German alternative investment house Aquila Capital recently published a paper on the emergence of real assets as an investment destination for institutional investors. As institutions look to commit 20 percent of their portfolios to real assets, agriculture will be increasingly in the limelight. But investment managers must be careful to ensure they have the right on-the-ground management if the strategy is to work, argues Detlef Schoen, head of farm investments at the firm.
The 2008 economic crisis reshaped the global financial landscape. It has caused years of historically low interest rates and anaemic economic growth. As a result, bonds and equities are expected to deliver much lower returns going forward. Together with worries of rising inflation, this means that institutional investors are increasingly recognising the need to adjust their asset allocations in order to adjust to this new environment and future-proof their portfolios.
A recent paper published by Aquila Capital earlier this year, entitled Real Assets – The New Mainstream, stated that there will be a trend by institutional investors to reduce their exposure to bonds and equities and increase it to alternatives. Investment into real assets, such as infrastructure, agriculture, renewable energy, timber and real estate, will be particularly pronounced with allocations to these set to reach over 20 percent of investors’ portfolios.
This trend was reflected in research1 commissioned by Aquila Capital in 2014 that revealed around 60 percent of institutional investors in Europe expect allocations to real assets to increase over the next three years and more than four times as many respondents were positive on the investment outlook for real assets (41 percent) as opposed to those who were negative (10 percent).
Farmland will also play a key role in this investment story. Global population growth and rising prosperity in developing markets are fuelling the demand for agricultural products. There is plenty of evidence pointing to this. For example:
- According to the OECD2, calorie production needs to increase by at least 60 percent in the next 40 years, if the growing demand for food is to be met.
- Meat consumption in China, the most heavily populated country in the world, has quadrupled from 15kg to 60kg per person in the past 25 years3. According to a joint study by the Food and Agriculture Organization of the United Nations (FAO) and the Organization for Economic Co-operation and Development (OECD)4, global meat consumption is expected to increase by 1.6 percent each year over the next decade, resulting in more than 58 million tonnes of additional meat being consumed by 2023. Developing countries will account for more than 80 percent of the additional consumption.
- The above study also projects that the demand for dairy products will continue to expand at a rapid rate through the next decade, with the majority of demand coming from developing countries, in which the per capita consumption of dairy products is expected to increase by 1.9 percent a year for cheese and butter and by 1.2 percent percent for milk powder.
At the same time, there is a growing shortage of farmland due to the consequences of climate change and urbanisation and the growing prosperity of developing nations. Together with the above, this translates into a huge demand in investment requirements, beyond the reach of public financing alone, which will create a significant opportunity for the investment of private capital.
Agriculture investments provide investors with an opportunity to participate in sustainable food production to meet this growing demand. By investing in agriculture, investors can gain access to steady long-term cashflows, which are linked implicitly to inflation through food prices, while being supported by strong market fundamentals.
However, to understand and invest in this asset class, which offers the potential for sustainable market outperformance or ‘alpha generation’, specialist farm management expertise is required. The first wave of investors into farms over the last 15 years were often left disappointed because they had the wrong managers in the wrong geographies that lacked the necessary farm management expertise. There was also a misalignment of interests between asset managers and farmers.
Having in-depth expertise in farm management is critical to investment success. In our view, agricultural investments can be regarded as a combination of private equity, real estate and commodities. We believe that in this mix, private equity constitutes the largest value driver (at approximately 60 percent) due to the impact that farm management has on the value of the investment and the remaining two contribute approximately 20 percent respectively. The classic mistake in farmland investing therefore is not to buy the wrong farm, but to conduct the investment process simply from a real estate angle. Being an expert manager is key to the long-term success of a farmland investment strategy.
Investing in agricultural land can produce very attractive and competitive returns in comparison to other asset classes. Over the period 2000 to 2010, the benchmark HAIG Total Return Farmland Index produced annual average returns of 14.4 percent. This compares favourably with 1.4 percent for the S&P 500 Index on a total return basis, 4.9 percent for European government bonds and 1.8 percent for commodities.
Agriculture and other real assets represent a diversified set of investment opportunities, offering exposure to a wide variety of underlying assets, geographies, value drivers and key performance factors. They also offer stable cash flows, growth potential, inflation-hedging and risk mitigation over the long term _ all of which make them an attractive investment proposition for investors.
Source1: Research carried out among more than 50 institutional investors across Europe
Source2: UN Department of Economic and Social Affairs
Source3: Aquila Capital Investment GmbH, with calculations based on data from the OECD
Source4: FAO and OECD