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University Of Chicago Investment Office Investing In Timber Case Solution
Timber industry cannot be categorized in totality with other industries such as equities, bonds etc. because the factors that determine the change in yield vary considerably for other industries. Timber’s main factors are price of land, environment, and price of timber, government regulations, and then the timber price. The historical data is an example of how well timber industry was doing over the past years, but the reason why timber has gone up or gone down form each year. Furthermore, through keeping into perspective that some variables such as environment are uncontrollable; thus, the historical data cannot form a precedent for future trends.
Following questions are answered in this case study solution
What is the intersection between the investment philosophy of the UCIO and the current allocation to timber?
Did historical returns justify a larger allocation?
How much could we rely on the historical data?
Were there other assets that might provide similar benefits?
How would we adjust for the inherent liquidity risk exposure?
Case Analysis for University Of Chicago Investment Office Investing In Timber
1. What is the intersection between the investment philosophy of the UCIO and the current allocation to timber?
The University of Chicago Investment Office is a department within the University of Chicago which is mainly responsible for handling the endowment fund of the university. The main aim of this division is to find reasonable investment opportunities for the university without taking too high risk. By June 2004, the value of the endowment fund stood at 3.5 billion dollars. Mainly, the current portfolio of the university involved investments which were not very risky such as real estate, stocks, natural resources, bonds and private equities. The university has specifically defined different asset classes to ensure optimal levels of return for a given investment made in different asset classes.
The investment philosophy of UCIO follows that investments will be made according to the level of returns generated by that investment. For instance, UCIO will give more management focus to opportunities which will provide a high level of returns and vice versa. The timber industry in United States has shown very strong investment perspectives which are aligned with the investment policy of UCIO. For instance, over the past fourteen years, timber has shown more or less average normal returns. This means that investment in timber is less volatile as compared to other investment opportunities available to the firm such as bonds, stocks, real estate and so on. Moreover, high growth potential in timber can be observed through the financial performance of timber business in the industry. During the years, 2002 to 2004, Plum Creek Timber has earned maximum revenues through the sale of timber. Currently, UCIO is only investing 8% of its total portfolio in the real asset class. This analysis shows that, UCIO is not making justice between its investment philosophy and the current allocation of resources.
2. Did historical returns justify a larger allocation?
When justifying higher allocation in a certain industry; factors such as asset liability surplus and sufficient asset return in contrast to the risk involved must be taken into account. The risk for a greater investment increases with the increase in the number of variables associated with a particular investment; in case of timber factors such as environment, land prices, government regulations add to the risk. According to the historical data it can be analyzed that the timber industry has been stable compared to other industries as it has resulted in a negative yield only three times in the past couple of years. The yield in the recent years has also increased as compared to other sectors, and with 31.76% return Plum Creek Timber has given the highest yield in 2004. In addition, the revenue Plum Creek Timber received by timber sales is roughly half of the total revenue which reveals that the company is not entirely dependent on one asset but rather there 3 other vital areas such as real state, manufacturing via which Plum Creek Timber manages its revenue. In addition, despite a decreased return yield in the year 2002. Plum Creek Timber still managed to give a dividend of $1.49 which shows that the return is roughly constant. On the other hand; however, there is a potential risk involved when one analyses the historical data of prices for Saw timber, which reveal wide fluctuation over the period of time. Hence, there is a possibility of a higher risk with a higher return because if the price of timber falls in the coming years it might be that investments will be exposed to potential risk, but Plum Creek Timber yield is considerably higher that the inflation in the past years which is evident from exhibit 6. Currently, UCIO’s share is around 8% in this sector. But keeping into consideration the risk involved and the high return that Plum Creek Timber is giving at the moment; it shall be a just decision to allocate a larger portion in the portfolio.
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