Finance & Markets / May 27, 2020

Agriculture ETFs: The Pros and Cons

Disclaimer: The opinions and observations expressed  in this article do not necessarily represent the official position of Farmfolio or its affiliates. No part of this document is intended to serve as formal advice, not should be interpreted as such. Farmfolio and its affiliates assume no legal responsibility for any investment decision made on the basis of this document. Seek the counsel of an independent financial advisor before making any investment decision.

Despite their relatively short history, Exchange-Traded Funds, or ETFs, have become commonplace in the current investment landscape. Tracing their origins to around the early 90’s, ETFs have grown immensely in a short period of time. ETFs now compete directly with stocks, mutual funds, and even private equity funds.

An exchange traded fund is an investment fund comprising of a basket of securities. They trade on an exchange, very much like a stock. But this is where the difference ends. Due to the nature of the fund, an ETF comprises of a mix of assets; from stocks and commodities to fixed income and even credits.

As you can guess by now, the composition of an ETF can vary greatly, allowing ETFs to cater to a wide range of investor profiles. These range from the basic, ‘vanilla’ ETFs such as index funds to more exotic fund compositions such as thematic ETFs.

The growth of exchange traded funds

 

The underlying trends do not lie!

For the year 2019, the global ETF market rose to $6.18 trillion in assets under management (AUM). That is an average of 25% growth on a yearly basis over 16 years.

ETF AUM Growth (Source: Statista)
ETF AUM Growth (Source: Statista)

 

ETFs are popular for several reasons. Some of the most cited reasons include their liquidity, low cost, and tax efficiency. And to top it all, ETFs do not need high capital requirements, unlike other closed end or custom funds.

And what is more, you an easily invest in ETFs as if you were buying or selling stocks. Despite the low barrier to entry, ETFs are widely dominated by institutional investors, who generally are also active in the private equity business.

Liquidity is one of the biggest factors for choosing ETFs. More recently, central banks, starting with the Federal Reserve have begun dipping their hands into ETFs as well. At the time of writing, the US Federal Reserve holds about $1.8 billion in corporate debt ETFs.

The Bank of Japan is another high profiled central bank, actively involved in the ETF markets.

Diving into agriculture ETFs

 

When it comes to agriculture ETFs, investors have a choice of picking from a wide range of funds, such as food, farming, logistics, and commodity ETFs are also available. Even within agriculture, ETFs are a broad space, and investors can dig deeper if they choose.

Whether you want to have an exposure to commodities, or agriculture and farming, there is an ETF that is available.

The benefits of investing in such niche ETFs is their risk ratios. Therefore, these niche ETFs often find a way into one’s portfolio allocation. This is because agriculture ETFs (used as an umbrella term) in general do not have strong correlations to stocks or bonds.

Investors who are interested in the agriculture sector typically have a choice of the following ETF categories to choose from:

  • General ETFs: Broad based ETFs offer exposure to a mix of underlying commodities. Some of the big names include, Powershares DB Agriculture (DBA), iPath Dow Jones-UBS Agriculture Subindex total return (JJA), E-TRACS UBS Bloomberg CMCI Agriculture ETN (UAG)
  • Livestocks: These ETFs mimic some of the livestock futures, namely Lean hogs, and The iPath Pure Beta Livestock ETN (LSTK) is a combination of both, while iPath Dow-Jones UBS Livestock Subindex Total Return ETN (COW) tracks the cattle market more closely.
  • Grains: Grain ETFs allow investors to track the performance of the agriculture grains such as iPath Pure Beta Grains (WEET) or iPath Dow Jones-UBS Grains Subindex Total Return ETN (JJG)
  • Agribusiness: Lastly, investors who seek exposure to agribusiness stocks have the choice of picking ETFs such as Market Vectors Agribusiness ETF (MOO) or even the MSCI Global Agriculture Producers Fund (VEGI)

If investors are interested in ETFs for their high liquidity and lower risk profiles, they are dissuaded by low dividend yields. ETFs, especially in agriculture, generally produce lower yields than private equity investments. In addition, as ETFs are often limited to a narrower range of large-cap stocks within a given index, these funds can lack exposure to the small- and mid-cap stocks that can sometimes be the best performers.

Below is a comparison of agri ETFs from various categories on a year to date performance of the Dow Jones index.

 

Agriculture ETFs Ytd
Agriculture ETFs Ytd

Can you really compare ETFs to other funds?

Investing in ETFs can give different results based on your risk profile and investing style. There are many other types of funds that compete with ETFs. More commonly mutual funds, or even private equity (PE) funds are touted synonymously.

Depending on the economic conditions, ETFs and private equity tend to behave differently. Studies show that amid recessions, private equity investments outperform public equity investments. And this report from E&Y hints that PE firms are already prepared for the current downturn.

Growth in private equity is also steadily on the rise, as seen from the total AUM in PE for 2019.

Private Equity Assets under management, 2019. Source: McKinsey, Prequin
Private Equity Assets under management, 2019. Source: McKinsey, Prequin

This only goes to show how different styles of investment are attracting new fund flows.

So, when it comes to ETFs or private equity or any other type of fund, the decision to choose must come from the investor. Investors should have a firm understanding of the risk profile of any potential investment, along with a clear view of their investment goals and style.

 

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