Agriculture Investment - A Must Read Article
Finding the best agriculture investment can be tricky for the inexperienced investor with little or no knowledge of the sector, but there are of course many different options available including agriculture investment funds, direct agricultural land investment, and purchasing equities in agricultural companies. In this article I will go some way to investigating the different options, the risks they present to investors, the mechanics of how each type of agriculture investment works, and the returns that are currently being achieved.
Firstly we will look at the relevance of agriculture investment for the current economic climate, and whether this particular sector shows us the signs of being able to generate growth and income.
The Current Economic Climate
The global economy is still in a state of turmoil, and the UK in particular is cutting back public spending to reduce an unmanageable national debt, the population is growing, and qu antitative easing is likely to lead us into a period of extended inflation. Also, the lack of economic visibility means that it is very hard to value assets such as stocks, and interest rates being so low means that our cash deposits are not generating any tangible income to speak of.
So what does this mean for investors? It means that we need to buy assets that have a positive correlation with inflation i.e. they go up in value quicker than the rate of inflation, these assets must also generate an income to replace the income we have lost from cash, and finally any asset that we purchase must also have a strong and measurable track record.
It is very clear that agriculture investment, especially investing in agricultural land, displays the characteristics of growth, income, a positive correlation with inflation, is easy to value, and has a clear and evident track record to analyse, and as such agriculture investment ticks all of the relevant boxes to potentially become the ideal asset class for investors today.
Agriculture Investment Fundamentals
The fundamentals supporting agriculture investment are pretty easy to measure; as the global population grows we need more food, to produce more food we need more agricultural land as this is the resource that provides all of the grain and cereals that we eat, and all of the space to graze the livestock that end up on our plate. So we are dealing with a very basic question of supply and demand, if demand increases and supply can't keep up, the value of the underlying asset increases, so let's look at some of the key indicators of supply and demand for agriculture investment.
For seven of the last eight years we have consumed more grain than we have produced, bringing the global store down to critical levels.
Since 1961 the amount of agricultural land per person has dropped by 50% (0.42 hectares per person down to 0.21 hectares per person in 2007).
The global population is expected to grow by 9 billion by 2050.
Most think tanks and experts believe that we will need to increase the amount of agricultural land by 50% to support that growth, essentially a productive field the size of greater London need to be found every week.
In the last ten years virtually no more land has been bought into production as climate change, degradation and development and a host of other factors mean that there is little or no more new land we could use to farm.
The underlying asset that produces our food, the land, will become more valuable as more people demand food.
Agricultural land value rise when the food it produces can be sold for a higher price, making owning farmland more profitable, and food prices are at a 40 year low, leaving room for around 400% price inflation. In fact a bushel of wheat cost around $ 27 in the early seventies and now costs just $ 3.
Farmland in the UK has risen in value by 20% from June 2009 to June 2010, and 13% in 2010 alone according to the Knight Frank Farmland Index.
So the fundamentals supporting agriculture investment are sound and very clearly demonstrate a good picture for potential investment. But can we absorb price inflation? Well there are a myriad of studies that tell us very clearly that as a population, we absorb increases in food prices almost 100%, and sacrifice spending in other areas, so yes, we can.
Methods of Agriculture Investment
Agriculture Investment Funds
There are many types of agriculture investment funds to choose from, most invest in farming businesses, other purely in arable land, and others by stock in agricultural services companies. Most agriculture investment funds are showing excellent growth, and the fact that they are buying has increased the level of demand in the market therefore their mere presence is contributing to capital growth. Rural agent Savills recently commented on the fact that they have access to £7 billion in capital from fund to purchase farms, that is enough capital to purchase six times the amount of farmland that will be advertised in the UK this year, in fact, according to Knight Frank there has been 30% less farmland advertised this year from last, and buyer enquiries have increased by 9%.
To talk about risk for a moment, the risk involved with this fund based investment strategy is that you give over control to a fund manager who will spend your money for you and acquire assets that he or she believes are relevant. Also, if one fund performs badly, that usually has a knock on effect for other agriculture investment funds as confidence in this particular strategy takes a hot, you can therefore lose value through no fault of your own. You also have to pay a fund management fee, eating into your profits.
In terms of the returns one can expect from a fund, this varies wildly but most p roject annual returns of around 10%, although this will vary depending on a whole host of factors including the fund management, investment strategy, and general market conditions.
Buying Shares in Agricultural Companies as an Agriculture Investment
Another option for chose considering cashing in on agriculture investment is to purchase shares in an agricultural business, be that a farming business, or a services business, the options to consider vary wildly and careful thought must be undertaken to pick a suitable market (LSE, NASDAQ etc), and then a suitable company in which to invest. The business of picking shares remains, in my opinion, a job best left to those with the time, experience and resources to carefully research the company, its management, and it product line, and only those company displaying sound fundamentals should be added to a portfolio.
The risk here is as with any equity based investment, a down-swing in the market c an cause a good company to lose value and thus affect the wealth of the investor in a negative way. We have all seen recently how a bear market can bring down profitable companies and the whole premise of agriculture investment is to avoid financial markets and add an element of non-correlation to a portfolio, ensuring the investor owns an asset that is unaffected by volatile stock markets.
So does an agriculture investment in the form of shares fit the bill? Well not really, as we were looking for stability, non-correlation, a positive correlation with inflation and income, and this mode of agriculture investment ticks none of those boxes other than a nominal dividend.
Buying Farmland as an Agriculture Investment
In my opinion the most sensible strategy for investors is to acquire profitable farmland that has a track record of producing an income yield, and rent that land to a commercial farmer. This mode of agriculture investment allows t he buyer to access an asset that displays all of the characteristics that we are looking for, non-correlation with stock markets, positive correlation with inflation, income and growth, as UK farmland continues to increase in value yet is still only half the price of agricultural land in Ireland, Denmark and the Netherlands, leaving a huge margin for future growth.
There are of course a number of risks to consider here as well, sourcing good land for example, and of course sourcing and managing a farming tenant, these risks can all be managed effectively by partnering with a specialist agriculture investment consultancy that will handle the sourcing of both land and tenant and also handle all ongoing management too.
So to summarise, if one is to make an agriculture investment, the best option right at this moment is to buy agricultural land, giving the investor growth and income in a volatile market.
David Garner is Partner at boutique alternative investment boutique DGC Asset Management Limited.
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