Natural Resources

Natural resources comprise commodities and raw land used for agricultural purposes, specifically farming and timber. Managing this asset class requires specialized knowledge of the features of natural resources. An increasing number of portfolios include natural resources, which justifies a separate examination of the sector. There has been rapid development in offering indirect investment in natural resources through exchange-traded funds (ETFs), limited partnerships, REITs, swaps, and futures.

Commodities, such as crude oil, soybeans, copper, and gold, are seen as investments. Investments in commodities can be either “hard” (those mined, such as copper, or extracted, such as oil) or “soft” (those grown over a period of time, such as livestock, grains, and cash crops, such as coffee).

Timberland investment involves ownership of raw land and the harvesting of its trees for lumber, thus generating an income stream and the potential for capital gain, and timberland has been included in large institutional portfolios for decades. Farmland as an investment is a more recent phenomenon, with only a few dedicated funds involved. With population growth, weather, and water management becoming more topical, however, investors may turn to these assets to actively address sustainability.

• Investments in farmland and timberland are similar in certain respects to real estate investments but also exhibit several important differences.
• While raw land’s investment returns occur strictly from price changes of the asset, both farmland and timberland generate returns from the assets’ income stream in addition to price changes of the assets.
• Timberland’s income stream differs from that of farmland in that the harvest time of timber can be chosen while crops from farmland are harvested on a regular cycle.
• Commodity investments are typically entered into via derivative markets, although some investors may find value in investment in physical commodities directly or through specialized funds.
• The prices available on commodities through derivative markets must be related to the prices on the same commodities in physical markets to prevent arbitrage opportunities.
• The forward price of a commodity will be greater than the spot price on the same commodity only if the carrying costs of owning the physical commodity are greater than the non-cash benefits of owning the physical commodity.
• Investing in commodities is motivated by its potential for high expected return, its potential for diversifying a portfolio of traditional assets, and inflation protection. Commodities exhibit high correlation with inflation over the last 30 years, suggesting that commodities are an effective inflation hedge.
• Farmland and timberland investments trade infrequently and in non-public markets. As a result, they are likely to appear as less volatile than commodities and other publicly traded risky assets (such as stocks), despite the fact that both asset classes face significant risks, such as weather-related threats.
• Farmland and timberland provide diversification potential to portfolios consisting primarily of traditional assets (i.e., stocks and bonds). Historical correlations between these asset classes and traditional assets have been close to zero.