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  • Is now a good time to invest in agriculture?


    Given that the yields on traditional assets have remained at historic lows, investors have increasingly been allocating to private markets. Whilst there has been a large amount of investor money flowing into private markets across private equity, private debt and infrastructure, there has been very little flowing towards agriculture.

    We feel that agriculture is an asset class that can provide an attractive and diversified source of returns.

    Agriculture as an asset class

    In the simplest sense, investing in agriculture involves the production of raw materials to sell further along the supply chain. There are two main routes to investing in agriculture:

    1. Farmland, which includes crops and/or livestock that end up on supermarket shelves; and

    2. Forestry, which includes the production of materials such as timber that can be used for construction.

    There are various models in which investors can access the asset class and invest in agriculture.

    • Own and lease model. Investors buy land and lease it to farmers with no involvement in the production process, similar to investing in commercial property.
    • Own and operate model. Investors buy land and are ultimately responsible for the production of any crops or raising of livestock, essentially acting as the farmers.
    • Partnership model. This involves buying the land (majority stake, which can be anywhere between 51% and 95%), in partnership with a farmer. This is an attractive agriculture model because it ensures the alignment with the operators, the expansion of deal sourcing network and the platform approach allows for increased growth and scalability benefits.
    • Private equity model. This is a relatively shorter-term strategy, which involves buying land and attempting to realise returns through an exit strategy after value creation; e.g. asset roll-ups, land improvement, brownfield development such as change of land use.

    Agriculture investing has evolved to include agribusinesses, through public or private equity. There is no set rule for what constitutes an agribusiness but generally speaking, broadly half of its revenue must be directly or indirectly linked to agriculture. This will include companies that are involved in any of the steps required to send an agricultural good to market, namely production, processing, and distribution.

    Deere & Company, often recognised by its brand name, John Deere, a popular brand for tractors in the UK, is an example of an agribusiness which is solely involved in the manufacturing stage of agriculture production.

    Why invest in agriculture?

    An allocation to agriculture can provide many benefits to a portfolio. The most important is diversification. Agriculture has historically had a low or negative correlation with other asset classes, both traditional and alternative. The majority of agriculture , which is farmland, is linked to produce. People are always going to need food and so agriculture prices will not necessarily move in the same way as financial markets.

    Figure 1: Asset class correlations with Farmland, 2000-2019

    US Equities 10-year US Treasuries 3-Month Treasury Bills Corporate Bonds REITs Gold Global Equities Emerging Market Equities
    0.07 (0.08) 0.11 (0.43) (0.06) (0.02) 0.21 0.08

    In addition, we expect agriculture returns to be broadly linked to inflation. Farmland and forestry and the underlying agricultural commodities that are produced tend to generate value in real terms. The value of the underlying land will also have a link to inflation and acts as a good store of value, proving to provide downside protection historically. This means an allocation to agriculture could be useful within a wider portfolio, particularly in the current economic environment of increasing inflationary pressures.Source: Fiera Comox

    As well as the portfolio benefits that agriculture bring, the return potential for agriculture can be as high as 8-10%, given the positive secular trends currently in motion. As with any investment idea, higher returns can typically be obtained through a private equity model. 

    The trends driving agriculture investment

    Returns within agriculture are generated through both the sale of the agricultural goods and the appreciation in the capital value of the underlying land. As such, long-term trends, particularly demographics, are expected to drive these returns as this will continue to result in demand to significantly outweigh supply.

    Population growth is by far the most important trend. By 2050, the global population is estimated to exceed 9.5 billion. This will drive up the demand for food (crops, livestock) and housing (timber for construction needs) considerably, which means that agricultural production must increase or be more efficient. And because of the demand/supply imbalance, prices are likely to rise over time.

    Figure 2: United Nations, 1950 to 2050

    Not only is a rising population a positive, but within demographics the expansion of the global middle class and changing consumer habits should also support the sector. The westernisation of diets in Asia (i.e. greater protein consumption in China, particularly beef) and trends such as veganism and sustainable/organic sourced produce are becoming more popular in developed nations. This is also creating opportunities in various subsets of agriculture.

    Long-term supply trends will also help to maintain the demand and supply imbalance, which again should support the agricultural sector. With finite resources and declining arable land, land values are likely to continue to rise. Additionally, land improvement strategies are likely to be a good source of potential value creation.

    Environmental, Social and Governance (ESG) and sustainability

    ESG factors are important to consider in any investment and it is no different for agriculture. There are some clear environmental risks and opportunities with certain aspects of agriculture, particularly farmland. A lot of land, especially in emerging countries, that is used for farming purposes is a direct result of deforestation. Food and crop (e.g. beef and nut production) also requires a significant amount of water resource and animal-related production; in particular generates a staggering amount of carbon emissions. (See below.)

    There is an increasing interest in a type of farming called agroforestry; i.e. sustainable agriculture where, instead of intensive cropping, it combines growing trees with crops. This strategy is better for soil, habitats, biodiversity and pest control.

    The preservation of nature and farming responsibly provides an opportunity to mitigate climate change risk. If agricultural projects are sustainable, there is significant upside potential if we see the appropriate pricing for carbon and/or fines for excessive pollution or harmful chemical use. 

