The two timber-focused ETFs in the market today—the $300 million iShares Global Timber & Forestry ETF (WOOD | B-21) and the $200 million Guggenheim Timber ETF (CUT | C-18)—have been forging new highs recently despite ongoing weakness in the lumber market.
To some extent, lumber prices offer a good indication of the health of economic sectors such as housing and manufacturing. As a commodity, the lumber/timber market is known for being volatile because demand for wood varies dramatically based on consumer tastes, housing demand and new technologies in manufacturing.
The myriad factors that impact lumber and timber prices help explain why timber shows such low correlation to other commodities, and why it’s often used as a portfolio diversifier. But the latest round of economic data shows that demand for home construction is down, with housing starts clocking in some 2.5 percent lower year-on-year as of March. Manufacturing data hasn’t been all that strong either.
And today, the Wall Street Journal reported that CalPERS, one of the country’s largest public pension funds, is trimming its ownership of timber (in the form of acres of forest) by about a fifth, as it reconsiders its exposure to risk given timber’s years of poor performance. It is selling 300,000 acres of forestry.
Equities ETFs Doing Well
But WOOD and CUT are up year-to-date because they are equity funds that own companies involved with the lumber and timber industry. They are not linked to the gyrations of the timber futures and spot markets.
CUT has been doing particularly well, having rallied now more than 10 percent—or three times as much as WOOD—since the beginning of the year thanks to its multifactor selection process used to identify global timber stocks with the greatest risk/return potential.
Companies comprising WOOD and CUT have also benefited from the upward momentum stock markets have seen in recent years, particularly in the U.S. Consider that in the past three years, as the S&P 500 ground nearly 70 percent higher, these ETFs rallied along, as the chart below shows:
Charts courtesy of StockCharts.com
What makes these funds interesting is the fact that they tap into a highly concentrated sector—the top three timber companies represent 60 percent of the overall market—but they each go through great lengths to diversify that company-specific risk.
In the case of WOOD, which tracks the S&P Global Timber & Forestry Index—a cap-weighted index of the 25 largest forestry firms around the world—that effort translates into diversifying exposure outside of the timber market. That means owning packaging and agricultural companies as well.
In fact, about 60 percent of WOOD is invested outside the forest and timber sector. More than 50 percent of the fund is tied to U.S. companies, and paper product names lead the mix with a 28.5 percent allocation.
CUT, meanwhile, opts for a multifactor weighting methodology in order to create a more diverse portfolio. The fund caps individual weightings at 4.5 percent at each rebalance. The U.S. represents only one third of the portfolio, followed by a 16.5 percent allocation to Brazilian names.
Paper product companies also lead CUT’s segment exposure, with a 44 percent weighting.
From a price point perspective, CUT is much more costly to own. It comes with an expense ratio of 71 bps, and it trades with an average spread of 27 bps, putting the cost of ownership closer to 98 bps, or $98 per $10,000 invested. WOOD charges 48 bps in expense ratio, and with an average spread of 25 bps, it costs about 73 bps to own.