By: Heinrich Wittleder
Fixed-income securities have been a good way historically to diversify a portfolio and lower exposure to stock market volatility, but 2018 may prove to be the year to exercise caution and rethink one’s investment strategies.
In March, the Federal Reserve board hiked its benchmark funds rate by a quarter point, to a range of 1.5 % to 1.75%. The Federal Reserve has indicated it could raise rates a few more times throughout 2018, citing strength in the US labor market, a low unemployment rate and moderate economic growth. If that happens, due to the inverse relationship between bond prices and interest rates, bonds traded today may be less desirable in the future. Meaning you'd be better off buying new bonds in the marketplace than maintaining the low rate locked into a bond today.
Many industry experts in fixed income investing such as Bill Gross, contend we have entered a bear market in bonds. Some analysts even argue that this is just the beginning of a prolonged slump for bonds. But what are the implications and repercussion of this possible trend for investors and what alternatives are available?
The Need for Portfolio Diversification
The general investing benefit behind bonds for most portfolio managers and investors is the low volatility, and thus less risk exposure, in comparison to equity investments. Bonds can be used in conjunction with stocks, as there is less correlation between the two, dampening the ups and downs of your portfolio. Diversification needs to be a top priority in order to lower unsystematic investment risk exposure. Bonds have proven to be ideal for such purposes.
Holders of corporate bonds are more likely than equity holders to be repaid if a company faces bankruptcy. Furthermore, government bonds are considered close to risk free, since default of government supported by a strong economy is unlikely, and hypothetically speaking, governments usually have an army to back up their financial obligations.
Alternative Investments in Agriculture
But in a time of rising interest rates, return on investments with long-term bond investments is looking bleak, with investors searching for alternatives. Portfolio managers face several investment alternatives to choose from as bond substitutions. One alternative to bonds accompanied by similar risk profiles and diversification benefits are investments in agriculture. In the current economic environment, the agricultural asset class is attracting renewed interest from a wide range of private and institutional investors seeking exceptional alpha returns. Agriculture investments can provide increased wealth protection during a period of market uncertainty and benefits, such as capital preservation, a strong inflation hedge, uncorrelated returns to other financial instruments, and strong long-term growth.
A major attractive feature of agricultural investing next to bonds is the low correlation between returns on agricultural assets and the broader markets. Over the past 10 years, the correlation of the quarterly returns with the Standard & Poor ’s 500 and farm land has been 0.098%. While the US 10 year Treasury Bond mean return (currently about 3%) and volatility in the time between 1991 and 2017 were 5.9% and 9.2% respectively, farmland had a mean return of 11.5% with a volatility of 6.7% in the same time period. It’s no wonder major investors, like Warren Buffet, seek agriculture as an integral part of their portfolios.
Benefits of Investing in Agriculture
There are a variety of factors that endorse the attractiveness of agricultural investments.
The planet will have 9 billion people by 2050, demanding a necessary increase in food and agricultural production. A growing population will place additional pressure on scarce farmland resources to produce the necessary crop volumes. Even with anticipated increases in crop yields per acre, urbanization in most parts in the world has resulted in growing cities and the destruction of fertile farm land, increasing scarcity of land for the upcoming decades.
Moreover, growing middle classes in emerging markets are changing their consumption preferences to more animal-protein intensive diets, and consequently the agricultural feed input. Renewable resources are sustainable and non-depleting, making the asset class attractive for many longer-term investment strategies.
While there are many ways to invest in most stages of the agricultural value chain, including agribusiness equity, derivatives, and Exchange Traded Funds, the farming and agribusiness sector is not as easily accessible for private investors. Agriculture is usually a capital intensive and fragmented industry with tightly held family-run enterprises. However, this is slowly changing as farmers open up to direct investments as an alternative to debt using tailor-made investment structures.
With interest rates projected to rise and money being retrieved out of bond markets, agriculture assets attributes may be a lucrative investment alternative to diversify portfolio risk, while at the same time contributing to nurturing a growing and globalized world.
About the Author:
Heinrich Wittleder is KrogerFarms' Investment Analysis Intern. The German native is currently pursuing his Masters in Agribusiness at Texas A&M. He studied in the Netherlands for his undergrad at the Erasmus University in Rotterdam. Wittleder has completed numerous internships in agriculture, including laboring on a farm in Namibia and working in commodity trade finance at a Dutch bank.