    Also, an investment in agriculture (specifically forestry) could be used as a way of offsetting the risk of highly carbon intensive portfolios. It is possible that regulatory rules will be put in place requiring businesses to hit certain ESG/carbon criteria which could result in an increase in investment into forestry. There are also an increasing number of firms targeting net-zero by 2050, which means many of them may look to investment in forestry funds to offset their carbon emissions.

    This means investors can move into this asset class early and front-run the opportunity to benefit from the upside potential and the anticipation that the asset class will be institutionalised and see significant inflows in the coming years. 

    Along with the environmental impact of agriculture, there is a clear social impact aspect to this type of investment. With the global population expected to continue increasing over the coming years, investment into increasing agricultural production and efficiency will be vital. 

    Finally, it is worth noting that the carbon storage qualities of forestry has seen a growth of demand for it. 

    • Agriculture is sensitive to physical climate change risk which could be acute (i.e. freak weather events) or chronic (i.e shorter growing seasons). In order to mitigate this risk it is important to diversify by geography and type of exposure. 
    • Returns are generated through the sale of produce. Therefore, changes in the underlying commodity price can have a big impact on returns.
    • Other sectors compete for water resources and the sector is vulnerable to water scarcity.
    • With population growth comes urbanisation, which removes the crop-producing land available for agriculture.
    • There are regulatory and tax risks that come with governments changing policy, such as tariffs or subsidies. 
    • Investments can be exposed to changes in exchange rates and currency.
    • It is sensible to look at investment time horizons. Investors with shorter-term investment horizons will likely have no desire to preserve the land properly.
    • The location of the land is important due to potential transport limitations. With population growth comes urbanisation, which removes the crop-producing land for agriculture. 
    • There could be competition from genetically modified crops replacing a chunk of agricultural produce. 
    • There can be liquidity risk. In some cases there may be closed-ended funds with terms of up to ten years. Even in open-ended funds, there would most likely be lock-in periods.

    Once the approach and roles have been agreed, the GMP equalisation calculations can be run. The extent to which the administrators are involved with this will vary from scheme to scheme, but as an absolute minimum it will involve loading a new set of data to member records on the administration system. New fields will be needed to store the new benefits on the administration system and an audit trail will need to be produced.

    There will be other tasks too. For example, if GMP  is converted then a process review will need to take place to remove all reference to GMP. If dual records are being implemented, then new processes will be needed to undertake the ongoing comparison to check that a member is still being paid the higher of equalised benefits.

    Member communication is also highly important. Communicating to members the changes to their benefits and responding to queries raised will be a crucial part of the role. Who is better placed than administrators to convey this difficult to understand topic to members?

    Should you invest in agriculture?

    An allocation to agriculture would be useful addition to a private markets portfolio alongside private debt and equity, property and infrastructure. The allocation would enhance a portfolio through adding diversification and positive sustainable impact.

    With population growth and changing consumer habits, demand for food and timber will only rise. There is also a massive shortfall in supply with the amount of arable land declining rapidly. As a result of these long-term demographic trends, the supply and demand imbalance is likely to persist, which should support the asset class.

    Forestry in particular also has positive environmental benefits with respect to carbon offsets, so can be attractive from that perspective, for both investors and institutions looking to achieve net-zero emissions.

    Given these benefits, it is likely that many institutions will allocate to agriculture in some form over the coming years, particularly given that it is the is the last remaining “conventional” asset class that remains largely untapped within private markets. We therefore believe that investors can front-run the opportunity now to generate attractive returns.

    One of our clients sought to invest in inflation-linked assets, resulting in an investment in agriculture. Our in-house research team considered various real assets that provided inflation-linked returns such as residential property, infrastructure and agriculture. We ultimately recommended the client invest in agriculture, because it solved their inflation-linked requirements while providing diversification from traditional asset classes.

    The client invested in an open-ended agriculture fund, which offered geographical diversification, with investments in agricultural land in nine different climate regions, and sectoral diversification, as the portfolio includes 13 different agricultural commodities, including wheat, dairy and maple syrup.

    The client’s initial apprehensions around investing in agriculture related to farming practices, including the water efficiency and treatment of the land. To address this, the fund that our client invested in has various ESG initiatives. It has saved almost 6000 mega litres of water through shade cloth technology and new irrigation systems. Moreover, the development of precision spray technology in farms in Queensland has reduced pesticide usage by 90%. These are just some of the benefits the fund has been able to provide.

    Overall, this investment provided diversification with strong risk-adjusted, inflation-linked returns, in addition to demonstrating firm ESG credentials and hard evidence of positive externalities. As such, the investment in agriculture has proven successful for our client since they have invested.

    Once the approach and roles have been agreed, the GMP equalisation calculations can be run. The extent to which the administrators are involved with this will vary from scheme to scheme, but as an absolute minimum it will involve loading a new set of data to member records on the administration system. New fields will be needed to store the new benefits on the administration system and an audit trail will need to be produced.

    There will be other tasks too. For example, if GMP  is converted then a process review will need to take place to remove all reference to GMP. If dual records are being implemented, then new processes will be needed to undertake the ongoing comparison to check that a member is still being paid the higher of equalised benefits.

    Member communication is also highly important. Communicating to members the changes to their benefits and responding to queries raised will be a crucial part of the role. Who is better placed than administrators to convey this difficult to understand topic to members?

    More information

    For more information about this topic, please contact your usual Barnett Waddingham consultant.

    You can also get in touch with the below authors or contact amy.taylor@barnett-waddingham.co.uk, a key contributor to this blog. 

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