Article / August 10, 2020

How to Invest in Agriculture: 3 Investment Vehicles

Disclaimer: the statements and opinions expressed in this document are solely those of the author and are not intended to be construed as legal advice. Farmfolio assumes no legal responsibility for any investment based on this document. Always consult with a third party advisor on how to invest in any opportunity.

The great American investor Peter Lynch once said, “Know what you own and why you own it.” When it comes to alternative investments, this concept is especially prescient. Investors look to alternatives for many reasons: diversification, inflation hedging, long-term appreciation, income, and transparency, to name a few. Alternatives are a vast category, ranging from ETFs to fine wine, and the goals of investors in alternatives are equally diverse.

In a financial world in which many asset classes are becoming more correlated, diversification takes on even greater importance. In the hunt for alternative investments, there is a sector that stands out for its stability, essential nature, and diversification potential: agriculture.

But not all agriculture investments are right for all investors. There are a plethora of factors to consider when thinking about how to invest in agriculture. Let’s examine a few asset classes within agriculture and the investor profiles that suit them.

Private Equity

Private equity investment in the ag spaces comes with a wide range of benefits. One of the most significant is that these assets are not publicly traded, and therefore are not as vulnerable to the whims of the market. Many agribusinesses perform perfectly well even during down markets, so the potential for diversification is high for this type of investment.

Another major benefit of private equity investments in agriculture is their return potential. Getting in on the early stages of an agribusiness that goes on to see success can offer investors significant returns. Private equity investors can realize considerable appreciation and cash yields if they pick a winner, especially if they do so early on.

But private equity investment has its limits. First and foremost, the space is not available to retail investors. Accreditation is a must. Prohibitively large capital requirements mean the space is reserved for accredited and institutional investors.

Secondly, liquidity is a concern. The non-publicly traded nature of private equity investments is, for some, a double-edged sword. This type of investment is better suited to investors with a longer time horizon, who aren’t going to need the capital right away.

Lastly, investing in private equity requires an especially intensive due diligence process. In agriculture, this means asking a number of questions. How is the business valued? Where is the project located? Who is the operator? What stage of the supply chain does the business focus on? Is the commodity in question viable in the long term? Is there a commercialization strategy in place? What about logistics?  The list goes on and on, and it is vital to have clear answers to these questions when deciding how to invest.

Overall, private equity in agriculture is ideal for accredited investors who are looking for appreciation and cash flow over the long term. Depending on the opportunity, a low aversion to risk may be needed, but the return potential is significant. Due diligence is particularly important in this case, as is a base level of trust in the General Partner.

Debt

While not technically alternatives, there are many ‘alternative’ methods of accessing debt investments, and the agriculture space is certainly one of them. Debt vehicles in the ag space feature many of the same benefits as debt in general: lower risk, consistent yields, and accessibility. Not everyone who’s wondering how to invest in agriculture can pay a six-figure ticket price, after all.

Many investors look to debt for its stability. While not always low risk, debt can reduce seasonal risk, regulatory risk, and operational risk. It also provides scalability because the majority of farms are family farms who have historically used debt as a means of accessing the capital they need to operate.

There are many steps across the agribusiness supply chain where some type of debt financing is employed. Accounts receivables financing, for example, is crucial for many agribusinesses. Exporters, importers, providers of inputs, and especially farmers rely heavily on debt financing to succeed. From short to medium to long-term financing, private debt is a key component of agribusiness.

Debt can allow investors to gain exposure to a specific agricultural commodity without the risks involved in other investment vehicles. But with lower risk comes lower reward,  and yields from agriculture debt can be lower than for other forms of investment, especially in developed markets. Collateralization is a key factor, and can lead to higher yield and increased stability.

In general, debt can be a low-risk way of accessing the ag space, while providing the cash flow certainty that many investors are looking for. Barriers to entry are also far less stringent and capital requirements are significantly lower than with private equity. Risk-averse investors seeking income may prefer this type of investment, as well as those with flexible time horizons.

Farmland

Farmland has long been seen as an ideal means of diversification, not only for its insulation from publicly traded markets but also due to its attractive combination of appreciation and cash yields. Farmland has performed well historically, and can be ideal for investors seeking a long-term allocation. Farmland is not without its downsides or its barriers to entry, but if done correctly, it can grant exposure to the fundamental necessity of agriculture and the demographic trends that drive its growth.

Like any real estate opportunity, farmland is about location. It’s about the quality of the land, the climate conditions, the commodity being grown, the market access, and the potential for appreciation. Not all farmland is created equal, and when thinking about how to invest in agriculture, knowing the hierarchy of farmland value is critical.

That said, it’s worth mentioning that farmland in developed countries, especially the United States, is appreciating much less quickly and producing much lower cash yields than it once did. A focus on staple crops like corn and soybeans, along with higher operational costs in terms of labor and inputs, is lowering yields, and high land prices are slowing appreciation.

The best opportunities for farmland investment lie in emerging markets. Low operating costs, inexpensive land, and excellent climatic conditions can make farmland investments in emerging regions like Latin America highly attractive, provided there is a vehicle to access them. However, even in this context, there are some factors to consider.

Which emerging economies are truly poised for large-scale growth in the ag sector? Even in Latin America, large swaths of fertile land have already been developed in countries like Chile and Argentina. At the turn of the millennium, the agriculture sector in those countries was growing rapidly, but has slowed in recent years.

A key factor when considering how to invest in agriculture is land quality, not only in terms of topographical diversity, but also market access, rainfall, ambient temperature and moisture levels, soil fertility, and many other factors. Infrastructure capacity is also a major factor, as farmland can appreciate tremendously as infrastructure improves.

Crop focus is also key. In places like Brazil, government-subsidized production of corn for biofuels (highly correlated with oil production) along with soybeans are proving highly unattractive, while also generating serious criticism over deforestation and environmental exploitation.

Demographic trends and shrinking arable land have positioned farmland as an alternative asset with high potential for appreciation and cash yields, especially in emerging markets. Investors who can meet the capital requirements, as well as identify solutions for commercialization and farm management, will have an edge when it comes to farmland investments.

Needless to say, it is crucial to consult with a third-party advisor when considering any investment decision, and allocations to agriculture are no exception. As always, thorough due diligence is key, and all opportunities must be reviewed with the greatest of care. Many investors have chosen the ag space for diversification, but only your own independent research can determine which ag investment vehicles are right for you.

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