Growing returns: investing in agriculture

Is now a good time to invest in agriculture?

Given that the yields on traditional assets have remained at historic lows, investors have increasingly been allocating to private markets. Whilst there has been a large amount of investor money flowing into private markets across private equity, private debt and infrastructure, there has been very little flowing towards agriculture.

We feel that agriculture is an asset class that can provide an attractive and diversified source of returns.

Agriculture as an asset class

In the simplest sense, investing in agriculture involves the production of raw materials to sell further along the supply chain. There are two main routes to investing in agriculture:

1. Farmland, which includes crops and/or livestock that end up on supermarket shelves; and

2. Forestry, which includes the production of materials such as timber that can be used for construction.

There are various agriculture investment models in which investors can access the asset class and invest in agriculture.

• Own and lease model. Investors buy land and lease it to farmers with no involvement in the production process, similar to investing in commercial property.
• Own and operate model. Investors buy land and are ultimately responsible for the production of any crops or raising of livestock, essentially acting as the farmers.
• Partnership model. This involves buying the land (majority stake, which can be anywhere between 51% and 95%), in partnership with a farmer. This is an attractive agriculture model because it ensures the alignment with the operators, the expansion of deal sourcing network and the platform approach allows for increased growth and scalability benefits.
• Private equity model. This is a relatively shorter-term strategy, which involves buying land and attempting to realise returns through an exit strategy after value creation; e.g. asset roll-ups, land improvement, brownfield development such as change of land use.

Agriculture investing has evolved to include agribusinesses, through public or private equity. There is no set rule for what constitutes an agribusiness but generally speaking, broadly half of its revenue must be directly or indirectly linked to agriculture. This will include companies that are involved in any of the steps required to send an agricultural good to market, namely production, processing, and distribution.

Deere & Company, often recognised by its brand name, John Deere, a popular brand for tractors in the UK, is an example of an agribusiness which is solely involved in the manufacturing stage of agriculture production.

Why invest in agriculture?

An allocation to agriculture can provide many benefits to a portfolio. The most important is diversification. Agriculture has historically had a low or negative correlation with other asset classes, both traditional and alternative. The majority of agriculture , which is farmland, is linked to produce. People are always going to need food and so agriculture prices will not necessarily move in the same way as financial markets.

Figure 1: Asset class correlations with Farmland, 2000-2019

In addition, we expect agriculture investment returns to be broadly linked to inflation. Farmland and forestry and the underlying agricultural commodities that are produced tend to generate value in real terms. The value of the underlying land will also have a link to inflation and acts as a good store of value, proving to provide downside protection historically. This means an allocation to agriculture could be useful within a wider portfolio, particularly in the current economic environment of increasing inflationary pressures.Source: Fiera Comox

As well as the portfolio benefits that agriculture bring, the return potential for agriculture can be as high as 8-10%, given the positive secular trends currently in motion. As with any investment idea, higher returns can typically be obtained through a private equity model. 

The trends driving investment in agriculture

Returns within agriculture are generated through both the sale of the agricultural goods and the appreciation in the capital value of the underlying land. As such, long-term trends, particularly demographics, are expected to drive these returns as this will continue to result in demand to significantly outweigh supply.

Population growth is by far the most important trend. By 2050, the global population is estimated to exceed 9.5 billion. This will drive up the demand for food (crops, livestock) and housing (timber for construction needs) considerably, which means that agricultural production must increase or be more efficient. And because of the demand/supply imbalance, prices are likely to rise over time.

Figure 2: United Nations, 1950 to 2050

Not only is a rising population a positive, but within demographics the expansion of the global middle class and changing consumer habits should also support the sector. The westernisation of diets in Asia (i.e. greater protein consumption in China, particularly beef) and trends such as veganism and sustainable/organic sourced produce are becoming more popular in developed nations. This is also creating opportunities in various subsets of agriculture.

Long-term supply trends will also help to maintain the demand and supply imbalance, which again should support the agricultural sector. With finite resources and declining arable land, land values are likely to continue to rise. Additionally, land improvement strategies are likely to be a good source of potential value creation.

Environmental, Social and Governance (ESG) and sustainability

ESG factors are important to consider in any investment and it is no different for agriculture. There are some clear environmental risks and opportunities with certain aspects of agriculture, particularly farmland. A lot of land, especially in emerging countries, that is used for farming purposes is a direct result of deforestation. Food and crop (e.g. beef and nut production) also requires a significant amount of water resource and animal-related production; in particular generates a staggering amount of carbon emissions. (See below.)

^{Source: Climate Watch, the World Resources Institute (2020)}

There is an increasing interest in a type of farming called agroforestry; i.e. sustainable agriculture where, instead of intensive cropping, it combines growing trees with crops. This strategy is better for soil, habitats, biodiversity and pest control.

The preservation of nature and farming responsibly provides an opportunity to mitigate climate change risk. If agricultural projects are sustainable, there is significant upside potential if we see the appropriate pricing for carbon and/or fines for excessive pollution or harmful chemical use. 

Also, an investment in agriculture (specifically forestry) could be used as a way of offsetting the risk of highly carbon intensive portfolios. It is possible that regulatory rules will be put in place requiring businesses to hit certain ESG/carbon criteria which could result in an increase in investment into forestry. There are also an increasing number of firms targeting net-zero by 2050, which means many of them may look to investment in forestry funds to offset their carbon emissions.

This means investors can move into this asset class early and front-run the opportunity to benefit from the upside potential and the anticipation that the asset class will be institutionalised and see significant inflows in the coming years. 

Along with the environmental impact of agriculture, there is a clear social impact aspect to this type of investment. With the global population expected to continue increasing over the coming years, investment into increasing agricultural production and efficiency will be vital. 

Finally, it is worth noting that the carbon storage qualities of forestry has seen a growth of demand for it. 

^{Source: United Nations - Population Division (2019 Revision)}

Should you invest in agriculture?

An allocation to agriculture would be useful addition to a private markets portfolio alongside private debt and equity, property and infrastructure. The allocation would enhance a portfolio through adding diversification and positive sustainable impact.

With population growth and changing consumer habits, demand for food and timber will only rise. There is also a massive shortfall in supply with the amount of arable land declining rapidly. As a result of these long-term demographic trends, the supply and demand imbalance is likely to persist, which should support the asset class.

Forestry in particular also has positive environmental benefits with respect to carbon offsets, so can be attractive from that perspective, for both investors and institutions looking to achieve net-zero emissions.

Given these benefits, it is likely that many institutions will allocate to agriculture in some form over the coming years, particularly given that it is the is the last remaining “conventional” asset class that remains largely untapped within private markets. We therefore believe that investors can front-run the opportunity now to invest in agriculture to generate attractive returns.

More information

For more information about this topic, please contact your usual Barnett Waddingham consultant.

You can also get in touch with the below authors or contact amy.taylor@barnett-waddingham.co.uk, a key contributor to this blog.