Headwinds in Commodities: Declining farmland values present opportunities for investment managers
September 22, 2016
In the past decade a growing amount of capital has targeted farmland investments. This period of growth for the asset class has been accompanied by land values appreciating faster than the long-run trend. Despite increased popularity, farmland investments remain a small asset class in terms of invested capital. Net farm income reached record highs in 2013 and then fell by 38 percent in 2015, causing land values to decrease 3 percent. Land values are expected to continue their decline in 2016.
This presents an opportunity for investment managers to take a more hands-on management approach in order to outperform those with a passive strategy.
National farmland values have grown at an annual rate of 7 percent over the past 15 years compared to the long-term average of 4 percent. Meanwhile, institutional and high-net-worth investors have begun investing in farmland, attracted by the long-term nature of the investment, inflation protection, and limited correlation to the general economy. The NCREIF Farmland Index total returns show a mere 0.02 correlation to the S&P 500’s total return since 1992.
According to Valoral Advisors, the number of institutional funds with an agricultural mandate has increased by nearly tenfold over the 2005–2016 period, from 32 to 312. As of 2016, these funds manage roughly $52 billion in assets, and one-third specialize in farmland investing.
Farmland investments have generated attractive returns and outperformed the S&P 500’s total return over the past decade. The financial measure called the Sharpe ratio compares investment returns by adjusting for different levels of risk. During the past 10 years, the average Sharpe Ratio for the Farmland Index and S&P 500 total return is 1.87 and 0.20, respectively. In essence, the Farmland Index is paying over nine times more for every unit of risk an investor accepts compared to the S&P 500 total return.
The strong U.S. dollar resulted in an oversupply of numerous commodities in the United States and abroad, depressing commodity prices and farm incomes. Nationally, land values peaked in 2013, fell 3 percent in 2014, and fell another 3 percent in 2015. Land values could fall another 12 percent in 2016.
Depressed farm incomes and peaking land values suggest that in the short term, returns from agricultural investments will depend more on managerial ability to weather the storm than capital appreciation. This presents an opportunity for investment managers to take a more active management approach in order to outperform those with a passive strategy. Passive managers focus on ensuring that their farmland has a tenant, but are seldom involved in the production process. This results in the farm operator bearing the responsibility of managing both the production and marketing of the agricultural goods. Conversely, active managers are more involved in the production process, assisting with strategies to mitigate price risk and providing capital to invest in profitable projects and technologies. Managers and farm operators who can develop a plan together that leverages the knowledge of both parties will likely outperform managers who choose to take a passive approach.
Author Eric Rama (email@example.com) is an associate in the agricultural finance group at MetLife.
Real Assets Adviser is the first publication dedicated to providing actionable information on the real assets class and facilitating important business connections for registered investment advisers (RIAs), wealth managers, family offices and independent broker/dealers. Coverage includes real estate, infrastructure, energy, commodities/precious metals, agriculture and timberland.