Is Big Money Leaving Ag? | March 2014

Why investors may have soured on agricultural commodity funds.

The last decade saw boom times for agriculture. Supply squeezes, emerging market growth and dire warnings about the planet’s ability to feed itself combined to spark waves of investment interest in the sector all over the world. Since then times have tempered, the result of bumper crops, slowing economies and dampening prices for agricultural commodities.

The result, according to some investment experts, is that ag investing may have lost its lustre—perhaps to the point where the big money represented by fund managers and institutional investors is now flowing out of the sector.

Michael Coleman is firmly in that camp.

“Investors have cooled on the commodity story,” says the veteran trader and co-founder of the Merchant Commodity Fund, a Singapore-based discretionary fund that typically has somewhere between 30 to 50 per cent of its capital invested in agricultural commodities. Coleman says Merchant has seen a massive drop in capital in the past two years with assets under its management shrinking from US$1.5 billion at the start of 2011 to just US$130 million today.

“Sadly, our experience has been reasonably typical,” says Coleman, a former Cargill trader who eight years ago founded Aisling Analytics, the holding company for Merchant, along with former Cargill colleague Doug King.

The result, he says, is that a number of high profile discretionary funds with “reasonably-sized agricultural exposures” have had to shut down in recent months. One example is the U.K.’s Clive Capital, which at its peak had $5 billion in assets, according to Coleman.

And it’s not just discretionary fund managers, he says, who are feeling the pinch. Coleman believes institutional and other large investors aren’t as keen on commodity index investing or commodity exchange traded funds as they once were.

“I think in general there have been fairly significant outflows on the commodity sector. Those outflows have been concentrated more with discretionary funds [like Merchant],” he says. “Where there’s been less outflow is in the index investing. So I think the situation vis-à-vis in the ag market is that commodity index money is still a sizeable element in the market, but that money is not growing. It hasn’t been pulled out yet, but my sense is that there hasn’t been much new addition.”

Low Returns on Investment
Agriculture products, the so-called soft commodities, are part of the larger commodity picture that includes energy and minerals. Gold and other hard commodity investments have performed poorly in recent years, dragging down the sector generally.

“Overall, commodities have been very disappointing for investors,” Coleman says. “It’s been a case of, generally, returns not being very good. So if you’ve been a commodity index investor through the biggest bull market since the early years of the 20th century, you actually haven’t made any money.”

Coleman says such things as strong economic growth in emerging markets like China contributed to a robust ag sector and corresponding investor interest during much of the 2000s. Since then the ag picture has changed as a result of shifting supply and demand factors.

“From an investor’s point of view, at the top headline level, it looks like this commodity super-cycle, if it’s not over, it’s taking a breather,” says Coleman, pointing to recent news items about lower growth trajectories projected for China and big supply-side increases in various ag commodities as the kind of stories influencing investors these days. “There’s no top headline story anymore about why I should be invested in commodities.”

According to Coleman, a lot of money flowed into gold and other commodity investments, much of that into index funds, for diversification purposes and as a hedge against inflation. “That argument for diversification and inflation hedging has been much weakened over the last couple of years,” he says.

Coleman maintains many investors unfamiliar with the sector jumped on the ag commodities bandwagon during the mid-2000s—and many of them have since left.

“Commodities were in a boon, and lots of people who hadn’t traded commodities before got involved and have been disappointed,” Coleman explains. Compounding the problem, he says, is the fact that over the last year, commodities have “massively underperformed” other equities.

What does Coleman think it’ll take to turn ag commodity investment around? “It’s got to be some combination of Chinese and emerging market growth reaccelerating and really the creation of shortage again,” he says. “In the period 2004 to 2008, you had structural deficits appear in a wide range of agricultural commodities, so prices went up and that attracted more investment.”

However, Coleman believes a bearish ag market is a trend that could continue for some time. “Commodities have been hot, now they’re cool and they’re probably going to be cool for awhile,” he says. “The last time they went cool was back in 1981, and they stayed cold for 20 years.”

Diego Parrilla is founder and CEO of NARECO Advisors, an asset management firm specializing in natural resources and commodities also based in Singapore. Parrilla agrees investment interest in the ag sector has definitely cooled as a result of soft commodity prices, and he believes biofuels also come into play.

“I think the agricultural flows are a reflection of the general sentiment towards commodities,” says Parrilla. “The energy revolution in our view will have a major deflationary impact across energy prices, and that will impact agricultural commodities as well, which have seen a major increase in production capacity to cope with biofuel demand and government mandates. If Mother Nature is kind and we see normal weather, we could see much lower agricultural prices for a long time.”

Parrilla believes that on the supply side, it will take “some very adverse weather” negatively affecting agricultural production to spark strong tactical interest by investors in the ag sector. “Otherwise the trend remains for lower interest, and given the herd-ish mentality of investors they are unlikely to get involved,” he says.

Market Volatility
Philippe de la Perouse is director of HighQuest Partners Global Food and Agribusiness Practice, a market research and management consulting firm based in St. Louis. Mo. While he agrees there has been “quite a bit of movement” in the commodity index funds in recent years, de la Perouse stresses volatility is the nature of the beast.

“Those are fairly liquid strategies, so the money there has a tendency to kind of swing,” he says. “I think we’re going to continue to see fairly strong volatility in the markets.”

However, de la Perouse is optimistic about the long-term prospects of ag investing. “I would argue there’s still a lot of opportunity,” he says. “There are lots of ways to play, to invest in agriculture besides commodity index funds.”

One of those ways is to look at buying farmland with an eye on the long term. “To say that farmland investing today is not a good deal, I would argue that someone who has a 30-year time horizon, it may be a great time to buy,” he says. “It’s a different perspective, different needs.”

De la Perouse cites the case of numerous large corporate landholders in the United States that are looking for investments which preserve capital and provide a return over the long haul as a means to meet long-term financial commitments. “They’re investing in farmland, but they’re looking at it as a 25- to 30-year investment,” he says. “That’s quite different than if you’re a private equity investor and you’re looking at a seven-year life cycle or term on your fund.”

De la Perouse suggests infrastructure required to support production and movement of food is another aspect of agriculture that shouldn’t  be overlooked by investors. “The money, it hasn’t really come to the infrastructure area, which is really where I see the big opportunity,” he says.

“The commodity business is like the real estate business. It’s all about location—the location where the commodities are grown and where the consumption markets are located and getting them from one place to the other,” de la Perouse says. “Whether it’s building of fixed facilities, networks of elevators, storage facilities, transloading facilities or port facilities. I see a lot of opportunity on the logistics side.” 

Mark Halsall