Old MacDonald had an investment in agriculture

Investing in farmland is not always as straightforward as it might appear. One New York-based hedge fund apparently pulled out of a Brazilian farm project on discovering the deal would only produce positive cash flows one month a year, a period known to those in the trade as a “harvest”.business in Romania Meanwhile, foreign investors that have snapped up farmland in poorer parts of Africa have been pilloried for putting local tenant farmers out of work and, potentially, reducing local food supplies by exporting their produce. More ON THIS STORY US farmland prices keep on rising Farmland values triple in ten years How to... How to . . . invest in farmland Investors take an interest in farmland Agricultural traders in a sweat over US drought THE BIG PICTURE Investors rush to be a part of the crowd Renewable energy lifts hopes of a safe return Concerns mount over UK retail bond issues Wonga debacle shows need for portfolio scrutiny But despite these setbacks, the likes of Sweden’s AP2 pension fund and the UK’s Pension Protection Fund have invested in farmland and, unsurprisingly, asset managers such as TIAA-CREF of the US and Insight Investment of the UK are queueing up to feed this demand. Indeed, one such house, Hamburg-based Aquila Capital, believes the investment opportunity is now better than ever. “There is a sea change that has gone unnoticed,” says Detlef Schoen, managing partner, farm investments at Aquila. “All of a sudden very good [farmers] have begun to welcome financial investors, largely because their traditional sources of funding are drying up. “Banks are in retreat, asset values have ballooned and farms are getting bigger, so there is a huge equity gap. It’s a fantastic opportunity.” Charmion McBride, head of innovation and development at Insight Investment romania , which has made a number of farmland investments, says: “The supply and demand fundamentals are quite compelling, as are the real-asset characteristics – the hedge against inflation, the ability to provide income, the fact that farmland has been resilient across economic cycles, the fact it diversifies any portfolio. It’s going to be a big growth area.” Insight believes the opportunities are significant, with the global value of farmland around $8tn, while aggregate institutional investment to date amounts to somewhere between $15bn and $25bn. Many of the arguments in favour of farmland are well known. Jeremy Grantham, co-founder and chief investment strategist at GMO, the US asset manager, pointed out last year that food production will need to rise between 60 and 100 per cent by 2050 to feed a rapidly rising global population that is increasingly able to demand more resource-intensive foods such as meat, which create additional demand for animal feed. Taking into account water shortages, climate change and slowing growth in crop yields, Mr Grantham foresaw a “long-term and politically dangerous food crisis”. However, according to Mr Schoen, until recently financial investors were not needed in the sector, and there was little incentive for the most productive farmers to welcome them in. “The first wave of investors into farms over the past 15 years was often left disappointed because they had the wrong managers in the wrong geographies with a misalignment of interests between asset managers and farmers,” he says. “But we now have access to top-class farmers who in the recent past would not have given us a look-in and they are the ones offering excellent returns. For an investor the danger is to not pick the right farms – the top 25 per cent are about 50 per cent better than the rest.” Aquila cites two reasons for the improved opportunity set. First, fewer than half the farmers in the developed world have identified a potential successor, according to Farmtransfers, a research project, as their children increasingly favour alternative careers. This is likely to lead to more merger and acquisition activity as these farms are instead sold on, often to other farmers. The UN’s Food and Agriculture Organisation estimated in 2009 that $208bn of private capital would be needed to finance this structural change every year for the foreseeable future. However, the broader scaling back of bank lending has created an “equity gap” that offers “unprecedented investment opportunities” for financial investors, Mr Schoen says. He cites the case of a dairy farmer in the Australian state of New South Wales, who had to buy out his siblings to take on the family farm, as well as pay his parents enough to retire on. He also wanted to buy an adjacent farm from an elderly neighbour, offering attractive economies of scale, and needed a 75 per cent loan-to-value deal to finance both. “Any banker up to five years ago would have given him a loan. Today, no chance,” says Mr Schoen. Instead Aquila bought a 70 per cent equity stake in the combined operation. “Before, these farmers would not have talked to you. Why would they have given up their earnings potential?” Although Aquila takes equity stakes, Mr Schoen says the holding actually works more like debt. Aquila receives a guaranteed 3 per cent a year return (assuming the farmer can borrow to fund this if he loses money), with the farmer receiving the next tranche of income and the remainder split 70-30 in Aquila’s favour. Mr Schoen envisages pre-tax, post-fee returns of 5-7 per cent a year from such investments, plus a capital gain resulting from the productivity improvements he believes are possible. After 15 years or so, he forecasts the farmers will have acquired enough capital to buy Aquila out. The German house argues that, by teaming up with “good, young expanding farmers”, who retain an equity stake in a farm, rather than being tenants, it is able to generate “alpha”, ie to outperform the asset class at large. Perhaps unsurprisingly, other investors believe they are also perfectly capable of generating alpha. TIAA-CREF has invested around $4bn of its $523bn of assets in farmland since 2007. Its local affiliate asset managers, who have an agricultural investment background, buy land and then engage local tenant farmers. “We have been able to identify tenants and local operators who employ responsible and modern farming practices, and we are able to support their growth,” says Biff Ourso, a director and portfolio manager. He lauds the benefits farmland brings to TIAA-CREF’s portfolio, arguing it is a good hedge against inflation, has a low correlation to other asset classes and has historically provided a return of 8-12 per cent, including capital growth. Insight also believes it can generate alpha by making improvements to farms, for instance by building infrastructure such as milking plants; improving irrigation and the genetics of livestock; and by consolidating small leasehold plots into larger, more efficient farms. It has attracted long-term investors such as pension funds, family offices and sovereign wealth funds, and believes this approach can generate annual returns of 12-15 per cent. Copyright The Financial Times Limited 2013. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.