Abdullah Nauphal, Insight Investment CIO, says that the buy and lease model is generating returns of around 15%.
Agriculture: a challenging investment with great potential
Rising food prices, agricultural land’s long-term inflation-linked characteristics and low correlation to most asset classes, are driving renewed interest in agriculture as an investment class.
The Food and Agricultural Organisation food price index rose by 2 per cent in the three months to February 2012, reflecting rising demand from a growing world population, more particularly in India and China. Meanwhile, extreme weather events and increased usage of farm land for biofuels have dented food production in Western Europe, China and Latin America, boosting the cost of agricultural commodities from wheat to palm oil. The rising cost of foodstuffs is driving up inflation and the cost of land in both emerging and developed economies. The UK’s retail price index (RPI) is 10% weighted to food prices and the level of US farm values has risen 20% in the past year alone.
Investment models
Successful investment in agricultural assets is easier said than done. Gaining exposure can be done via a variety of routes, all of which have their drawbacks. Agricultural stocks are volatile: commodity ownership involves storage, ownership costs and risks. Commodity index funds are cheap and easy, but have a high correlation to equity markets and finally, direct land investment requires scale and faces major foreign ownership issues.
Guillermo Badino, of Cazenave y Asociados, an Argentinian consultant on agricultural management, says there are three principle investment models for investment in agricultural land. Buying and holding has been the traditional route for pension funds, whereby they buy the land and wait for it to appreciate over time – a business model which typically generates a total return of around 8% per annum (3-4% cash return, 2.5% inflation and 2% land appreciation). Alternatively, pension funds can buy and lease the land and wait for technological changes, such as GM crops, to triple yields and thereby the land’s value. Badino says that US, Dutch and Swedish pension funds already have US$3.5bn invested in this way.
The second model, to buy and develop, is a more risky route, typically used by hedge funds, and involves buying raw pasture land and converting it into highly productive agricultural land to boost its value.
The third model, leasing land to local managers is even more risky as investors need to recruit local agricultural experts and monitor them closely. The model has the advantage of circumventing land ownership limits which are starting to apply in a number of countries, including Argentina, Brazil and Madagascar. Abdullah Nauphal, Insight Investment CIO, speaking at the NAPF investment conference in March, said that the buy and lease model is generating returns of around 15%.
The £35bn BT pension scheme, advised by Hermes, its fund manager, is seeking to replace its 3% commodity futures exposure with a US$1bn direct investment in agricultural land. BT is investigating opportunities in the US, Canada, Brazil and Australia, but not the UK, due to its low turnover and parcels of land which tend to come to market with residential property in the middle of it. In addition, there is a huge debate around tenants’ rights to buy in Scotland. BT management director, Helene Winch, says: “BT is considering owning land and leasing it to tenants and gaining asset diversity by buying into a variety of crops and locations.”
The $470bn TIAA-Cref is the second largest owner of agricultural land in the US (after the Mormon church). The scheme holds $2bn of farmland in the US, Australia and Brazil, as well as stakes in other big landowners. TIAFF-Cref has created two funds, one for itself and one for third party investors. The latter buys and leases land in Brazil, partnering with Brazilian entities so that the fund remains compliant with land ownership rules requiring a 51% investment by a local partner and 49% by the institutional investor.
As for US farmland, although TIAA-Cref fund manager, Roger Ferguson believes prices cannot go on rising at their current rate, he remains confident that agricultural land will continue to provide considerable financial security for long term investors: “Agriculture is an important long term play, which is focused on the growing middle classes around the world and their changing eating habits.”
Ferguson says that farmland has produced average annual returns above 10% since 1970, outstripping most other asset classes, while the National Council of Real Estate Investment Fiduciaries says returns for US farmland are 78.88% (over 5 years) and 309.83% (over 10 years).
Hurdles to investment
For pension funds which do not have the scale to invest in land, private equity firms such as Cordiant Capital specialise in private sector debt in emerging markets, lending to agribusinesses, machinery and equipment manufacturers, fertiliser producers and grain handlers. The risks associated with direct agricultural investment - liquidity, nationalism, currency volatility and crop failure (due to the increasing occurrence of extreme weather conditions) - mean that in depth due diligence is necessary for successful investment.
Resistance by some countries to ownership of indigenous land by foreign investors is growing. Nearly two years ago, Brazil banned foreigners from buying large tracts of land, prompted by alarm at Chinese interest in buying Brazilian farms to secure its supply of soya beans. Private sector investment is unlikely to resume until a new law, which is currently stuck in Brazil’s legislature, is passed. In Argentina, a law bans foreigners from owning more than 49% of any parcel of land and there is a new tax of 5%-15% on the transportation of grain. This means that of the 70% of Argentinean land which is in agricultural use, two thirds (20m hectares) are under lease. In Africa, the hurdles to ownership are even greater as land ownership and food security issues are more acute. Badino says that in Mozambique and Angola, the governments’ priorities are to feed their own peoples and then to export. However, going into a leasing model with a local manager is possible, although this can mean having to deal with a former Communist government.
Nauphal says the risk of a backlash from nationalistic governments wishing to protect indigenous lands and peoples can never be eliminated, but that it is mitigable. New UN guidelines on limits to the size of agricultural land sales are due to be ratified in May at a special session of the UN Food and Agriculture Organization in Rome. The guidelines say countries should provide ‘safeguards’ to protect tenure rights. There is also an ongoing debate over the ethics of investing in soft commodity futures. Some argue that speculation drives prices higher, thereby increasing volatility.
Exit strategy
While agricultural land has the potential to provide a source of long term fixed income, the hurdles are enormous. Extreme illiquidity and sensitivity to geo-political risk mean that diversification of holdings and careful selection are key.
Political risk in Argentina is such that Guillermo Badino does not recommend investing there are the moment: “There is a lack of rule of law in Argentina because the government is changing every day and it is not a good environment if you are trying to run a business here. Argentina is definitely a target country, but not today.”
There are 54 investment funds with US$7.44bn of agricultural investments around the world, much of it acquired during the last decade, according to a HighQuest report for the OECD. This amount is expected to double or triple in the near to long term. Lorenzo Rossi, bfinance managing director, warns, “Some of the agricultural funds do not have a clear exit mechanism for investors. There can also be problems with transportation and hidden costs due to local taxes and laws, so it is not clear how investors will receive a decent return. One solution is for investors to buy into local companies which own and manage the land.” Helene Winch agrees, “Investing in agriculture takes time and getting out is even more of a problem than getting in.”
P.A.
