Our agriculture roundtable gathered portfolio managers and investment consultants from North America, Denmark, Sweden and the UK to explore the unique features of agricultural investing and how it is adapting to investors’ evolving ESG and sustainability priorities.

You can read the summary here or watch the video below.

Panelists:

  • Matt Corbett is a partner in Fiera Comox, a global developed world land-based agriculture fund managing USD 1 billion.
  • Jonas Lindgren is a partner at COIN in Stockholm, which advises Swedish asset owners on traditional and alternative assets.
  • Pete Drewienciewicz is Chief Investment Officer for Global Assets, at Redington in London, an institutional consultant with $600 billion of assets under advice, across traditional and alternative assets.
  • Mads Jensen is co-founder, partner and professional director of Jentzen Advisors in Copenhagen, which advises tier two institutional investors in Denmark on traditional and alternative assets.

Moderated by Hamlin Lovell, Contributing Editor at NordicInvestor

The Asset Class in a Portfolio Context

  • Diversification, Yield, Recession-Proofing, Inflation Protection, ESG

Agriculture can be grouped with other illiquid real assets, including real estate, infrastructure, and forestry but it has some distinguishing and unique features and also provides diversification within real asset portfolios:

“even if sophisticated portfolio allocators already have exposure to the larger asset classes of real estate, infrastructure and forestry, allocations to agriculture can add diversification and improve portfolio Sharpe ratios. A well-diversified agriculture portfolio can also provide a relatively stable yield, and some investors are moving capital from other income strategies to agriculture. Agriculture is a small asset class, but it has a place in any portfolio in our view,” says Corbett.

Agriculture is perceived as a relatively defensive asset class. It remained lowly correlated during 2001, 2008 and 2020. During the Covid crisis it was carved out of lockdown restrictions and requirements to work from home because governments recognized it as essential.

“We have also looked at forestry. Agriculture is still a relatively small part of client portfolios and is a learning curve for both our clients and us. We find that agriculture has some attractive features. Land is in finite supply. Food is a necessity, so demand is there regardless of economic recessions or business cycles. It also benefits from a growing population,” says Lindgren.

With developed world inflation at 40-year highs in early 2022, inflation protection is also sought after:

“agriculture might not have an explicit linkage with inflation but it does show some of the strongest correlations to realized inflation. The returns, risk profile and yield are all very attractive. ESG is another attraction: clients are also more focused on natural capital, climate and ESG considerations, where agriculture can contribute positively. Overall it is a big tickbox,” says Drewienciewicz.

All of these features are appealing even for investors who are only just starting to contemplate agriculture:

“agriculture is still an emerging asset class for our Danish institutional investor clients. They are seeking inflation protection, diversification, and positive ESG impact,” says Jensen.

Sizing and Scaling Up Agriculture

  • Consolidation potential

Agriculture is often a small part of investor portfolios not least because it is a small investible asset class, partly because many smaller farmers in many countries are not open to third party investors.

There is no simple rule to determine the right size for individual investment opportunities:

“The optimal size of projects depends on the commodity. It could be larger for cattle farming and row crops can also offer significant economies of scale. There are also colocation considerations: some smaller assets could be efficient if they are close to processing plants. And some smaller lots can be acquired at lower prices,” argues Drewienciewicz.

The size and scale of farms vary enormously both within and between countries, because most agriculture sectors have not yet consolidated in the way that other industries have.

“Asset quality varies by subsector, but overall the best risk adjusted returns come from a process of scaling up an agricultural business from small scale to medium or larger, and many farming businesses do not have the capital to grow. Very few farming businesses are mega-size compared with other asset classes,” observes Corbett.

Different Operating and Business Models 

  • Alignment of financial and sustainability incentives

Projects of various sizes can be accessed through models, which include private equity partnerships, own and lease or corporate farming and can be tailored to operators’ expertise, and appetite for complexity. Different models can arguably align – or misalign – financial and ESG incentives, over various time horizons. A limited life lease may not incentivize farmers beyond its life, and could create perverse incentives to overwork and deplete the land, while a fixed salary from a company may not encourage them to improve. 

Some advisers are somewhat agnostic on models:

“We are not indifferent as to different models, but are open-minded so long as the model aligns incentives on returns and sustainability,” says Lindgren.

“We have a slight preference for specialist in-house expertise at asset managers, who can then select the best operating models, which can involve other specialists, but this is not the only option. We have also seen that own and lease can work well with the right incentives,” points out Drewienciewicz

Some asset managers have a clear preference for their own tried and tested structures:

“we have implemented an equity partnership model over several decades, and we find it is critical both for good returns and aligning sustainability outcomes over very long time periods. We like to see farmers and food producers having equity stakes alongside investors. Our farming partners are local to industries and communities, and have decades long horizons stretching out to the next generation. We can also see merits in other approaches, but are emphasizing alignment of economics and sustainability,”  explains Corbett.

Managing commodity price volatility

  • Diversification or hedging or both?

