Investing in a breadbasket

Cerulli Global Edge, April 2010

Australia is, as some of its natives say, a quarry and a breadbasket. Mining and farming have been two of the main drivers of its economy for decades and will only grow in importance as Asian industrialisation and wealth brings greater demand for resources and crops.

Both also represent natural asset classes for investment. But, while Australia’s mining industry is within easy reach of investors through the dozens of listed resource companies, getting exposure to the agricultural and pastoral theme has been harder. AWB Limited, which is active in grain trading, rural businesses and financial services, is a rare example of a large-cap listed stock in the agribusiness sector.

Instead, two very different themes have emerged around Australian agriculture as an investment class: the tax-effective managed investment scheme, and institutional products.

The first class has a very mixed reputation in Australia. The Australian Taxation Office, among the more draconian of the world’s tax bodies, has long granted a tax deduction on interest when investors borrow to invest in, among other things, agriculture. This fact has led to a wealth of managed investment schemes being developed – collective investment products which put money into a dazzling range of livestock and horticultural possibilities, including vineyards, ostrich farming, truffles, timber, cricket bat willow and macadamia nut plantations.

The form with these schemes has typically been that the investor participates in a lease of some land that is used for a crop or plant (or, in the case of livestock, animals themselves). A fee is then paid to a manager who would, in the case of a horticultural scheme for example, be responsible for planting, maintaining and harvesting the crop, and for finding a buyer. To make the best of the tax benefit, the structure is usually that the sponsor (or an affiliated bank) lends the buyer the money to make the investment, charging interest, which then becomes a tax deduction.

Even in the best of times many of these products have had a very bad name. Fundamentally, financial planners have felt that too many investors have got so caught up in the tax exemption (natural in a place where many people lose half their income to tax) and completely lost sight of the question of whether the underlying investment is actually any good. While there are reputable players involved – Macquarie has become a major player in this area – the ground is fertile for disreputable players, and when that happens, there can be a double hit: investors can not only lose their money if the scheme fails, but might also find the tax exemption revoked if the ATO decides there was never any realistic chance of it making viable income in the first place. One experienced financial planner tells Cerulli he only knows of one investor who has ever held one of these investments to maturity and received a return on their capital.

Through the 2000s the sector did appear to raise its game and improve transparency, performance and professionalism. For investors who could live with the fact that the schemes, even if successful, would take between five and 20 years to generate income, and that in almost all cases they didn’t own but leased the land, they might even have made sense. But things turned really sour in the financial crisis. 

Then, the two largest managed investment schemes in the country, the forestry schemes Great Southern and Timbercorp, collapsed, affecting 61,000 investors who had put $3 billion into them. These were supposed to be profitable and environmentally sound schemes which would help reduce reliance on old growth forests and support the plantation of millions of hectares of plantation timber. It’s hard to see an obvious way back into the mainstream for managed investment schemes.

There is, however, another field: institutional funds. Macquarie, for example, has a business arm called Macquarie Agricultural Funds Management which manages assets from beef cattle and dairy to grains, oil seeds, wheat, canola, sorghum, barley, almonds and wine grapes for institutional clients. The most visible expression of this is the Macquarie Pastoral Fund, which has raised A$800 million in investments and commitments and invested over A$500 million of it, mainly for institutions. All told Macquarie manages more than three million hectares of agricultural assets in Australia, and manages about A$1 billion in the sector, making it one of the largest agribusiness groups in the country.

For groups like Macquarie land ownership is only part of a broader range of businesses: another line would be agricultural risk products, if for example Cadbury wanted to hedge its cocoa exposure. Shipping finance and advisory services to agribusiness companies, and agricultural commodities research, are part of the same overall business.

But the ownership of land, cattle and crop is the most visible part of it, and it rests on a straightforward macro theme: giving investors exposure to the increasing protein consumption in emerging markets, particularly Asia, and more particularly China. Australia is ideally placed for export to these markets; it is acknowledged worldwide as a green, clean, disease free provider; and it is among the world leaders by volume in terms of exports of things like beef and grain.

Customers for this exposure tend to be institutional, partly because any product that gives exposure to farm production tends to be long-term by necessity, often a closed-end, lock-up fund with a five to eight year maturity. Superannuation funds are among the potential buyers: in July three super funds, the Catholic Superannuation Retirement Fund, AustralianSuper, and Auscoal, alongside AMP Capital Investors, raised about $200 million to invest in Australian farms through the Sustainable Agriculture Fund. The premise here was a sustainable, diversified farming product rather than any kind of tax minimisation scheme, and was developed with Melbourne University’s Land and Environment Faculty. The fund will invest in wheat, cattle, dairy and crops. Elsewhere, First Super announced it would invest in agriculture and would look at purchasing distressed Timbercorp assets; others that have either engaged institutional funds or invested directly in agriculture include Telstra Super, AMP Future Directions and Victoria Super. AMP as an overall entity was long considered one of the largest pastoral landowners in Australia, although it’s difficult to quantify.

It is not, though, anything like as much as some think it should be, which suggests room for greater engagement of the A$1 trillion superannuation industry with this asset class. Australian Agribusiness Group put out a report in November saying that less than 0.01 per cent of superannuation funds went into Australian agriculture, yet that international pension funds had put in more than $1.5 billion, or three times the local total. AAG argued that doing so would have protected Australian super funds from the global financial crisis. AAG also claims that the top 25% of Australian agriculture provided 11.2 per cent annual returns over the last 12 years with one third of volatility of the All Ordinaries index.

Some feel that the Australian agricultural sector has not helped itself by failing to promote the fact that it is at the cutting edge of agricultural technology, and indeed has had to be in order to thrive without the government protection afforded to farmers in other countries. Australian farmers have had to improve efficiency to compete and today export five times more food than Australia could consume, Macquarie says.

While Macquarie is the biggest name in the industry, some boutiques have sprung up too and more are likely to follow. Rural Funds Management, for example, is an agricultural fund and farm manager with $300 million under management, and manages a portfolio of large-scale farming and agricultural enterprises in land, water, infrastructure, poultry, viticulture, cotton, almonds and cut flowers. Established in 1997, it is the responsible entity to seven managed investment schemes, one tax-deductible scheme, and is the manager of an unlisted public company and two unit trusts. It was acquired by Great Southern in 2007 and briefly changed its name, but for obvious reasons has since changed it back again.

For the future, there is certain to be evolution of commodities as an investment class, and soft commodities – those you can eat – will inevitably be part of that even if the trend is initially driven by metals. This is partly because there’s a strong case to be made for their merits as a diversifier in a portfolio, and partly because it is such a clear area of strength in Australia. Whether this comes through mutual funds, structured products or exchange-traded funds, or a combination, remains to be seen.