Agri Investor Forum: Ag funds navigating shifts in LP sentiment

Shifting LP sentiment amid increased competition for fixed income allocations will continue to challenge agricultural fund managers in the near term, as steps towards defining the asset class’s long-term role continue to crystallize, according to panelists at the 2018 Agri Investor Forum in Chicago.

Speaking during the conference’s opening panel Tuesday, moderator Atish Babu, vice president at permanent crops focused Agricultural Capital, began by citing an April Townsend report to the New Mexico State Investment Council that recommended the $24.7 billion pension refrain from new fund commitments to ag in favor of secondaries and co-investments and a strengthened focus on infrastructure and other real assets.

“As a fund manager, that’s a pretty jarring statement to see,” Babu said. “As we’ve gone around during the last couple of months talking to new LPs and our current LPs, it’s a sentiment that we are actually seeing starting to come to fruition.”

Babu, who explained that AC’s fundraising for its $548 million second fund focused largely on public pensions, said ag funds are struggling to meet global LPs’ current return expectations of CPI + 4 percent/LIBOR + 3 or 4 percent.

Lara Banks, a managing director for natural resources at San Francisco-headquartered Makena Capital Management – an  approximately $20 billion endowment-style fund with a seven percent allocation to natural resources – said that most agricultural funds she sees offer returns of between 7 and 8 percent, which do not meet her net 12 percent hurdle rate.

Banks added she would not expect more than 15 percent annual returns from any ag strategy in the current environment.

“I don’t like to underwrite to very high appreciation, but most of the decks I see are 5 to 6 percent appreciation, but we look at a 3 to 4 percent appreciation and 3 percent rate of return,” said Banks. “Core-plus would be our holdings of existing permanent crops, that I think we can get those into the 10 to 12 percent range.”

Banks confirmed that, while energy has proved to be a better fit among near-term options for the sustainable sleeve of the natural resources portfolio under which Makena’s agricultural investments are housed, she remains interested in investing in the market over the long term. The balance of her focus within the asset class has shifted of late, she said, toward agribusiness joint ventures and co-investments that reduce expenses after a recent analysis found that as much as a third of returns on its farmland investments were going to fees.

“That’s fine if you are making a 30 percent IRR, but if you are making a 12, it just doesn’t hit our hurdle rates,” Banks said.

PGIM Agricultural Investments chief investment officer Jamie Shen, who manages about $1 billion in permanent and row crop assets with a concentration in West Coast permanent crop assets, stressed how the role of agriculture, and corresponding return expectations, vary significantly by investor type.

PGIM’s current focus on permanent crops was in part a reflection, she said, of how important it is not to underestimate the significance of the fact that in coming years, agricultural fund managers will struggle against changes in the fixed income landscape as returns on US Treasury bills continue to rise.

“Row crops made a ton of sense when we had a much lower 10-year Treasury, but now that’s going up, you really have to think about what you are doing on the appreciation side, and how that investment is going to do better in an institutional portfolio, better than just a Treasury bond,” she said.

Plenty to go around

Despite an early focus on challenges facing funds currently in market, Shen’s comments about how interest in agriculture funds is rising among PGIM’s core client base of large pension funds helped shift focus to more encouraging recent signs about the long term.

Such investors, according to Shen, are driven by desire for diversification, current yield and correlation to other asset classes and are more concerned with the consistency of a 7 or 8 percent return than the opportunity to generate more current income through ag allocations.

“What’s nice about this industry, is that there’s plenty to go around,” said Shen, adding that she doesn’t feel the sense of animosity that can characterize competition in other asset classes.

She added that, while it was true that most agricultural managers focus on very private dealflow and even very large transactions can happen through very quiet processes, PGIM recently spent a year reworking a deal she knew at least two of her competitors to have already passed on.

Shen said she has seen several investors looking to use capital previously devoted to timber for farmland and recently met with a large public plan considering a first-time move into the market.

“If, let’s say, a pension fund that has a couple hundred billion really wants to come into this space and make it meaningful; and they say even one percent is $2 billion, they’re not going to give $2 billion to one of the investment managers. They are going to want to diversity it.”

Because most investment managers in the space would see a commitment of between $200 million and $300 million as a significant one, Shen continued, such an opportunity would provide an important chance for the asset class to continue its evolution.

“If one pension fund comes into the space, it can feed a lot of us to be out there doing our thing,” Shen summarized. “There is room for more investment managers and I think there is room for the current investment managers to all grow at the pace they should be growing. The risk is when you give investment managers too much money and they start doing things they shouldn’t be doing to put that money out.”