Agriculture appeals partly for long-term inflation protection, but it is not a pure play on inflation or on agricultural commodity prices. There are many moving parts in the economics of owning farms. The income in any given year is determined by commodity prices, but also volumes that could be influenced by weather, catastrophes, pests, trade wars, military wars, sanctions, counter-sanctions, and other factors, and then the valuation of assets should in theory have some relationship to interest rates, discount rates and risk premiums. Therefore, agricultural commodity prices are only one part of an equation that relies on mother nature and on expertise in running a business.

“There are other ways of more efficiently getting long exposure to agricultural prices,” Jensen sums up.

Many investors anyway have a limited tolerance for shorter-term volatility of a pure long only commodity investment. Early 2022 demonstrates how volatile some agricultural commodities can be, as Russia’s invasion of Ukraine, enforced migration, blockading of ports, and leaving landmines on farmland, potentially delays shipments of grains as well as sowing for the next harvest. Therefore, investors like to see portfolio diversification reducing volatility, and some would also welcome a degree of commodity price hedging:

“We like to see diversification by crop and commodity and we would definitely look into hedging policies,” says Jensen.

“Truly diversified exposure across a broad set of uncorrelated commodity groups, going beyond highly correlated row crops, is the primary way to diversify commodity price risk, rather than synthetic exposure to commodity trading via hedges,” argues Corbett.

Any hedges need to manage practical and operational complexities. Hedges, and their associated cash requirements, are a moving target that is not perfectly synchronized with revenues from agricultural production, which can give rise to mismatches:

“in theory it is very appealing to use hedging to lock in prices and de-risk the proposition. The problem is that futures and forwards do not go beyond 12 months and require variable amounts of collateral, which needs cash or credit lines. If prices rise the hedger needs to post more liquid collateral. De-risking is desirable but derivatives may not be a great answer,” explains Drewienciewicz.

Managing Country Risks

  • Avoiding emerging markets political and ESG risks

Investors certainly want to diversify commodity price and geographic risks, and some of them may also want to completely avoid certain country risks, especially in emerging and frontier markets.

“We seek a lot of commodity and geographic diversification and do not want to be too concentrated in one area or output type. We have seen over the past few weeks how the best-laid plans can come undone surprisingly quickly,” reflects Drewienciewicz.

“For real assets in general, our goal is to get exposure to the cashflows of the market. We do not want to introduce other types of risk and return, such as currency or political risks that are not inherent to the asset class. We could allow some sort of satellite emerging market investment on top of the core but overall have more of a home bias,” says Lindgren.

“We are hesitant to invest in some of the more exotic emerging markets where property rights are not as well defined. We would prefer North America, Western Europe, and Australia or New Zealand,” points out Jensen.

“We stick to developed markets. Emerging markets provide a private equity type risk but do not offer a private equity type return. They add a lot of unmanageable non-agricultural risk that is not rewarded,” asserts Corbett.

The panelists also agreed that emerging markets can also be more challenging for ESG, in terms of environmental issues such as a lack of carbon credit markets, social issues such as worker conditions, and also governance.

Managing Climate and Catastrophe Risk

  • Selection, diversification, mitigation and insurance

Global warming and climate risks could increase productivity in some regions, but since it can contribute to problems such as forest fires, coastal erosion, and droughts, overall it is a risk factor to avoid or mitigate.

“Global warming might improve agricultural yields in some areas, but I am not an expert on where they are. Overall, more volatile weather increases uncertainty in outcomes and encourages us to look for some forms of climate mitigation,” stresses Drewienciewicz.

Climate risk is avoided for clear economic reasons and not just to satisfy investors’ ESG policies:

“we invest in regions with comparatively low climate risk, because it amplifies other risks. Climate change risk makes marginal farms more marginal over time it increases the delta between them and other farms,” explains Corbett.

Climate risks can be mitigated by investment in infrastructure around projects:

“we also invest in resource efficiency to increase our buffer of safety against volatile environmental factors. For instance, investing in water supplies and water efficient production methods helps to insulate us against future reductions in water,” adds Corbett.

There is some debate over whether regional selection, diversification and mitigation are enough to spread catastrophe risk, or whether any explicit catastrophe insurance is needed:

“diversification can help to mitigate natural disasters and perils, such as hurricanes and forest fires, to make sure you do not have all of your eggs in one basket. We also see a need for some insurance. We would not insure every peril risk, but would insure against devastating disasters that could severely jeopardize a business plan,” argues Jensen.

Carbon, methane and water pricing, usage and capture

  • Nascent but increasingly relevant considerations

Buying carbon credits, and investing in offsetting projects such as capture, are often needed to meet net zero or other carbon targets at fund, asset manager, company, industry, country and global levels in a various investment strategies. Methane and water are also especially germane to agriculture.

Market pricing is one solution;

“It would be a logical long-term move to eventually have pricing curves for carbon, methane and water to price in the externalities that are not priced in. Water scarcity is likely to become a very big issue well before 2050,” predicts Drewienciewicz.

