearly half the fund is invested in foreign stocks and more than one quarter of this amount is invested in Japan, a market where I think there are still bargains.

Let's look specifically at some of his top names. What follows is a list of his five largest holdings as of March 31, 2004:

 Forest for the Trees: A REIT That Grows

Of the top five names, his largest position, Rayonier (RYN:nyse) , is an appealing investment possibility.

The 80-year-old Rayonier converted to a real estate investment trust (REIT) effective Jan. 1 of this year, becoming only the second publicly traded timber REIT, after Plum Creek Timber (PCL:nyse ). Rayonier is the keeper of many trees stretched over 2.1 million acres, mainly in the United States. The bulk of the company's holdings are in the Southeast and consist mostly of Southern pine. Rayonier sells about 40% of its products to non-U.S. buyers.

In addition to timber, the company sells 2-4% of its land holdings annually to residential and commercial developers, as well as for conservation and recreational use. Rayonier's other operations produce a wide variety of materials for use in such goods as cigarette filters, packaging materials and diapers, among others. 

Management maintains that it will pay $2.24 this year in dividends, which (based on a $40 stock) gives investors an attractive yield of 5.6%, with prospects for growth in the years ahead.

Timber itself is a fascinating asset and has been enthusiastically endorsed by contrarian par excellence Jeremy Grantham at Grantham, Mayo, Van Otterloo & Co.  

 Slow Growth Under the Sun Delivers Strong Value

Trees come in two main varieties, as far as investors are concerned. There are softwoods (such as pine, spruce, fir and hemlock) and there are hardwoods (such as cherry, oak and maple). The first thing you learn about trees is that they take a long time to grow from seed to harvest. Natural Southern pines take between 45-60 years from seed to harvest, though intensely managed Southern pine plantations have shortened that horizon to 25-30 years. Eastern hardwoods generally have a rotation between 60-80 years. Again, intensive management of these properties can shorten the time horizon. There are other types of tree farms, which are less significant when viewed as a slice of the total forestry industry. Fuel wood plantations have harvest cycles of only 5-15 years, and Christmas trees typically rotate from 4-12 years. 

These long growing periods directly impact the value of the timber. As the trees grow, their value increases at a much greater rate, a process known as "in-growth." For example, a 10-inch tree might fetch $5, while the same tree at 25 inches would bring 30-100 times more than that. 

Harvesting of trees does not follow the seasonal pattern of crop harvests. With trees, you can harvest more when prices are favorable and harvest less when prices drop. Your inventory is "stored on the stump" as they say, and grows as nature allows, indifferent to the pace of economic activity. This ability to harvest during more favorable times gives timber investments a sort of option quality, which adds to their attractiveness.

 The Tree Index

Investment returns in lumber are tricky to understand. You have probably heard a variety of numbers thrown around that show how timber has beaten inflation and how it has compared favorably to most other asset classes. The problem lies with the quality of most of those indexes from which the data is taken. Experts in the industry realize their weaknesses and are working to improve our understanding of the historical returns on timber. They caution not to make too much of indicated past returns.

The National Council of Real Estate Investment Fiduciaries (NCREIF) created the Timberland Property Index (TPI) in 1994 and has tracked data going back to 1987. The TPI represented an improvement over prior attempts in that it broke up its data regionally and also reported an income and a capital appreciation component. It still suffered from weaknesses inherent in any timber index, namely, it relies on reported appraised values. These appraisals are not done frequently, maybe every year or every other year -- quite different from the real-time stock quotes or bond prices available in more liquid markets.

In contrast, timber is not a liquid market with easily quotable returns. Nonetheless, the weight of the evidence suggests timber returns have been strong. The TPI shows a 16.1% annual return since 1987.

Despite the TPI, the actual performance of any collection of trees can vary substantially from the index based on the mix and age of trees, the score card with Mother Nature and local conditions. Also, as with any commodity, investors should remember that purchases made in commodity companies are different from buying the underlying commodity itself, and that there is many a slip twixt lip and cup. Therefore, investors should be wary using these sorts of indexes as benchmarks or to build an expectation of returns.

Investors may be interested in knowing how timber has performed in periods prior to 1987. In the opinion of the Hancock Timber Resource Group, co-creators of the TPI, there was not enough institutional ownership in previous years to create a "robust measure of performance." This opinion, however, has not prevented others from taking a crack at it.

The folks at Graham, Mayo & Otterloo have a presentation available on their Web site, which I have reproduced below, though I am not clear exactly how these data were constructed. The GMO chart clearly shows how timber (in this case one of the lower grades of timber -- Southern pine) has outpaced the PPI (which they use as a proxy for inflation). 

The same report also notes that timber consumption exceeds that of cement, steel, plastic and aluminum combined. With environmental restrictions and increased scrutiny of existing forestland, new supply of forests for commercial use grows slowly.

As noted previously, GMO has been among timber's biggest boosters. They also show timber relative to a security market line that shows how timber has outperformed most other asset classes with considerably lower volatility, often used as a proxy for risk. Therefore, as another way to hedge against inflation, it appears that timber provides another possible solution. As an asset class, timber also appears uncorrelated with the general stock market. A timber REIT, where the bulk of the earnings are paid to you, the shareholder, is probably the easiest way for most investors to gain timber exposure. Moreover, in the particular case of Rayonier, you have the endorsement of one of the finest investors in the market today.

Got Trees?

We will not be adding Rayonier to the Capital & Crisis portfolio, since we have already recommended a very similar security in Plum Creek Timber. The investment thesis behind both is essentially the same, and I would recommend that if you don't own Plum Creek, consider adding Rayonier. Rayonier has a much smaller market capitalization of about $2 billion, compared with nearly $6 billion for Plum Creek, and Rayonier pays a larger dividend of about 5.5%, compared to about 4.5% for Plum Creek.  The greater potential for growth lies perhaps with the smaller company, though the stock prices for each of these companies have tracked the other fairly closely over the past six months to a year. In either case, we thought it would be helpful to examine the long-term investment potential of timber, while peeking over the shoulder of one of the finest mutual fund managers in America.