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Agriculture Funds – An Introduction


by David Garner - 02.07.2014

An Introduction to Agricultural Investment Funds

In this article we offer a broad introduction to various types of agriculture fund including mutual funds, land funds, and private equity type offerings. For a more comprehensive analysis and understanding of agricultural investments in general, download our Agriculture Investors Report available as a free download.

 

Learn: Download the Agriculture Investor’s Report here

Analyse: Request the Agriculture Fund Directory here

Invest: View agricultural private equity Investment opportunities here

 

Why are Investors Turning to Agriculture?

In such a fast-paced global economy it is essential for those with a need to maintain or grow their wealth to be aware of and understand developing social, technological, demographic, and economic trends, and to position themselves and their investments accordingly. Most of those that stay ahead of the curve continually readjust their strategy and approach, diversifying into new sectors and assets classes.

One sector that has experienced a huge surge in private investment in recent years is agriculture. Whether investing in the stock market, private equity, commodities, or land and farms, the interest from investors is significant and growing, and little wonder given the sectors’ essential nature.

According to most estimates; over 80 million new mouths come to the global dinner table every year, not to mention the fact that over 5 billion of the world’s poorest emerging market populations are enjoying an exponential growth in household income as their economies expand rapidly. Coming off such a low base means that, in many cases, household income can double or triple over the course of a year. More often than not, the vast majority of this increased household buying power is spent on improving living standards and ‘evolving’ to a more protein-rich, resource-intensive, western-style diet, and all of this adds a tremendous upward pressure to demand for food, animal feed, and biofuels.

But whilst a growing population and an increasing global appetite for meat are driving a massive and rapid expansion in the agricultural sector, there are fundamental limits to increasing productivity in order to meet this demand, and it is this combination of rising demand and limited supply that drives value growth as well as sector expansion. Millions upon millions of hectares of productive arable land is lost every year to a range of human interferences; from poor agricultural practice degrading soil, to climate change, water security issues, and urbanisation. In fact, up to 50,000 square kilometres of productive agricultural land is lost to urbanisation alone every year, and investors are seeking to leverage this disparity in supply and demand by taking a stake in the food sector.

Which Type of Agriculture Fund is for me?

There are of course a number of ways in which one might decide to invest in agriculture, from mutual funds to land acquisitions, but most investors will ultimately stick to the status quo and opt for a fund of some sort. This could mean investing in a sector-specific mutual fund that selects shares in businesses operating within the agricultural supply chain such as food processors, farmers, chemical manufacturers, or machinery manufacturers. It might mean investing in certain commodities with the expectation that rising demand will push up prices. It may also mean investing in a farmland fund in order to capitalise on the value growth driven by increasing demand for a diminishing essential asset.

Undoubtedly the vast majority of investors will ultimately plump for a managed equity fund of some sort; because they are easy to buy and sell, they fit well within tax wrappers such as ISA’s, they have a high degree of liquidity, and there are plenty to choose from, not to mention we are mostly conditioned by society to think of equities and equity funds when we think about investing. But there are also a number of alternatives, and in order to really pick the right fund or investment for you, one must consider a number of variables and take a position:

 

Key Considerations

  • Asset Class (equities, commodities, land etc.)

  • Investment Strategy

  • Regional Exposure

  • Management Capability

  • Sub-Sector Exposure

  • Diversity

  • Investor Requirements (Liquidity, timeframe, available capital etc)

 

Whether it be equity funds, commodities funds, or land funds, all offer a different set of characteristics, risks, drivers, correlations, and investment performance, so in order to better understand the sector and make more informed investment decisions, we recommend you download our Free Agriculture Asset Class Analysis Report and get a broad handle on the major influencing factors that drive the agricultural sector and the performance of various assets.

Here follows a brief introduction to the four main types of investment fund that offer exposure to the agricultural supply chain.

Mutual Funds that Invest in Agriculture

By far the most common type of agriculture fund – a traditional equity fund – will invest shareholder capital in publicly traded equities of companies operating within the agricultural supply chain. A Fund Manager and his or her team will be responsible for selecting which companies the fund invests in; and the fund will more often than not use one of the key agricultural indices as its performance benchmark. There are a number of these types of funds available, usually structured as an open-ended investment company such as a UCITS or SICAV.

Some funds will have a specific regional focus. Others have a focus on a particular part of the supply chain. The Pictet Agriculture Fund for example invests predominantly in shares of companies whose activities are production, processing and supply; such as food processors and farming companies. In most cases the Fund Manager will select shares across the entire supply chain in an attempt to capture sector-wide growth and balance out the risk, and so will hold shares in a range of businesses such as fertiliser companies, tractor manufacturers, farming companies, logistics businesses and/or food processors and even retailers.

