Articles of Interest
Investing in Farmland Can Provide an Effective Inflation Hedge with Downside Protection
Post-Pandemic Challenges for Investors
At the beginning of COVID-19 pandemic, central banks around the world started the era of monetary easing that resulted in record inflation by mid-2022. In response to rising inflation, central banks then started increasing interest rates at an unprecedented rate. As we enter the fourth quarter of 2023, interest rates are at a multi-decade high, with the potential of further rate hikes.
Keeping in view the market conditions and investment challenges of recent years, investors are looking for an asset class that can deliver strong returns with low volatility, provide a good hedge to inflation, and show resilience in the times of market crisis. Investment in Farmland may be the answer.
Farmland Investing is an Attractive Solution to Current Challenges
The investment case for Farmland is intuitive. Farmland produces food! It is not closely tied to the broad economic cycle. Therefore, it provides diversification in times when other investments like stocks and bonds are under stress. Because of this crucial role, high-quality farmland has been, and will continue to be, a good long-term investment.
Two trends that are driving the case for investment in Farmland are the rising demand for food due to the increasing world population and the shrinking size of total arable land available for farming. According to American Farmland Trust, in the last 20 years, more than 11 million acres of U.S. farmland were lost to developmental real estate and other commercial uses. Similarly, according to Statistics Canada, since 2011 Canada has lost 4% of its actively operated farmland acres. There is a similar trend in almost all countries around the world.
Generally, Farmland as an investment is negatively correlated with equity markets and positively correlated with the Consumer Price Index (CPI). There are also multiple sources of income for investors from Farmland investments.
Income yield is mainly a result of the sale of agricultural products and can be enhanced by non‐farmland income, like cell phone tower leases, wind and solar energy leases, and the sale of carbon credits. In the case of leased farmland, the rental income can be a stable and reliable contributor to total returns, even during periods of stock market stress.
Capital appreciation results from the rise in land values over time, driven by increasing demand for real asset investments, improved crop yield from advancements in technology, and better operational management of the properties.
Features of Farmland as an Investible Asset
1. Inflation Projection
Inflation has affected both farm input prices as well as commodity prices but, it has affected the commodity prices more than the farm inputs. The resulting increase in farmland revenues and limited farmland supply led to an increase in farmland values in most farming regions. In Canada, according to FCC Farmland Value Report 2022, arable land values increased by 12.8% in 2022 (compared to 8.3% in 2021).
Farmland has maintained a positive correlation with CPI for last 30 years, with a score of 0.17. This correlation shot up to an impressive 0.97 during the inflationary period of 2020-2022 (Nasdaq), showing Farmland's position in portfolios as an excellent inflation hedge.
2. Diversification and downside risk protection during recessions
Even though Farmland experiences cycles just like other asset classes, it provides downside protection as it is not correlated with the economic cycle – it is focused on producing necessities of life with a very stable demand.
3. History of strong returns and low volatility
Farmland has posted higher mean returns (10.71% - NCREIF Farmland Index) than US Stocks (9.58% - S&P 500 Total Return Index) and US Bonds (Bloomberg Barclays U.S. Aggregate Index - 4.62%) between 1992 and 2022. The standard deviation of the average annual returns of US Farmland during the same period was 6.64% (NCREIF Farmland Index) compared to 17.80% for US stocks for the same period. Farmland’s low volatility can be particularly valuable in periods of financial uncertainty.
Barriers with Farmland Investments
Farmland investments are typically alternative asset classes and generally considered real assets. Experience and knowledge of this niche strategy is important to properly manage risk.
Lease based on fixed dollar amount per acre
Lower cash rent plus a share in crop revenue
Owner and farmer share cost of inputs and revenue of crop
Farmer performs all the machine operations on the owner's land in exchange for a set fee or rate
Owner directly operates the property, providing machinery, personnel and crop inputs
Annual crops such as corn, soybeans, cotton, wheat, and rice
Perpetual such as fruit and nut crops
Investing in farmland involves several risks such as commodity price volatility, lowered harvest volumes (due to fire, disease, pests), water availability, adverse weather, climate change and geopolitical risk. Use of modern farming techniques, and technology can be useful in mitigating some of the risks associated with adverse weather and climate change. Credit risk associated with lease models can be controlled thorough initial due diligence, ongoing monitoring of tenant farmers and enforcement of lease covenants. Investors will want to look for funds offering adequate level of diversification across farming regions, crops, operating models, and farmers.
