Emerging Markets / August 9, 2016

Financial Instruments for Agricultural Investment

If all of humanity lived to the same lifestyle and consumption level as North America or Western Europe, the resources of 2.5 planets would be necessary. Thus, over the last decade, agriculture has become a coveted sector for financial investment, similar to the place that was formerly occupied by the fossil fuels industry. Because of demographic and societal dynamics, both agriculture and energy are regarded as consistent industries with a low correlation to the stock markets. Likewise, energy and agriculture have the potential to provide higher yields than the interest rates currently prevailing in the North American and European bond markets. Similar to the energy sector, food and agriculture are indispensable goods for the world to function. However, unlike the fossil fuels market, food is not easily replaceable by alternative resources. Therefore, agriculture serves to diversify portfolios and provide yields even during tough economic times. This article explores some of the financial instruments that exist today within the agriculture industry.

Real Assets

Over the last several months, fund managers and financiers, such as William Gross, have pointed to the advantage of holding real and tangible assets amidst the imbalance and uncertainty created by the low federal interest rates. Appreciating assets include precious metals (e.g. gold) and real estate; both of which can provide high yields. Chief within the real estate category are foreign investments and agriculture. Foreign investments are coveted because of the still sluggish housing market in the United States and farmland because of its productive value. There are, however, several key elements and differences to be considered when investing in agriculture. Understanding these characteristics allows investors to properly diversify their portfolios and benefit from higher yields.

Financial Instruments

Two of the instruments available to invest in the agriculture industry are Exchange Traded Funds (ETFs) and, a variant of these, exchange traded notes. Agricultural ETFs normally own commodities or track the performance of commodity indexes, such as corn and coffee. Though useful instruments, the main shortcoming of ETFs is that they do not capitalize on the ensemble of agricultural products, particularly those that enjoy the most growth. Representing commodities or agricultural tools, such as tractors and plows, ETFs do not benefit from the growth across the whole food and farmland industry.

While agricultural commodities and inputs have shown resilience and experienced growth over the last decade, the fast growing agriculture industry goes beyond extensively cultivated row crops. Amongst the most lucrative agricultural products are nuts, fruits, and other niche products geared towards specific sectors of the consumer goods market. In this regard, Farmland Real Estate Investment Trusts (REITs) have a higher potential to benefit from and reflect the gains of both row crops as well as permanent crops. Though relatively limited in the US exchanges and not so lucrative over the last several years, Farmland REITs do represent a wide spectrum of agricultural products from strawberries and avocados to corn and cattle.

One of the main issues with the two instruments exposed above is that they focus of domestic US production and farmland. Furthermore, because farmland is relatively new to the financial markets and because of their small market size (under US$150 million market-cap), REITs and ETFs experience liquidity and price stability issues. Having low trading volumes, agricultural ETFs and REITs are exposed to significant changes in price provoked by relatively small transactions of one or two-thousand shares. Finally, because they are micro-cap entities, institutional investors are limited by the percentages binding single-holder participation.

(Read more on Financial Instruments for Farm Real Estate Investments)

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