“We would agree that if things are priced, they should get taken into account in modelling. Some risks such as hurricanes can affect developed and emerging markets equally. Others such as water scarcity are more of an issue for emerging markets,” finds Lindgren.

Capture is another approach, which could tie in with pricing if it helped to reduce the amount of credits that needed to be bought. Agriculture can play a role not only in minimizing its own carbon and methane emissions, but also in capturing these gases. Just as trees in forests can breathe in carbon, farmland can be used to sequester carbon.

“Ten years ago, carbon capture was very speculative, but today it is becoming an increasingly viable optionality of land usage. Marginal farmland is viable for carbon capture to focus on the next generation,” observes Corbett.

For some industries such as airlines, planting a forest in South America is an extra cost that is completely unrelated to their core business, but for agriculture the longer term economic incentives are often well coordinated with the environmental ones.

“Overall, positive ESG outcomes for farmland go hand in hand with positive economic outcomes. Carbon capture and efficient water usage are very good for long-term viability on a 10- or 20-year view, hence long-term capital structures are important,” says Corbett.

Worker Rights and Social Contribution

  • Emerging market uncertainties and feeding growing populations

Climate and carbon are often the top priorities in ESG policies, but social considerations should not be overlooked – “environment has been very much at the forefront and social has often been ignored,” has been Lingren’s experience.

“Being industry leaders in employee health and safety is one of our top criteria. Alignment of interest with our local operating partners who are local to communities is also important, as they are often one of the largest employers and have been for decades. This risk can be managed in highly regulated developed markets but are extraordinarily difficult or almost unmanageable in emerging markets,” argues Corbett.

“A good place to start is to ask managers to commit to the UN Global Compact and international worker protection standards. This is more difficult away from western economies,” points out Jensen.

Enhancing agricultural efficiency makes a clear contribution to United Nations Sustainable Development Goal #2: Zero Hunger,

“The major contribution of agriculture is feeding a growing population. Some 95% of traditional agriculture is sub-scale, which means that not enough food is being produced, and it is resource intensive. Modern infrastructure using proven technologies can use about half the water per apple. There are many other proven technologies that can be transformative when they are rolled out over many sectors,” illustrates Corbett.

Agriculture can also have a positive impact on other SDGs and may feed into other frameworks for gauging impact:

“Clients are very concerned about carbon dioxide and are also starting to publish other SDG indicators in different areas such as water,” says Jensen.

“The SDGs are one framework for measuring and reporting the positive impact of investments, and the EU taxonomy is another one,” points out Lindgren.

ESG opportunities:

  • Consumer preferences for organic foods and sustainable protein

Agriculture is a growing market because the global population is growing, and certain fashionable segments could grow even faster than the market.

“We see big consumer demand for plant-based products, but have not yet looked into this in detail for investments. Our clients would prefer to avoid agricultural pesticides and pollutants,” says Jensen.

“Organic foods is a super interesting trend, and investors would prefer to avoid GM (Genetically Modified) food,” says Lindgren.

Vehicle structures

  • Closed end, open end and hybrid structures balance multiple objectives

A wider menu of off the shelf and bespoke investment vehicle options are available many institutional investors who need to weigh up and balance considerations around fairness between investor groups, optimizing returns and incentives, and operational complexity. The choice of vehicle can also influence how much of investors’ illiquidity budget is consumed by agriculture.

“Historically we would have usually seen closed end funds and still think they can be a cleaner approach. Now we can also consider open-ended funds, so long as they are well structured over details such valuation, legacy assets, and transfers between investors,” says Drewienciewicz.

Open-ended funds should be operationally simpler:

“open-ended funds avoid the operational burden of managing capital calls,” illustrates Lindgren.

Optionality over the timing of exits is one attraction of open-ended funds:

“closed-end funds can force a sale at the wrong point of the cycle at a massive discount. An open-ended, perpetual fund matches the generational mindset of the best farmers who are thinking well beyond a 5- or 7-year fund life.. It can also take longer than 5 years to reap the rewards from investments in infrastructure such as irrigation,” observes Corbett.

The closed versus open-ended fund debate is partly a false dichotomy, since in practice open-ended funds are clearly not daily dealing mutual funds. They cannot offer unfettered liquidity and are somewhat hybrid in nature, with limits on inflows based on what they can deploy, and soft lockups and/or gates limiting outflows, and sometimes penalty fees for some redemptions.

Valuations probably need to be more frequent and thorough in an open-ended fund:

“We agree that open-ended funds can mitigate vintage risk and forced selling, but as a matter of principle we are always wary of liquidity mismatches between vehicles and underlying assets. Therefore, frequent and independent valuations are needed so that investors can enter and exit at different times. On balance we judge that the disadvantages of a closed-end vehicle outweigh the disadvantages of an open-ended vehicle,” argues Jensen.

“It is not easy to structure an open-ended vehicle, but it is manageable to create transparency and fairness between current and future investors. These challenges are more manageable than the problems of a closed-end fund,” has been Corbett’s experience