Investors looking for an asset class showing strong returns over the turbulent year to date may have noticed the recent gains made by soft commodities such as corn.
The US midwest – a key growing area for crops like corn, wheat and soybeans – has been hit by its worst drought for 56 years, meaning yields are likely to be much worse than expected. The price of some agricultural commodities has reached record levels as a result.
The S&P GSCI Agriculture index rose by 24.10 per cent from the start of the year to 9 August, driven by a 43.19 per cent year-to-date gain in the S&P GSCI Soybean index and a 41.47 per cent increase in the S&P GSCI Corn index.
And gains look set to continue after the US Department of Agriculture lowered its production forecast for both corn and soybeans on 10 August. Corn yields are now expected to fall to 123.4 bushels per acre for 2012-13 – their lowest in 17 years – because of the drought.
Despite the price gains, products tracking soft commodities have not witnessed higher inflows. ETF Securities has seen outflows from wheat and corn exchange-traded commodities over the year to date as investors take profit from the price rises.
ETF Securities senior research analyst Martin Arnold says: “A lot of investors that find appeal in the agricultural space tend to a bit longer term in their investment horizons. Agriculture is generally impacted by longer-term trends – population growth, especially in emerging markets, and supply trends such as decreasing yields.
“When you’ve been holding agricultural products for one or two seasons and you start to see prices gains like this, it’s probably a very attractive time to reduce your exposure.”
Relying on the short-term gains of agricultural commodities for returns may not be the most prudent strategy as prices can literally change with the weather.
Capital Economics commodities economist Muktadir Ur Rahman says: “The current elevated levels of grains prices probably already reflect the worst possible outcome for US harvests.
“In the absence of any further adverse weather shocks, we believe that the prices of corn, wheat and soybeans will drop back by an average of 15 per cent over the remainder of this year.”
But adding exposure to agriculture in a portfolio need not entail directly investing in commodities or the passive products tracking them. Active funds focusing on agriculture – such as the £155.4m Sarasin AgriSar fund, the £132.6m Baring Global Agriculture fund and the £35m First State Global Agribusiness fund – invest in the companies engaged in the growing or raising of soft commodities.
The Sarasin AgriSar fund, which is managed by Henry Boucher and Mark Whitehead, does not seek to capitalise on short-term fluctuations in crop prices but seeks opportunities linked to improvements in agricultural productivity. This is achieved by looking at all levels of the agriculture chain – what Boucher calls a “field to fork” approach.
The managers say: “As equity investors in the sector, we focus on net farm incomes rather than direct crop prices. Despite the slowing global growth outlook, firmer crop prices and lower energy costs are supporting food producers and food consumption trends remain well underpinned by rising incomes.”
Baring Global Agriculture fund co-manager James Govan says the portfolio has been positioned to benefit from rising soft commodity price through holdings in the seed and fertiliser sectors.
The fund has increased its weighting to agricultural biotechnology corporation Monsanto in recognition of its increasing market share in US corn seeds and strong growth in South America.
Furthermore, the portfolio has a strong holding in Agrium, which makes the three main forms of fertiliser, and last month added to positions in fertiliser companies Potash Corp and Yara International as part of the theme.
Recent disposals include processing and distribution company Archer Daniels Midland and pork producer Smithfield Foods, as the profitability of the businesses is likely to be hit by the smaller US harvest and higher prices.
However, Goven adds that the returns of agriculture equity funds are not dependent on high commodity prices.
“In a downwards soft commodity price environment we can provide some protection by investing in meat, fish and dairy companies,” he says. “If you’re a chicken producer, for example, a large part of your costs are in corn and grains so they would benefit from a lower price environment.”
Hargreaves Lansdown investment analyst Richard Troue says the short-term price fluctuations mean he is not keen on directly investing in soft commodity through products such as ETCs. Troue would rather hold agricultural equity funds.
He says: “For investors who believe they can stay ahead of the curve, buying or selling ahead of such news, investing directly could be an option, but accurate timing is likely to be a challenge and the risk of missing the top or bottom high.”
Troue adds that agriculture is a specialist investment and says most investors would only want to allocate about 5 per cent of their portfolio to the area.
“Nevertheless, I am positive on agriculture as a long-term investment theme. With the prospect of over nine billion mouths to feed by 2050, investment in food production is set to rise,” he says.