Context Appropriate Communication: Comparing Investment Performance to Forest Sustainability

The growth of ESG investing – which screens investments and firms based on environmental, social, and governance criteria – and markets for forest carbon and other environmental “services” highlight the importance of clear communication skills and the value of those who possess them.

Consider the situation for professionals in the timberland investment sector, a part of our research portfolio at Forisk. Timberland professionals grapple with the most effective and “context appropriate” ways to report investment performance and forest sustainability. How do we answer questions ranging from cash flows to wood flows to rates of return? Finance, investing, and forestry, come down to math.

Example: The Math of Finance and Forestry

Consider measures of forest sustainability versus investment performance. Investment returns often focus on percentages, which simplify comparisons across investments. However, percentages communicate differently than dollar amounts. Saying “you earned 5% last year” differs than saying “you earned $5,000 on your $100,000 investment.” They mean the same thing, but hearing dollar amounts clarifies the implications of how much wealth you gained.

The math of investments can, when reported as percentages, camouflage the dollar impact of fees, as well. Consider two descriptions of investment management fees:

“You will pay a 1% annual fee on this $1 million investment.”

“You will pay a $10,000 annual fee on this $1 million.”

The phrases describe identical fee structures differently. Do they sound or feel identical? The Securities and Exchange Commission (SEC) has, since 2004, accounted for this issue in shareholder reports and quarterly portfolio disclosures by requiring the reporting of fees in both percentage terms and in dollars per $1,000 invested. 

The math of relative (percentage) measures versus absolute numbers applies to tree health and forest sustainability, which affects the reporting and communication of forest carbon investments and wood bioenergy projects. Saying that a timber market “has a growth-to-drain ratio of 1.1”, meaning growth exceeded removals by 10%, differs from saying “this market grows 1 million more tons than are harvested each year.” 

Conclusion

A percentage, while informative, provides incomplete information. We can always estimate performance in percentage terms, while absolute values, whether in dollars or tons or board feet, communicate the cash, wood, or forests available today.

Dollar-Cost Averaging: An Effective Investment Hack

Classic lessons and finance fundamentals inform my approach to investing. Start saving and investing early to crank the flywheel of compounding interest. Minimize costs to keep more of what you earn. Diversify to mitigate risk. Commit to regular and systematic investing, instead of trying to time the market. My Dad introduced this last one to me, years ago, through dollar-cost averaging

Words inform, and the name of this strategy previews its priorities. “Dollar” means money, as opposed to volume (e.g. numbers of shares). “Cost” is about what we spend (now) as opposed to what we might get later. “Averaging” speaks to doing this over time. In short, dollar-cost averaging is a process that focuses on what we can control.

With dollar-cost averaging, we regularly and systematically invest a fixed dollar amount, regardless the share or fund price or situation in the overall market. When prices are up, we will buy fewer shares, and when the market is down, our allocation pays for more shares. This strategy tends to result in a lower average cost per share over time when compared to lump-sum purchases.

If you participate in a workplace retirement plan with monthly contributions, such as a 401(k), you effectively employ dollar-cost averaging. In addition, users of 401(k) accounts and the like typically trade less frequently in those accounts, further reducing costs and preserving capital. The framework reduces emotion and anxiety while supporting a proactive approach to building wealth.

Dollar-Cost Averaging in Action

In the timber industry, my research focus at Forisk, the easiest vehicles for applying a dollar-cost averaging strategy are the publicly traded timberland-owning REITs (PotlatchDeltic (PCH); Rayonier (RYN); and Weyerhaeuser (WY)). The Forisk Timber REIT (FTR) Index, commonly called the “footer index,” is a market capitalization weighted index of the public timber REITs.[1] The figure below summarizes a dollar-cost averaging approach to investing in the timber REIT sector based on buying $10,000 worth of FTR Index shares at the end of each year for ten years from 2014 through 2023.

With this strategy, the weighted average cost per “share” is $277.44, while the straight average of the ten year-end prices was $285.21. With dollar-cost averaging, your portfolio has more of the lower-priced shares and fewer of the most expensive shares, which brings down the weighted average. The strategy is not always advantageous. If you had simply purchased $100,000 worth of shares at $270.52 in 2014, you would have been better off. For that reason, it helps to think of dollar-cost averaging as a robust and systematic approach to cost-effectively stay invested over time.

Discussion and Considerations

With the regular, systematic investing of dollar-cost averaging, you acquire more shares when the market is lower, thereby reducing the average per-share price in your portfolio. When the market rises, you acquire fewer share, but you still gain from rising prices because your portfolio already contains shares bought previously at lower prices. In this way, periodically buying fixed dollar amounts outperforms the regular buying of fixed numbers of shares.

