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FARMLAND BASICS

Agcapita principals appear regularly in the financial media discussing the farmland investment premise – click below to see more:

We believe that farmland is an excellent long-term investment.  We believe the world is in a period of elevated demand for crops due to the combined requirements for “food, feed, and fuel” – the population grows every year requiring each acre to produce more; emerging economies are moving to a high meat diet driving livestock feed demand; and biofuels are diverting crops from food use .  We believe Canadian farmland has some highly unique and useful characteristics – low volatility, low correlations to traditional asset classes, high risk adjusted returns, strong linkage to emerging market growth with limited political risk, reliable cash-flow generation, if structured correctly, minimal counter-party risk and in certain markets a margin of safety due to discounted prices.  Taking each of these in turn:

– Low Volatility: Farmland prices exhibit low volatility in general and in particular when compared to listed equities.  Canadian farmland prices have experienced approximately 1/4 the volatility of the S&P 500 over the last 20 years.

– Superior Absolute Returns: Farmland typically generates higher absolute returns than listed equities over most measurement periods.   The combination of lower volatility with these higher absolute returns leads to one of the most important financial qualities of farmland – high risk adjusted returns or Sharpe Ratios.

– Superior Risk Adjusted Returns/Sharpe Ratios: Investors in public equities are being asked to accept nominal returns below 6% over long periods but with increasingly high price volatility.  Meanwhile, farmland generates higher absolute returns but with lower price volatility.  The result is that farmland consistently generates superior risk adjusted returns over public equities – often by a substantial margin.

– Correlation: Farmland has a low correlation to traditional retail investments – public equities and bonds and commercial real estate.  Most of these traditional retail investments are exhibiting high positive cross correlations so it is very difficult for investors to construct diversified portfolios with the mainstream options.   So for investors looking for genuine diversification, allocations to non-traditional and uncorrelated sectors like farmland continue to grow in appeal.

– Emerging Market Linkage: As emerging markets develop, the consumption of energy and agriculture commodities increases rapidly at the early stages of GDP/capita growth.  However, direct investments into emerging markets come with considerable political risk.  By way of contrast, direct investments into farmland in developed nations provide linkage to emerging market growth but without political risk, opaque accounting, dubious legal systems etc.

– Cash-flow: By cash renting (i.e. leasing the land to farmers for 100% upfront cash payment rather than operating) an investor in farmland can look forward to reliable cash-flow (on the order of 5-6% gross pa) without operational risk.  In addition, as cash-rents tend to track land prices with a lag, farmland rental cash-flows tend to be inflation hedging themselves.

– Minimal Counter-party Risk: It is increasingly apparent that many financial intermediaries only appear to be well capitalized because risks, where apparent, are thought to be hedged. Via hedge transactions, intermediaries argue that net exposure, rather than gross, is the key measure for investors to consider. This is not the case and where there is a concentration of risk in critical counter-parties, in a world of high positive correlations across markets and asset classes, hedges can fail leaving bankrupt counter-parties behind.   It is because we believe that counter-party risk remains opaque and non-trivial that direct farmland investments make sense to us – an unlevered portfolio of farmland, with 100% up-front cash rental payments has no counter-party to fail.

– Margin of Safety: Western Canadian farmland trades at a demonstrable discount to global averages which we believe provides the critical margin of safety necessary for value investments.


 
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