Developed world versus emerging markets
From our experience, we have found that the majority of investors entering agricultural assets for the first time are seeking to ‘risk down’, not ‘risk up’. In general they are looking for assets that are less positively correlated with down markets and they are often prepared to sacrifice incrementally higher returns in favour of higher capital security and more reliable income. These investment objectives are generally more consistent with the risk profile of developed world agricultural economies than their emerging or frontier market piers.
Nevertheless, there is still growing investor demand for agricultural investments in these regions. This is primarily driven by the belief that the risk premium is worthwhile. While this may be true if successful outcomes are achieved, the risks are manifold and often underestimated by investors.
Having run large commercial farms in a number of emerging / frontier markets prior to establishing Consortium Land, members of our management team have gained significant firsthand experience of the challenges investors in these regions will face. In the fullness of time many investors may come to realise that the promised returns are easier to model than they are to deliver.
Although the potential for productivity gains (a much vaunted premise of emerging market investments) may be lower in the developed world, there are a number of reasons why total returns over the long-term may nevertheless be higher.
Emerging markets offer weaker legal protections, ownership rights are less enforceable and there are political and commercial risks associated with unstable regimes and higher levels of corruption. Additionally, less developed regions are often characterised by lower market access where vital agricultural inputs are concerned.
Countries with poorer populations for whom food is a high proportion of disposable income are also more prone to food security related trade restrictions. Higher agricultural commodity prices are of little use to agricultural investors who are unable to access more lucrative foreign markets due to export restrictions, or are unable to capitalise on local supply deficiencies because of prices controls. Farmers in regions where local access to fertilisers and other inputs are restricted are also more negatively impacted by rising input prices.
Although these are generalisations, investors considering agriculture for the first time might want to take account of the following advantages of advanced agricultural economies:
- Well developed and mature farmland markets (i.e. reduced development risk).
- Well developed produce marketing and transportation infrastructure.
- Access to highly experienced and reliable tenants and/or farm managers using modern, sustainable and efficient farming practices.
- Access to skilled workers and a well developed subcontracting base.
- Generally favourable commercial environment providing unrestricted access to agricultural inputs and capital items at competitive prices.
- High level of demand from wealthy local consumers.
- Free access to lucrative international export markets.
- Low risk of negative political interventions such as export restrictions and price controls.
- Little or no restriction on foreign direct freehold ownership of agricultural assets.
- High level of protection of property rights.
- Transparent and reliable legal frameworks.
- Efficient legislature with little or no corruption.
- High level of government R&D funding and other support for the agricultural sector.
- Stringent environmental standards which ensure that agricultural industries operate in an ethical and sustainable manner.
A holistic approach to assessing the investment potential of emerging / frontier agricultural markets often highlights ethical, social and/or environmental issues. From a ‘People, Planet, Profit’ perspective, investing in these regions often requires compromises that conflict with ethical guidelines or client mandates.
For example, much of the so called fallow, marginal or underutilised land (the development of which is often central to the return proposition) is in reality either supporting important natural ecosystems or occupied by native subsistence farmers who depend on the land for their wellbeing. The new development of large scale commercial farming enterprises therefore often relies on the destruction of these ecosystems and/or the eviction of indigenous people. In the case of more advanced agricultural economies almost all commercial scale farms have been in existence for generations so these issues don’t apply.
From an environmental perspective there is little doubt (in the mainstream scientific community) that for the planet to survive, unrestricted cropland expansion cannot be the primary source of production increases in the coming years. This view is increasingly supported by international treaties protecting the world’s remaining natural ecosystems. These policies are likely to become more restrictive in the future (and in our view, rightly so).
Increasing productivity on existing agricultural land through new technologies and sound management practices is the best and only way of ensuring that the world’s growing demand for food can be met sustainably (i.e. without the need to destroy any more of the planet’s crucial carbon sequestering ecosystems).
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