Fundamentally, dollar-cost averaging is a risk-averse, conservative approach. While it helps manage risk, it also reduces the likelihood of outsized returns. Dollar-cost averaging functions best in a world where the market always mean reverts. However, the stock market rises, tends to rise, has risen over time, even as it does so on a random path. If the market or asset of choice were guaranteed to increase and appreciate, we’d be better off investing all money now, regardless the prices. But that’s not how life or access to capital work. Most of us save and invest over time as we earn income and generate cash, and dollar-cost averaging serves as an investment hack, a short-cut for the person who wants a reasonable, low cost, relatively effective way to invest systematically without the stress of timing the market.

As a strategy, dollar-cost averaging is also agnostic and indifferent. It will acquire more shares of underperforming firms or funds as easily as attractive and performing investments, so there are still decisions to make. This is one reason why dollar-cost averaging fits well for investing in diversified index funds that tend to follow the overall market. 

Conclusion

With dollar-cost averaging, you buy shares of a stock or fund regularly over time at the prevailing prices. With this approach, your average cost is neither the highest nor lowest market price. It is a weighted average that systematically acquires more shares when they are cheaper and fewer when they are dear. This strategy keeps you invested in the market without any need to deliberate over “timing” the market.


[1] Initiated in 2008, the FTR Index provides a benchmark for comparing timber REITs to other timberland investment vehicles and the overall market. To subscribe to the free weekly FTR Index Summary and to obtain historical FTR Index data in an Excel format, please contact Pamela Smith, psmith@forisk.com.

Options and the Risk of Missing Out

In graduate school, I conducted research on managing risk in the forest industry. My working assumption was and remains that vigorous management of organizations requires the deliberate identification, assessment, and management of risks. In forestry, these include, for example, those in operations (e.g., equipment breakdowns), distributions (e.g., transportation delays), and human resources (e.g., hiring and retaining personnel). 

My research, however, focused on financial risks, which comprise those risks that a firm is not typically in the business of bearing. For a forestry firm or timberland investor, these may include the impacts of exchange rates, energy prices, and interest rates. Within this area, I studied the potential for timberland investors and forest owners to use financial contracts, operational hedges, and “options.” 

Options Have Value

Options? Yes, some view forest management as a series of real options. For capital budgeting and strategic planning, real option theory addresses limitations with net present value (NPV), which does not account for flexibility, volatility, and contingency with potential investments, whether in forestry or any other industry.

Flexibility. Volatility. Contingency. In the context of forestry, flexibility refers to the manager’s ability to defer, abandon, expand or reduce a silviculture investment or harvest schedule due to new information or investment opportunities. Volatility references changing market conditions – particularly changing timber prices – or new technologies that affect our view of potential investments. Contingency refers to situations where future investments depend on investments made today. Presumably, these options provide value and should be accounted for, or at least considered. 

Options, Flexibility, and the Risk of Missing Out

In practice, not all investors have the same levels of flexibility, exposure to volatility, or concerns about contingency. In many cases, traditional analytic approaches like NPV, which views decisions as fixed, is sufficient for making decisions. This makes real options analysis a whiteboard discussion for comparing and discussing a dynamic view of future choices for strategic planning, and less about risk mitigation.

For a firm focused on downside risk, risk management and hedging programs transform undesirable risks into acceptable and manageable forms by increasing certainty and decreasing volatility. The management of risk helps firms achieve their optimal risk profile by balancing the costs of hedging with the protection offered. 

While some view risk management defensively, others may incorporate risk management into a process of appraising investment opportunities, as risk features both potential upsides and downsides. The view of managing risk to protect the firm from catastrophes or losses ignores the risk of missing out on profitable or strategic opportunities with upside potential.  

In short, the risk of missing or underinvesting in promising projects represents a risk unto itself. Risk management can play a role in protecting and increasing the bundle of cash flows that make up the corporation, and the associated opportunities for future investments that require these cash flows. Rather than husbanding resources exclusively for precautionary safety nets or insurance-like reserves, risk management can include the allocation of capital among competing investment alternatives.

Conclusion

At a certain level, executives and investors manage risk instinctively. In forestry, this occurs through the normal calculus of assessing the risks and rewards associated with silvicultural treatments and timber sales. Executive professionals identify, assess, and manage the risk and uncertainty encountered by their operational activities in business environments subject to financial risks emanating from outside of their sectors, and in doing so preserve the ability, the option, to make opportunistic investments.

Framing Disruptions

Simple approaches can focus the mind. When thinking through the means and mechanisms by which disruptions could affect my business, my community, or the economy, I often ask two simple questions rooted in economic fundamentals[1]:

  • Big or small? In other words, how impactful, whether positive or negative, would we expect this disruption or change to be on local infrastructure, needed supplies, or aggregate demand? 
  • Long or short? What is the likely duration, whether positive or negative, of this disruption or change on supplies or demand in the community, market, or industry?

As an example from my work in the forest industry, consider the impacts of natural disasters on timber markets. In August 2005, Hurricane Katrina, a Category 5 event, struck the Gulf States, brutally affecting homes, forests, and infrastructure. As a disruption, how would we provide context to its impact on timberland owners? Consider these two questions to organize our thinking:

  • Big or small? Big event locally; devastating to some forests and damaging to many. 
  • Long or short? Short-term increase in supplies; negative impact on timberland value.

