Predictions of long-term potential in the agriculture sector have led investment managers to launch a number of themed funds in recent years, which are catching the attention of private investors. Their attraction is based on three long-term drivers – a rising global population, changing dietary habits in emerging markets and increasing use of biofuels. Farmers will clearly have to produce more crops to meet this demand.
“Demand has been outstripping supply,” says BlackRock’s Richard Davis, co-manager of the BGF World Agriculture fund, launched in February. “This upward pressure will make farms more profitable, and as a result of this, they will be incentivised to grow more crops. And that is where the investment opportunity lies – in the supply side response to improving farming economics,” he explains.
“If farmers do not increase the amount of food they are producing, we will see significant food price inflation, which is something governments do not want. If the price of platinum goes up and I can no longer buy jewellery, the government simply does not care. They do if the price of food goes up. We all know we are only three meals from anarchy. If you can’t eat for three consecutive meals, you will do something about it.”
For investors convinced by this argument, the question is how best to gain exposure to it. One way is to invest in commodities themselves, for example through an exchange traded fund (ETF) tracking prices of individual commodities.
Many investors are attracted to agricultural commodities because they are largely uncorrelated to equity markets, and therefore offer diversification benefits, but they can involve extreme short-term volatility. Agricultural commodity prices are dependent on a range of hard to predict factors, not least the weather.
In response to growing interest, Hedge Fund Research (HFR) launched a family of indices tracking the performance of commodity related hedge funds in 2009. “If you look back at what has transpired over the last six or seven months in the commodities space, you have seen not only a tremendous amount of volatility, but a tremendous amount of dispersion,” says HFR’s president Ken Heinz.
“A few of the major commodities are down significantly on the year, while others are up significantly. Wheat is the most obvious example. Whether the fund is focused on wheat, or natural gas or sugar, has dramatically different implications. Investors have come to understand exposure to the area to be more of a specialised undertaking and not a one-size-fits-all exposure.”
Rather than trying to predict future price moves, a number of funds are looking to play on the expectation of a broader agricultural boom, investing in agricultural equities rather than commodities themselves. These funds invest either in companies that are themselves farming businesses, owning land and growing crops, or those which sell goods and services to farmers, be it seeds, tractors, fertilizers or food producers.
“The attractiveness of equities over commodities is based on one key word – flexibility,” says Desmond Cheung, co-manager of the BlackRock fund.
“We have the ability to invest in different sub-sectors. Different companies will perform differently in different grain price environments. Some will perform well when grain prices are strong, others will benefit from the increase in production that will push down the price of grain, which challenges the myth that the only way to make money out of agriculture is when there is a food crisis and grain prices are high.”
The emergence of the biofuels industry has put further pressure on agriculture, as for the first time farmers have two customers, food companies and fuel companies. In the US today, 30 per cent of the corn crop is turned into biofuels, which has proved controversial as it is, in effect, “setting fire to food” as BlackRock’s Mr Davis puts it.
However, spurred on by climate change and the need for greater levels of renewable energy, this is only going to increase, as government legislation for increasing amounts that must be produced is driving the sector, both in the US and elsewhere.
“If Congress changed its mind, or we rethought our policy, that would be very disruptive,” says Bryan Agbabian, fund manager of Allianz RCM Agricultural Trends.
“I don’t see that happening, given the infrastructure that has been put in place. Farmers’ livelihoods would be put in jeopardy, the ethanol industry is starting to develop as well, and given that we have a President that was a senator from Illinois, I think it doubtful that there will be a significant change.”
A further benefit of agriculture themed funds is in providing exposure to emerging markets, since these are the countries that are seeing the fastest growing populations and changing dietary habits afforded by rising levels of income, and are therefore driving the sector. As populations in developing countries become increasingly wealthy, they tend to move from starch-based diets to more balanced ones, with increasing levels of protein consumption. And as a result farmers have to grow more grain to feed these animals.
