Sustainable agriculture ensures that production keeps up with both demographic changes and resource scarcity while providing economic development and investment portfolio growth. And agricultural production is big business, encompassing land, equipment, crop inputs (chemicals and seeds), expert production (farmers maximizing crop yields), value-added processing, and sales and distribution.  Agricultural sustainability depends on a number of factors, including agriculture practices, governmental policies, population trends, management of key resources, crop yields, and customer demand (such as for meat or other resource-intensive products).  For those seeking investments in sustainable agriculture, what are the pivotal issues that should underpin investor analysis and valuations in the sector?

To Begin: What is Sustainable Agriculture?

Food production, manufacturing, and distribution that is socially just and environmentally sustainable, leverages new technologies and new business models.  This co-evolved system borrows from the agro-industrial complex and from the “locavore/sustainable/organic” movement.  It uses advanced best management practices to boost agricultural productivity and efficiency to meet the growing demand for food, feed, fuel and fiber.

Geospatial analysis helps optimize agronomic conditions, land pricing, and input availability with labor and capital inputs allowing for economic efficiency.  The production system also uses Geographic Information Systems (GIS) to allow precise application and placement of important inputs such as fertilizers and advanced seeds that not only increases yield and productivity but also improves nutrition.

Advanced machinery, such as variable rate application of inputs, reduces tillage of the land while allowing for the precise amount of chemical inputs to avoid excess nutrient application.  These tools allow us to more effectively use inputs while conserving and optimizing water use.

And finally, biological agents that are region-specific allow us to control and manage pests with minimum exposure to harmful chemicals.  “Smart” agriculture couples advanced materials with highly efficient management of inputs. “Climate Smart” agriculture adapts this system to rapidly changing temperature and precipitation regimes to allow maximum resilience of our agricultural production system.

First-order processing and food manufacturing also leverage modern technologies, mostly using advanced communication and transportation systems to improve logistics.  Infrastructure improvements of ports, road and rail systems, and storage facilities, such as grain terminals and cold storage, reduce waste and minimize price volatility of important food-stuffs. The convergence of the agro-industrial complex with sustainable agriculture movement produces an advanced agriculture that simultaneously enhances production in developed and developing countries, reduces agricultural waste and provides meaningful jobs.  These trends are improving the lives of the subsistence, emerging economy farming community by proving education and training — building out agri-infrastructure and providing access to capital and to markets and to growing the use of technology deployed at scale.

How Do We Access Agriculture in the Capital Markets?

Accessing the growth of the agricultural industry requires exposure to multiple asset classes, each with its own risk-return profile.  First, owning farmland can provide capital appreciation and current yield while protecting against inflation and currency movements and may provide uncorrelated returns with other markets.  Of course, one needs to hire operators and control for input price volatility as well as be prepared for long-term illiquidity (up to 30 years).  And some farmland investments in developing countries are contested for their impact on local communities thereby adding reputational risk to the investor.

Second, agricultural commodities themselves such as futures contracts in the grain markets or livestock markets are poor vehicles for gaining direct exposure to the growth of the agribusiness theme. Passive strategies do not work well without significant backwardation to generate roll return and active strategies are highly volatile and have limited appeal, so they may have a limited place in an overall portfolio.  These markets are mostly used for natural hedgers.

Third, the private equity (PE) asset class holds some promise as agriculture is a large and fragmented sector with extraordinary growth potential, but requires significant capital and management and typically deal sizes are much smaller than the regular appetite for private equity investors.  Further, there have been a limited number of successful exits in the sector, thus thwarting significant attention from the large PE shops. Given that, there is a potential early-mover advantage to generate strong returns as more PE funds enter the markets.

And finally, the public equity asset class offers access to growth in agriculture as there is a broad investible universe which is focused on the core agricultural value chain and the companies are well covered by the capital markets and therefore have efficient access to growth capital.  Public equities will not have the same degree of uncorrelated returns as the other asset classes thereby requiring a skillful manager that will produce returns from company-specific attributes rather than common factor movements of the public markets.

How Do We Measure Success?

The sustainability impact of agribusiness can be measured along various axes.  As above, the theme of agriculture as a whole has a sustainability orientation because it recognizes the need for increased production given demographic trends, climate change and resource scarcity.  Secondly, we can determine the role companies have in advancing sustainable practices by providing new technologies, tools and advanced inputs.  And third, we can assess how an agribusiness company manages its own operations.

In agriculture, specific issues are paramount for the operations of any firm along the value chain. Water use, toxic emissions, impact on biodiversity and carbon emissions are key environmental factors which affect the sustainability of operating companies along the value chain.  Social issues include labor conditions, safeguards against negative livelihood impacts, and impact on community dynamics such as helping subsistence farmers benefit from global agricultural supply chains by engaging through out-grower schemes.

When considering these factors in conjunction with other market factors, skillful portfolio managers will seek to optimize risk exposure to the degree of risk management of these issues and determine the changes of the portfolio’s risk profile, such as exposure to beta, style, country, and expected returns, etc.  Of course, this type of management requires proper assignment of the portfolio’s benchmark in order to measure manager skill, rather than theme selection.

Overall sustainable agriculture is a journey, a co-evolution of sorts, with a rich history and a deeply complex value chain.  Investors would be wise to understand how this theme is already embedded in their asset allocation by determining current existing exposures and develop strategies for overweighting this theme in the coming decades.

Bruce M. Kahn, PhD is a Portfolio Manager at Sustainable Insight Capital Management.  He has over 25 years of relevant academic, environmental and investment management experience.  Bruce teaches Sustainable Agriculture, Finance and Statistics at Columbia University’s Earth Institute and holds a PhD in Land Resources from University of Wisconsin, Madison. He can be reached at bruce.kahn@sicm.com.
 

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