Farmland Investment Manager Fees
Although the investment management fee, operating cost, and performance fees charged by the funds vary significantly (some funds even charge farm management fees per acre or one-time farm acquisition fees), the annual investment cost of the North American Farmland funds reviewed by our team is in the range of 1.8% - 4%. However, there are several attractive Farmland funds with less than 2% annual fees and expenses.
Higher fees charged by Farmland managers reflects the fact that these are physical assets and a very local business that requires specialized knowledge and presence in the region, an understanding of local agricultural conditions, and strong community relationships to generate quality deal flow without over-reliance on farmland auctions (auctions are generally not the best source to acquire farms at a good discount). Moreover, the best-in-class managers have well-developed due diligence and monitoring capabilities which often requires engaging third-party experts for soil testing, water evaluations, pest control, etc.
If considering ESG integration by Farmland managers, looking at their approach towards adopting R&D and utilizing technology and environmentally sound farming practices to reduce the farm’s carbon footprint, water consumption and agricultural processes are crucial factors in the long-term success of a Farmland manager.
Just like other alternative asset classes, the universe of Farmland funds comprises both closed and open-ended funds. However, most open-ended Farmland funds have initial lock-up periods ranging from 1-5 years and redemption penalties for redeeming before 5-8 years of investing. These terms are employed to discourage investor turnover as well as to minimize the disruption for the remaining investors in the fund and the need to sell the farms to generate cash for redemption. Investors should carefully evaluate their liquidity profile before adding Farmland to a portfolio, especially if there are already sizable allocations to other illiquid asset classes such as real estate, private equity, and infrastructure.
Other Risk Factors
Investing in farmland carries additional risk factors that need to be considered in the context of the overall risk tolerance of investors. Climate related risk from natural disasters that can impact crop yields, water scarcity / restrictions on water, and future unknown government policies and political risks amongst other factors are all risks that can have a material impact on the viability of a farmland strategy. For this reason, like with any investment strategies, robust manager due-diligence and continued monitoring along with experience and understanding of this asset class are important to identify best in class managers that are commensurate with an investor’s risk tolerance.
Canadian Pension Plans and Farmland
Pension plans see different roles for a Farmland allocation in their portfolios. Some view it as buying a discounted asset with strong long-term growth potential whereas others see Farmland as a liability hedging asset because it resembles an inflation linked bond. This may depend on whether the plan is invested in an own-and-lease Farmland strategy (liability hedging) or own-and-operate (more risk and return potential).
In the current market environment of high-interest rates, high inflation and a looming threat of recession, investment in Farmland offers attractive qualities like the potential for strong expected returns, low volatility, and resilience in periods of market stress. However, these positive features come with lack of liquidity in the first 1-5 years of investment, and higher management fees than other types of real assets. When investing in Farmland, investors will need to consider the role Farmland is expected to have in the portfolio, liquidity needs and investment time horizon and overall risk tolerance.
FFC Canada - 2022 Farmland Values Report
American Farmland Trust – 2020 Annual Report
Rooted In Stability: How Farmland Investments Have Outperformed in Uncertain Economic Climates by Kenneth Adams, Benzinga Staff Writer April 14, 2023
The Reasons Why Wealthy Investors Consistently Turn to Farmland Investments May 2m, 2023 https://www.nasdaq.com/articles/the-reasons-why-wealthy-investors-consistently-turn-to-farmland-investments
A look at the role of farmland in pension portfolios, Benefits Canada June 3, 2019 https://www.benefitscanada.com/canadian-investment-review/alts/a-look-at-the-role-of-farmland-in-pension-portfolios/
Shoaib Baig, CFA CAIA – Principal, Investment and Risk Consulting, Telus Health
Based in Ottawa, Shoaib leads the Atlantic Investment and Risk Consulting Team at Telus Health. In his current position, he advises institutional clients on all aspects of Investment and risk management: investment policy, asset liability management studies, selection of investment managers, measuring managers’ performance and ESG Investing. Shoaib specialises in investment manager research in Farmland, Commercial Mortgages and Private Equity asset classes.
Shoaib has over 15 years of experience in the industry. Shoaib started his career as a corporate banker specializing in credit risk analysis of corporate and SMEs borrowers. Prior to coming to Telus Health, he held various positions in financial institutions including working at a credit guarantee fund targeted at SME credit in Germany.
Shoaib has a B.Sc in Banking and Finance from University of London (LSE), a LLM (Financial Services Law) from University of London (Queen Mary & UCL) and a Master in Public Policy from Hertie School of Governance Berlin. He also holds the Chartered Financial Analyst (CFA) and Chartered Alternative Investment Analyst (CAIA) designations.