Using Frameworks to Make Decisions

Simple frameworks add value to the extent that they prove useful. This analytic exercise supports decision analysis. Using experience, knowledge, and available data, it screens and ranks the relative importance of potential disruptions on lives, businesses, and markets. We can then probe assumptions and, while there may be no “right” answer, develop operable approaches to establish priorities.

With family or colleagues or neighbors, the resulting discussions can clarify how much control we have. Some disruptions, like a zombie apocalypse, get thrust upon us from the outside, while others, like new internet providers or car technologies, offer choices. And a big impact or opportunity for an individual, family, or single forest owner can be small for the overall market and community. 

With respect to applying this approach with executives and other decision-makers, I think in terms of “tactics” (operations) versus “strategies” (capital allocation). Disruptions that get handled on the ground via operations tend to qualify as shorter or smaller in this framework, while anything that requires a board meeting or act of Congress reflects longer-term disruptions affecting investments and strategic advantage. Given this approach, how do we develop strategies and assess exposures across multiple disruptions for these situations locally?

Time as a strategic idea remains malleable. Discussions about potential disruptions reinforce the arbitrary nature of the “short” and “long” term. The space and time required for impacts to realize themselves can extend beyond today, tomorrow, or next year. 

Conclusion

Regardless, we succeed by prioritizing in the name of preparation. My working assumption is that a person or firm that is ready for everything is ready for nothing. We avoid personal and organizational paralysis through taking positions on what matters, on where we have control, on eliminating the gnats and knots to go after the disruptions that threaten survival or offer outsized opportunities. 

In March 2020, I posted “Thinking Through Risk and Uncertainty: Contemplating the Coronavirus” and am returning to these themes as ideas and questions related to risk, disruption, and stability have become more frequent in my conversations. For those interested in a further discussion of strategic thinking (and how the coronavirus affects the forest industry), click here to read a five-page white paper.


[1] These questions are a variation on the frequency-severity framework used for insurance and risk management applications. In forestry, I have found it useful to think through duration – how long something lasts – rather than, or in addition to, the gap in time between occurrences. 

Developing and Hiring Managers: Values Come First

A new manager, whether promoted from within or hired from abroad, must learn to communicate and model the values and expectations of the organization. For the internal hire, that person has the advantage of in-house experience and a demonstrated potential to manage. (That’s why you promoted them.) 

For the hired manager, it’s unreasonable to plug them in and expect that they will seamlessly adhere, model, and reinforce the “core values” of your firm. Sometimes, yes, you simply need to get that newly hired manager onboard and rolling because everyone is working overtime, the wheels are falling off the bus, and the barbarians are at the gate. Regardless, close support and explicit nurturing improve the chances for success for the manager and the team.  

In an earlier post – Train or Hire? Both – I wrote about the importance of continually looking to upgrade the skills of a team through developing younger talent for future roles within the organization. In this post, I focus on a few priorities and approaches for helping newly hired and promoted managers succeed.

Values Come First

Your new manager must, first and foremost, share the values of the team and then also have the aptitude and interest in building the skills needed for the role. In my experience with human beings, it simply does not work the other way around. Values come first.

When someone becomes a manager or executive, the allocation and use of his or her time changes. Making this transition is hard; I struggle with it to this day. You spend more time managing and coaching and less time doing and analyzing.  In football, the head coach cannot run out onto the field and catch the ball, but in a business a manager can easily inject themselves into the process, so this is one of the hardest things to avoid and manage and develop. Know when to step in and when to step back, and this becomes easier when the person aligns with the values of the team.

Use Milestones and Timelines

The successful onboarding and (initial) performance of the manager is on you or me or whoever hired this person. Provide structure to this by working off of a clearly communicated plan with systematic support. Put your mentoring on a timeline, and let it work for both of you, as a source of reinforcement, and as a path for the new manager to reach back for feedback and ideas.  

In the early days, you guide and reinforce and advise; in the latter days, the manager updates and communicates with you. In addition to technical and business-specific skills, areas you may explicitly cover during the onboarding phase may include values and business priorities, business metrics and scorecards, and approaches to coaching and mentoring. Throughout, your best path is to role model the behaviors expected from the other managers, and then follow-up to ask questions and confirm understanding.

This “short” term investment explicitly reduces risk and increases the probability of a strong hiring ROI and well-functioning team. 

Conclusion

It is tempting, as the experienced veteran or senior executive or company founder, to show everyone how their jobs should be done and to push them to keep up with you. However, at some point, you must decide whether you want to “serve” the team, or glorify yourself as the leader and alpha dog. Remember, it takes a team to build a rocket ship and get to the moon. Finding ways for the team and for everyone to get better and succeed has a compounding effect. Ten individuals each getting 10% better outperforms you getting 20% better. Prioritize values, mentor and onboard with a plan, and role model what you want to develop and help others become productive managers and colleagues.