By Hamlin Lovell, NordicInvestor
Developed market land farming for yield, growth and inflation hedging
Agriculture can be grouped with other real assets such as forestry/timberland, real estate, infrastructure, precious metals, industrial metals, and equipment, but they all have distinguishing features.
The return profile of investing in agriculture has shown little correlation to anything else, and has proved resilient during crises such as 2001, 2008 and 2020. It held up well during the Covid crisis when governments encouraged food production and social distancing was anyway easy.
“Even a small allocation can boost Sharpe ratios. My former employer, one of the world’s largest pension funds, made a modest increase in their allocation to the asset class which significantly increased its overall Sharpe ratio,” says Matthew Corbett, who along with two other partners, launched a firm called Comox Equity Partners, in June 2017, and has partnered with Fiera Capital to help scale up the offering. Fiera Comox’s agriculture strategy assets are around USD 900 million as at the end of 2021.
Farmland has also been an effective inflation hedge. Valuations can show some sensitivity to a spike in interest rates, but overall returns through different environments have been between high single digits and low double digits.
“At my former employer, we launched the agriculture allocation, the average since inception return was above 16% IRR for a $3 billion asset base, and the strategy became a core real asset holding that was viewed as less risky than real estate or infrastructure,” says Corbett.
Though there is some immediate yield in the early years, it can take some time to ramp up to maximum returns and yields as a few years may be required to improve and consolidate assets.
Helping mid-market farmers obtain optimal scale
While infrastructure can involve single projects or assets, such as airports, worth tens of billions of dollars, agriculture is still a more fragmented industry with significant scope for efficiency gains.
“Farming remains an industry where 99% of players are small, and it is more difficult to capture the benefits of operating at scale. This allows well capitalized famers to gain an advantage through better tractors, water infrastructure and other equipment. The delta between top farmers and everyone else can be significant,” says Corbett.
“With a dairy business below 200 cows or an orchard below 100 acres it is more difficult to be efficient. These larger, and more well capitalized operations are able to invest in technology and infrastructure that mitigate yield volatility, increase operational efficiencies, and drive down cost structure. As an example, these operations are able to purchase technology such as camera sprayers at a cost of several hundred thousand dollars. This technology works by precisely targeting the application of agricultural inputs, such as herbicide, to only the places in the field that require them, saving significantly on inputs required and costs to the business when compared against traditional broadcast spray methods,” Corbett explains.
Other economies of scale include horizontal efficiencies from adjacent farms, and vertical synergies related to packaging and marketing further down the supply chain.
The key investment focus area is on mid-market players who have already achieved some degree of scale, but require further capital investment in order to maximize efficiency.
Aligning incentives with farmers
Ownership models include private equity joint ventures, own and lease or corporate ownership.
Corbett prefers an equity partnership approach alongside of an owner-operator, taking a stake but ensuring that the local operating partner(s) retain a significant stake to incentivize them and foster a partnership mentality with a long-term focus. He argues that,
“an own and lease model can misalign interests and reduce longer term returns. Meanwhile a corporate farming model, buying and operating the asset, only offers farmers a pay-cheque whereas our shared equity ownership gives them greater alignment of interest and incentives, along with maintaining the local expertise within the business”.
Dimensions of portfolio diversification
Virtually all countries grow some form of agriculture, even if it is cacti in a dry desert, but investment strategies will tend to focus on a narrow set of geographies and commodities.
“Many agricultural strategies are concentrated into one sector or one region. We take a more diversified approach in seeking the best relative value, but also to diversify and reduce risks,” says Corbett.
The Fiera Comox strategy is diversified by country, climate region, commodity and end market. As of February 2022, it has 220,000 acres, producing 14 commodities across 10 climate regions, spreading risks such as weather, harvests, pests, and pricing. There is diversification by commodity and crop type, which are lowly correlated. There are permanent crops, row crops, animal proteins, and other agricultural commodities. The rationale here is to try and optimize portfolio diversification in the same way as a global equity portfolio manager would. For Fiera Comox, each new investment does not only need to stand alone on its own merits, but should also contribute diversification benefits to the overall portfolio in terms of return patterns, and risk factors.
The objective is to partner with top tier, competitive producers who are good members of their local community in the production of a given commodity eg New Zealand for milk, Australia for cotton, Washington state for apples and cherries.
“We shy away from greenfield, pioneering projects, marginal farmland and producing regions dependent on subsidies, but rather we focus on core assets in core producing regions” says Corbett.
