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A look at the diversification benefits of farmland investing for pension funds

For institutional investors looking at farmland, various strategies are available that span a range of asset classes, from real assets to private equity to venture capital, said Bernice Miedzinski, president of Starbridge Capital Ltd., during a webinar hosted by the Canadian Investment Review this week.
 
Lower risk strategies include buying land and leasing it back to farmers, while higher risk strategies assume some operating risk.
 
“You really have to, as an investor, dig more deeply to make sure you understand what is the strategy from a risk-return perspective,” said Miedzinski.
 
Farmland will also fit into pension plans’ asset allocations in different ways, she noted. Some very large pension funds will include it in a separate natural resources bucket, while most small- and medium-sized pension funds will include it as part of a real assets bucket, together with real estate and infrastructure.
 
“If you have a low-risk strategy where you’re getting some income every year, you have unlevered farmland, which could be part of a liability-driven investment strategy because it’s a great long duration asset,” said Miedzinski.
 
Agriculture is a great portfolio diversifier because it has low or negative correlation with other asset classes, she noted.
 
Julie Koeninger, director of business development at Hancock Natural Resource Group Inc., spoke about core and core-plus agriculture investing during the webinar.
 
Core agriculture includes two types of crops: row and permanent, she said. Row crops, which are primarily bulk commodity crops traded in global markets, include corn, soybeans, cotton, wheat and rice, as well as some specialty crops such as potatoes and vegetables.
 
Permanent crops are higher-value crops that involve a long-term asset: a tree or vine. These include almonds and other nut crops, apples and other tree fruit, along with cranberries and wine grapes. They often undergo further processing, which adds value, such as roasted almonds, shelled pistachios or wine.
 
Core-plus investments include partial value chain integration involving processing, storage, packaging and marketing of agricultural products. Typically, this is done for permanent crops, said Koeninger.
 
“Permanent crops involving a tree or vine with a long-term life are typically directly operated; particularly if they’re developmental, greenfield investments that include a pre-productive period before cash flows begin. Direct operation by skilled property managers ensures that proper care is taken of the long-term asset during the developmental period and beyond. If you’re leasing a permanent crop property, you need to make sure that not just that one year’s crop is taken care of, but that the tree or vine is maintained for the long term. That’s why direct operation is typically preferable.”
 
However, direct operation also involves price and yield risk, making income typically more volatile than the row crop leased income.
 
Both permanent and row crop farmland returns can also be enhanced through alternative sources of income, added Koeninger, highlighting options like hunting and cell tower leases, solar and wind development, conservation easement sales and higher and better use property sales.
 
Koeninger also noted the importance of diversification in risk mitigation. “Diversification is really key. Given the lack of correlation among crop and commodity performance, crop and end-product diversification can mitigate the impact of individual commodity price-cycle risk while geographic diversification can mitigate localized weather risk.
 
“It’s unlikely that, if you invest in a variety of crops, they’re all going to have a down-price cycle at the same time. So investing in a single farm, or group of similar farms, in one region is typically more risky than investing in a globally diversified portfolio farm.”
 
Farmland can also be a diversifier within the real assets bucket, said Koeninger. “Within a real asset allocation, I think there’s room for a variety of assets and farmland, timberland real estate.  They don’t all move in lockstep if you look back to the correlations. There’s not perfect correlation of farmland with, say, real estate or timberland.
 
“So even within a real asset portfolio, farmland can be a diversifier. And the way this was really proven out was during the financial crisis where we saw timberland returns declined but farmland returns did not — people still need to eat. So that was a good example of why you still want to have some diversification, even within your real asset bucket.”
 
Also in the webinar, Jeff McAllister, vice-president of corporate development at Bonnefield Inc., highlighted the benefits of investing in Canadian agriculture, citing its inherent tax and currency advantages.
 
Canadian crops are also diverse, he noted, and less sensitive to geopolitics. “I think if you look at, certainly, the row crop market, the U.S., certain parts, are very much focused on corn and soybean production and hence are much more sensitive to global commodity prices and geopolitical tensions. And in Canada, partly based on geography, but as well just general focus on crop types, we just don’t have that same focus on those crops and [that] makes it less susceptible to some of those geopolitical tensions.”
 
However, he does acknowledge the challenges of investing in Canada. For example, farmland ownership is regulated by each province and some are more restrictive than others when it comes to investing. Manitoba and Saskatchewan prohibit institutional and foreign land ownership, making it impossible for institutional investors to access the asset class. Other provinces, like Alberta and Quebec, have more relaxed restrictions.
 
“The important thing here is there are many different provinces to navigate structures that are acceptable,” said McAllister. “So having a partner who understands how to invest and where dollars would work is important.”
 
Another challenge in Canada is scale, he added, noting the farm environment and agricultural community are still segmented in terms of small family farms spread throughout the country. “Compared to some other countries, specifically Australia and the U.S., we still don’t see that presence of large and corporate farms that are common in other geographies. And, in terms of pipeline development, it just increases the number of relationships you . . . have to have and the number of deals you actually have to look at. And so I think that, for a lot of institutions and plan sponsors, achieving that scale in Canada has been challenging, historically.”
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