Agricultural commodities have experienced mixed success over the last year, but investment in the sector has been gaining traction as enthusiasts anticipate the next super cycle.
Investors buy commodities for diversification benefits and as a hedge against inflation. While gold has been the "hot" trade this year, interest in farmland and "soft" commodities, such as wheat, sugar and palm oil, is growing because of the compelling demand – and –supply story. With production limited, inventories low and increased global demand prices are expected to rebound sharply in 2010.
That said many investors are reluctant to build up positions in agriculture because of a lack of familiarity. Matt Sena, manager of a commodities fund for Castlestone Management in New York, urges investors not to delay. "Traditional commodity plays such as gold have experienced huge price hikes in recent months but many of the 'softs', particularly corn and wheat, look good value," he says. "We expect price volatility over the coming months but this is not the time to be sitting on the fence."
Jonathan Bell, an investment advisor with Stanhope Capital, a London-based multi-family office, shares Sena's enthusiasm for agriculture. "We have been exploring every investment avenue from buying farm land to investing in Exchange Traded Funds," he says.
"Sovereign wealth funds have been grabbing land where they can but we felt this route was not for us as it requires a specialist knowledge. We have also looked at the growing market for agricultural ETFs but, after careful consideration, decided to opt for an actively managed commodities fund that is one third invested in agriculture."
Despite their simplicity and popularity with high net worth investors, ETFs are clearly not to everyone's taste. Agricultural ETFs, which track the future prices of commodities, are especially tricky as the future price of a given commodity can be significantly different from the current spot price – a facet of the investment that Bell was uncomfortable with. Futures contracts commit the holders to buy or sell at a future date, at whatever the current price is. When future prices are in cantango - running at a premium to the current spot price – returns may be significantly eroded.
Paul Justice, a Boston-based ETF strategist with funds data provider Morningstar Inc, is also sceptical about the investment merits of single commodity ETFs. He suggests that investors choose a broadly diversified ETF that provides exposure to a basket of commodities. As well as being less expensive than a single contract, diversified ETFs tend to be less volatile.
Justice also recommends that investors avoid large funds as they could run up against position limits. "US regulators are paying close attention to agricultural funds that are running close to federally mandated limits," he says. "If a fund has too much exposure to any one commodity it could be held to account for distorting the price of futures."
Aside from a direct investment in farmland, passive ETFs and actively managed agricultural funds run by the likes of Schroders and Castlestone Management, there is another way to capture gains from rising food prices while diversifying investment exposure.
Back in 2005 Pergam Finance, a Paris-based investment company, launched a fund, Campos Orientales, to buy farmland in Argentina and Uruguay. The fund's mission: to purchase poorly managed cattle farms with an eye towards converting them to highly efficient cattle and crop farms. Once the farms reach their optimum production levels, typically after four years, they are sold on at a profit.
Debra Rockabrand, a client advisor at Pergam Finance, says that the fund, which has a minimum subscription of $1 million, is suited to ultra high net worth investors who are disillusioned with traditional allocations in stocks and bonds, and who want an alternative investment that is not too risky.
"We chose farmland in Argentina and Uruguay for the quality of the soil, climate conditions and proximity to ports," says Rockebrand. "Farmland prices have held up well in South America but they are still significantly lower than in Europe. We see no reason why this fund cannot continue to meet its target Internal Rate of Return of 15 percent per annum."