Pensions turn to operating strategies as endowments get hungry for land

Investor demand for agriculture strategies with an operating component has increased in recent years as the return outlook for core farmland strategies moderated, according to a senior exec at Hamilton Lane.

Brent Burnett, previously managing director at Real Asset Portfolio Management, the real asset specialists acquired by Hamilton Lane in August, told Agri Investor that a focus on capturing incremental value throughout the ag value chain means investors are willing to take the extra risk that comes with agricultural operations, provided they are paid to do so.

“Institutional investors are hesitant to just go into traditional core farmland,” Burnett said.  “The land price has gotten so expensive and at the same time you are starting to see this disconnect between land and income. Investors today are thinking, ‘Do I want to sit in a queue and wait for a manager to just acquire more land, at what I think may be a pretty significant valuation risk, or do I want to find a group that can really add value at the operating/integration level and capture that margin,’” he said.

Managers have responded by providing closed-end funds focused on vertically integrated, operating strategies or approaches dedicated to agribusiness, according to Burnett. These have proven popular with investors, he said.

Tastes and preferences

Burnett added that Hamilton Lane’s acquisition of RAPM was itself a reflection of the increasing importance of real assets. He explained that his clients at both firms have been a mix of state municipal pensions, university endowments, insurance companies and multi-family offices.

While all view agriculture as a means to protect against inflation while also providing income and capital appreciation, the relative importance of those functions varies depending on the type of investor, with state funds often more focused on income and family offices on capital appreciation.

Although pensions’ preference for income has made them more hesitant to back core farmland strategies, investor types such as family offices and university endowments are increasingly interested in agricultural land, according to Burnett. He said these investor types have moderated their return and holding period expectations in recent years as the asset class has evolved.

“We have been very surprised at what those groups have been willing to pay for core farmland in the Midwest”
Brent Burnett, Hamilton Lane

“The reason they want to hold farmland is for portfolio diversification benefits and downside protection more so than upside potential, which may have driven them in the past,” he said.

While many smaller non-pension investors have been frustrated by the challenges that come along with trying to build scale in agriculture through traditional fund pledges, larger investors are increasingly turning to direct investments in the sector, according to Burnett.

“Many of the large family offices have formed their own agricultural investment arms to go out and acquire ag property directly,” Burnett said. “We have been very surprised at what those groups have been willing to pay for core farmland in the Midwest, even for permanent cropland in the Pacific North-West, they bid it down to 3 or 4 percent in some cases.”

Scale problem

Real estate often gobbles up about half of clients’ real asset allocations, according to Burnett, with energy and infrastructure each accounting for an additional between 15 and 20 percent, leaving 10-20 percent for timber and agriculture.

“Part of that limitation on where we look to allocate to timber and ag within a real assets portfolio is really just driven by the size of the opportunity set and the limitations in trying to build out large-scale portfolios in these sub-sectors,” Burnett said.

His firm has focused on identifying managers within sub-sectors where resource scarcity is a factor, like water and mitigation banking.

“This is a pretty specialized expertise. Not only is the world small but we think that the number of groups that do it well is even smaller,” he said.