The primary countries targeted are developed economies such as the US, Canada, Australia and New Zealand, Chile, Uruguay and Western Europe, which include a range of climate regions.
Pricing risk, hedging, catastrophes and insurance
Agriculture usually entails some exposure to commodity price volatility. Most of the commodities that Fiera Comox produces do not have futures markets for hedging, and Comox does not undertake synthetic hedging. The strategy does however carry out some forward selling that involves bespoke contracts with local buyers, rather than synthetic hedging strategies.
A few commodities, such as cotton, are more industrial, though not completely homogeneous in nature.
“Australian cotton commands a premium due to its high quality, and because Australia is a large producer able to guarantee security of supply. We can therefore typically earn a premium on our forward sales,” says Corbett.
Insurance is a complicated area, but it is obtained where feasible, but again diversification is the key risk mitigant for Fiera Comox.
“Our biggest insurance is diversification against risks such as pestilence and disease. Catastrophic crop risk is diversified, and we have never had a catastrophic crop loss that has a material negative impact on the overall impact of our strategy,” he recalls.
ESG risk considerations: climate, carbon, water and forest fires
Whether or not strategies are branded as impact per se, they need to consider sustainability and ESG challenges. There are multiple ESG angles, but no universally accepted standard frameworks exist for agriculture.
Fiera Comox is one example of a manager that has developed its own range of sustainability criteria and factors. The choice of regions is one:
“we want to avoid areas with the highest climate risk, and the gap between highest and lowest risk areas will only widen in the future,” says Corbett.
Sustainability in agriculture needs to be looked at from multiple angles, there is not one single or simple metric providing the answer.
‘’Assessing the sustainability practices of a farm can be complex considering the importance of variables attributable to soil quality and exposure to elements (sun, wind, water) just to name a few.” argues Corbett.
There are however some useful certifications which helps in getting leading practices recognized in the industry which are being utilized by Fiera Comox and others that are being evaluated. Additionally, a specialist ESG consultant is also helping to gauge the strategy’s positive contribution to decarbonization.
Carbon capture can be achieved through forests, oceans, and technologies and there are nascent projects in farms as well. For example,
“Zero till farming keeps carbon underground sequestered in the soil, while traditional tilling up releases the carbon back into the atmosphere. We are working on a carbon sequestration project, which measures the benefit of what we do and how we could further innovate in this space. There is no perfect measuring stick for carbon sequestration in agriculture and the related certifications are not mature in the way that they are for timber,” he explains.
Water use and efficiency can be more easily monitored and often improved. Fiera Comox’s key aims on water are to ensure access to sustainable supplies on each farming enterprise eg from rainfall; refrain from selling water rights, avoid competing with humans for water, and increase water efficiency by reducing “drop per crop”.
“Our underwriting considers declining water supply scenarios and seeks to identify efficient water use and opportunities for improvement. We are working hand in hand with our farm partners to reduce water use in fruit farming for example. Our apple producer uses up to 50% less water than others, and is water-efficient,” he points out.
Meanwhile, farming equipment is becoming cleaner and greener.
On the social side, employee wages, conditions and medical care are important inside agriculture projects. For society as a whole, sustainable farming with enhanced yields can help to feed the growing world population.
ESG opportunities: organic foods and sustainable protein
Consumer preferences for organic produce are one example of ESG as a source of opportunity. Some of Fiera Comox’s investments, such as maple syrup in Northern Vermont, are not only attuned to consumer preferences for healthier sugars but already employ organic production, while others, such as a cherry and golden kiwi fruit producer in California, are transitioning portions of the property to organic and may soon be one of the largest organic cherry producers in California.
The Fiera Comox strategy is not exposed to insect proteins, plant-based meat and fish substitutes, however, because it is focused on more established, natural commodities.
Vehicle structures
Real assets can be accessed through separately managed accounts or comingled vehicles including closed and open-ended structures. Closed ended structures were traditionally the dominant model but a wider menu of structures is now on offer. An open-ended structure (albeit with a soft lockup in the first five years) is relatively unusual, but arguably has certain advantages.
“It allows flexibility over the timing of exits. We have the ability to exit at the best time, not when we are forced to based on the vehicle structure. We are a very long-term owner and partner. However, we may sell some non-core parts of the portfolio if it is in the best interest of our investors. We have gone through the process of building businesses worth $50 to $300 million,” concludes Corbett, underscoring his long-term vision.