This type of fund might suit an Investor who wants to try and capture the financial growth and yield of companies operating in a growing market or sector, but one should remember that any investment where the underlying asset is publicly traded equities will share a very high correlation with the overall performance of financial markets and is likely to have a higher volatility than other asset classes such as real estate. Investors should also be aware that the performance of these types of funds is reliant to a large extent of the ability of the Fund Manager to pick good stocks, and only very few agriculture funds have consistently outperformed their benchmark.

 

Advantages of investing in agricultural mutual funds

  • Professionally managed

  • Highly regulated

  • Mostly liquid

  • Diverse holdings

  • Can capture sector-wide expansion

  • Opportunity to invest with small amounts of capital

 

Disadvantages of investing in agricultural mutual funds

  • High correlation with financial market performance

  • Contingent on good management

  • Most underperform their benchmark

  • Can have high fees regardless of performance

  • Limited to stocks and shares

  • Reliant on underlying company performance

 

Investing in Agriculture through Private Equity

For Investors with a greater appetite for risk and less need for liquidity, investing in smaller privately owned companies with high growth potential might be more appropriate than traditional equity funds. This route to the sector might be particularly attractive to those with an appetite to invest in new technologies; for example manufacturers of new chemicals that might have a big impact on productivity, or in small but highly productive niche farming businesses.

Private equity investments are inherently more risky and illiquid than publicly traded equities and typically have a 10-year term and a specific private equity style structure with a general partner and limited partner. PE funds are often only suitable for experienced investors capable of bearing the long term economic risk of the investments, although the recent trend for crowd funding has opened up the space to investors with as little as £10, and there are other incentives too such as the UK Government’s Enterprise Investment Scheme and Seed Enterprise Investment Scheme which both offer generous tax breaks for investments in qualifying private companies.

The aim of the Fund Manager is to invest shareholder capital in often relatively new privately held companies with the potential for rapid growth and excellent returns. At present there are very few publicly accessible private equity funds investing purely in agricultural businesses so investors are limited to finding and investing in individual companies.

DGC Asset Management takes a private equity style approach to investing in agriculture; developing underutilised farmland for the modern intensive production of high value, high demand crops. Developed assets are then committed to DGC’s private corporate investment vehicle – Vaccinium (UK) Limited – itself a private company limited by shares in which High Net Worth and Sophisticated Investors may invest in order to take a stake in the underlying asset and associated farming businesses.

Whether you want to try and capture the general demand-fuelled growth in food production, processing, transporting and/or retailing, or you want a more direct exposure to agricultural production, picking the right entry point is key. If the need for instant liquidity is a defining factor in your investment selection process then mutual funds might be considered more appropriate than private equity. If however you are seeking bigger returns and more direct exposure to rising commodity and land prices in the long-term; then direct investment in agricultural assets or private equity projects might be more up your street.

 

Advantages of private equity investment in agriculture

  • Very high return potential (best performing asset class)

  • More flexible structures, terms and management

  • Invest with small amounts of capital (crowdfunding)

  • Management often have ‘skin in the game’

  • Investors may be able to take a more active role

 

Disadvantages of private equity investment in agriculture

  • Limited opportunities for smaller investors

  • Higher risk than public equities

  • Relatively illiquid in the short term

  • Funds can have high performance fees

  • New companies may have inexperienced management

 

Agricultural Land Funds

Buying productive agricultural land is perhaps the rawest form of investment in agriculture, and arguably makes the most sense for long-term investors seeking capital preservation, growth, income and a non-correlated, physical asset. However farms are large and expensive to buy, and require a tremendous amount of niche expertise and experience to operate, so a managed collective investment such as a farmland fund might be a more appropriate choice for many than direct acquisitions.

There are relatively few farmland funds to choose from when compared to equity funds, and the very nature of the asset class makes it difficult to consolidate multiple land holdings in various regions into an evenly balanced fund. There are however a small number of private funds and other investment vehicles that afford smaller investors access to farmland, and whilst it is true that there are significantly more funds aimed at institutional investors, there are some that can be accessed by smaller private investors with relatively small amounts of capital.

As noted here; the traditional fund environment does not lend itself to the management of agricultural land assets. Mostly due to the liquidity aspect. For example, it might require the sale of significant assets in order to meet redemptions in a traditional fund structure, and so one must accept a certain amount of illiquidity when approaching this asset class, whether directly or via a fund.

There are broadly two types of investment strategy for farmland investors. There are funds that invest in existing farms, and others that add value by developing modern farms from underutilised land. The first model, commonly referred to as a ‘let land model’, is the most common and carries the lowest risk. These funds will buy land and lease it to a farmer; aiming to generate a return through organic capital growth, and to generate some income from lease payments. Farms are generally low risk in terms of income due to very high occupancy rates, although yields vary from less than 1% to more than 8% depending on the region and the asset.

