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Timber Ontario Teachers Pension Plan Board Considers An Alternative Investment Class Case Solution

Solution Id Length Case Author Case Publisher
2198 938 Words (4 Pages) Stephen R Foerster, Farzin Afshar Ivey Publishing : 9B01N008
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Investment in timberland refers to the acquisition of land having production capacity to grow an industrial wood crop which may be used in the manufacturing of plywood, paper, and lumber. The exit method from this investment for any pension fund is to liquidate the part of the property. In this regard, the actual annual return from the production of timber and liquidation of property is a difficult task for the fund manager. The return of timberland investment was driven by 3 factors which include timber product price changes, biological tree growth, and land value changes. Biological growth was independent of the changes in financial and economic conditions and resulted in value and volume changes over time making it a distinctive investment from typical real estate. The land prices were calculated using the per unit timber product prices in addition to the land prices. The timber prices were a function of the age of standing timber, quality, the complexity of harvest, soil fertility, and distance from the trading markets. 

Following questions are answered in this case study solution

  1. Problems in measuring the return of Timberland investment

  2. Pros & Cons of Timberland investment

  3. Recommendation for OTPPB

Case Analysis for Timber Ontario Teachers Pension Plan Board Considers An Alternative Investment Class

In addition to the above the return on investment was also a function of “ingrowth” whereby if the trees were able to grow large enough, their value grow substantially since they could be utilized in the manufacturing of higher value products. The prices of timber were cyclical in nature and largely affected by the demand and supply shocks and higher transportation costs. Historically, the prices have followed an increasing trend since supply remained limited while the demand witnessed a marginal increase. The fund manager also faces challenges to estimating future return in timberland investment based on projections of general economic conditions since the return in this asset class was negatively correlated with equity and fixed income assets with low correlation with traditional real estate investment. Unlike these typical assets, Timberland was not traded on any exchange, no presence of consistently tradable units, not possible to measure performance by an index.  

2. Pros & Cons of Timberland investment

There are various advantages of investments in Timberland. Various institutional investors have shown their interest in investing in Timberland on account of its growth and economic value. The demand for timberland has an increasing trend with an active market since it is considered a scarce resource. It helps the fund managers to achieve diversification since unlike other traditional investments in assets such as equity, bonds, and real estate, the timberland investment responded differently to economic events. Pension fund including OTPPB looks for investments which provide a suitable hedge against inflation. For example, 22% of OTPPB’s assets were invested in inflation-hedge instruments real estate, derivative contracts on commodities, and real-return bonds. Therefore, Timberland investment may profit pension fund managers another option for investment in inflation hedge instruments. 

Even within the timberland portfolio, sufficient diversification was available on account of tree age, timber market, property location, species, and end products. The risk pertaining to investment in a specific area of the crop may be rationalized by investment in several areas located in different regions with different cultivation conditions while mitigating natural risks and optimizing market opportunities. Since the price of timber and demand vary across different areas thereby opportunities for market return depended on the localized nature of the timber market. Investment in different areas offsets the risk of damage from various natural physical events while age diversification can be built by acquiring several properties with different stages of growth.

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