The second, arguably more strategic investment model is greenfield development such as is the case with Vaccinium (UK) Limited. Here land is acquired and developed into a much more profitable and valuable asset, creating a best in class asset that has been established with the latest modern infrastructure and available science. Depending on the crop selection, yields can reach as high as 20% due to a combination of on-farm efficiency and lower capital investment.

 

Advantages of farm funds

  • Closest correlation to long-term trends

  • Physical asset unlikely to depreciate in the long-term

  • Can offer high levels of income

  • Has outperformed equities over all timelines

  • Not correlated to financial market performance

 

Disadvantages of farm funds

  • Limited opportunities for smaller investors

  • Geopolitical security must be considered

  • Relatively illiquid in the short term

  • Assets must be well-managed (water, soil etc)

  • Difficult to create international scale

 

Commodity Funds

There are some straightforward investment funds that offer exposure to commodities such as the Schroder Agriculture Fund which is structured as a SICAV (the European-equivalent acronym for open ended investment vehicle with variable capital). However, the vast majority of commodity funds are Exchange Traded Funds (ETFs). ETFs are simply investment funds that can hold assets such as commodities, or bonds, and which trade on a stock exchange in order to provide liquidity to the end investor.

Focussing primarily on ETFs, there are two broad types; those that actually own and hold the physical commodities (gold funds are a good example), and those that trade futures and/or options, and there are also some that do both. There are some ETFs that invest in a basket of agricultural commodities, whereas others specialise in one particular commodity such as wheat, cotton or cocoa. This allows the informed investor to make very specific bets on price swings in particular commodities. For example, if the United States had a catastrophic wheat crop and halted exports, the price of wheat would likely shoot up rapidly, and so those investors with exposure to a wheat only ETF would benefit most, however it works both ways and if it was a bumper year with lots of excess stock, prices would fall and the relating ETF, and its investors, would suffer.

In fact, as ETFs have historically been perhaps the most accessible way to invest in agriculture, these types of funds have attracted masses of capital as Investors place their bets on a growing consumerist population and resource scarcity, whereas in fact this may not be the best way to leverage what are inherently long-term trends. Commodity markets are volatile and driven in the short-term by weather, politics, agricultural regulation, and consumer trends, all of which play a big part in setting short term values.

A good example of the above is the comparison between iPath Pure Beta Coffee ETF, which has delivered a year to date return of 59.97% (August, 2014), and the iPath Pure Beta Cotton ETF, which has fallen by -16.11% during the same period. It is the specifics of the coffee and cotton markets that have driven these returns rather than the long term trends of increasing consumption, and so investors should be wary of both single asset ETFs and commodities in general unless they really know their sector.

 

Advantages of commodity funds

  • Accessible to all investors

  • Low minimum investment

  • High degree of liquidity

  • Lots of choice in terms of asset and strategy

  • Allows for short sharp bets on price swings

 

Disadvantages of commodity funds

  • Can be volatile in the short term

  • Some funds lack diversity

  • Most are a bet specifically on food prices only

  • Returns are largely driven by sector specific events

  • Many believe commodity prices are a bubble

 

In Summary

There are all sorts of entry points to the agriculture sector for Investors to consider, each of which is driven by a different set of drivers, and will react differently to different market conditions.

Despite the fact that by far the most commonly held investments are commodity ETFs, this has been predominantly due to the fact that, on the face of it, investing in agricultural produce provides some exposure to the sector, but digging a little deeper this thinking is fundamentally flawed. Each commodity is subject to a wide range of drivers, some of which are specific to that particular commodity, and unrelated impact events in politics, climate, and financial markets will drive prices up and down, regardless of a growing global population and diminishing asset base.

As investors become more aware of the intricacies of the sector, interest has widened to include equity investments and land investments, the latter of which is the least accessible but perhaps displays the strongest correlation with the underlying themes that establish our interest in the first place. Now we are beginning to see the market react, and a number of alternative opportunities have emerged such as farmland funds and niche private equity style transactions designed to better capture the long-term growth in value that investors are seeking and offer stake in the underlying assets that form the cornerstone of the agricultural economy; the land itself.

For more information on opportunities to invest in productive farms producing a range of high value high demand commodities, please register your interest and request an Executive Summary.

 

Agriculture Fund Fact Sheets

 

 

 

 

 


Written by David Garner


David is a Partner with leading UK based real estate investment consultancy DGC Asset Management Limited. Since 2001 David has advised Investors on a range of niche real estate acquisitions and developments in the agriculture and distressed asset space with a gross development value exceeding £100 million.

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