Challenge Sustainability: Investing in Agribusiness

With an increase in the global population and changing food behaviour, agricultural goods are faced by a long-term increase in demand. However, with significantly decreasing supply due to the recent U.S. drought, this topic also faces crucial short-term challenges. This article deals with investment opportunities within the agribusiness value chain and sustainability criteria that should be considered.

Agribusiness investments raise investor’s attention due to a prospected long-term imbalance in supply and demand. Food scarcity is not a new phenomenon. In the past, instances of price spikes for agricultural goods have been met with a strong supply response and a subsequent levelling of prices. The supply side is facing limitations, as global productivity gains have been declining and farmland is damaged by intense cultivation, soil degradation or transferred by urbanisation and industrialisation. In addition, the impact of climate change like severe droughts limits production. The demand is driven by several social trends like the expected population growth or political mandates for biofuels: The US mandates more than a double of the current production of ethanol of 15.2 billion gallons today; biofuel production currently already counts for over 40% of US corn. Increasing wealth and the growth of the middle class in Asia will have a severe impact on agriculture due to higher meat consumption. In the last 30 years Chinese meat consumption has grown from 9 kg per capita per year to more than 50 kg. Livestock requires up to 8kg of feed for every kg of meat produced. To accommodate increased meat consumption, the United Nations has estimated that soybean production, which is primarily a feed crop, will need to grow 135% by 2050.

In addition, for many commodities buffer stocks are not sufficient any more to accommodate for short-term production setbacks, contributing to recent volatility and price peaks of agricultural commodity prices.

The direct investment in agricultural derivatives has raised severe criticism and campaigns by NGOs like Foodwatch or Oxfam. They raise ethical concerns about speculation driving up food prices and contributing to hunger and unrest in some countries. „Speculation can magnify the impact of real shocks, and even a small extra price increase can have serious consequences for the very poor“. Since spring 2012, several large German banks have pulled out of investing in basic food stuff like wheat or maize or removed agricultural products from a commodity index fund. This reaction also reflects the criticism by activist shareholders on several annual meetings by these banks.

Besides the direct involvement in agricultural commodities, investors can also choose to invest in the agricultural value chain. From a Responsible Investing perspective the whole sector needs to increase its efficiency, so that the increasing population can be fed. Investments in companies with adequate technologies and services can finance solutions targeting food scarcity.

The value chain contains producers like large farming, plantation, livestock or fish farming and reserve owners. Companies active in this cluster produce grains and oilseeds, sugar, milk, beef, pork and poultry, as well as wildcatch or farmed fish and timber. Producers are the primary beneficiaries of increasing prices for agricultural commodities. During the current drought in the US, a lot of farmers benefit from higher prices while roughly 80% of their crop shortfalls are covered by insurance contracts.

Production factors like seeds, fertilizers and crop protection products have in large part contributed to the steady growth in agricultural production efficiency over the last few decades. The improvement of agricultural equipment and machinery has allowed for the continuous improvement of the seedbed, reducing soil compression and limiting losses during harvest. The ability of pests to develop resistance has stimulated the chemical industry to develop pest management by efficient agrochemicals or the use of bio-fertilizers.

The consideration of sustainability factors is essential, even from a business perspective

Processing and logistics companies are primary processors of agricultural commodities that typically operate on a global scale and specialise in specific products, regions or trade routes. The increasing volatility in harvests will boot transports between areas with oversupply and others with shortages. Reducing waste during the value chain is just as important as increasing production. In warm climate hemispheres such as Asia, up to 25% of fresh produce is spoiled between production and consumption due to a lack of cold chains. A reduction in waste makes not only sense from a business perspective, but can also contribute a significant environmental and social benefit.

Besides the clusters mentioned in the upstream business, agribusiness investment funds also invest in downstream companies in the food business: Food intermediate and processing and production companies. Some funds even include retailers, restaurants or other service providers like packaging companies. The wide range of the value chain enables a very active management between the clusters according to the market timing: in times of high commodity prices the upstream segment is more favourable, while in times of risk aversion food companies in the downstream segment provide more defensive returns.

Since agriculture has direct environmental and social impacts, the consideration of these factors is essential, even from a business perspective: the excessive use of fertilizers has for example already degenerated land or reduced agricultural yields. The excessive use of water has lowered groundwater levels and led to a salinization of soils. Investors should therefore consider the application of sustainability criteria for fund managers, even if they do not explicitly label their funds as sustainable.

Fund managers considering ESG-factors are able to identify issues before they materialize in the stock price

The use of genetically modified seeds in agriculture has provoked a controversial debate on pros and cons: The modification of the genetic material can improve productivity, pest resistance or reduce water consumption of plants and can therefore enhance their resistance to droughts and therefore increase yields. The health effects, the increasing use of pesticides or the dependence of farmers in developing countries on the seed producers with a „terminator technology“ are matters controversially discussed especially in Europe.

On the other hand, the National Research Programme (NRP 59) of Switzerland could not identify any health or environmental risks related to green gene technology, as presented in their final report published on August 28th, 2012 on behalf of Switzerland’s Federal Office for Agriculture. With modest economic benefits under present conditions in Switzerland, the NRP 59 identifies potential for improvement if plants carrying combined traits, such as herbicide and disease resistance, are used.

As clear cutting of forests creates severe environmental problems, investors should look for companies with a certification of their timberland resources or a certified chain-of-custody. Palm oil plantations are often bashed to enforce the destruction of rainforests, therefore companies who participate and comply with the Roundtable for Sustainable Palm Oil are the better choice. There should be a consideration of animal welfare at livestock farms or the application of controversial pesticides and the application of guidelines for sustainable fish farming in order to avoid major controversies. Fund managers who screen the companies according to environmental and social risks and monitor public media and NGOs are able to identify issues before they materialize in the stock price.

In the upcoming edition of Kaiser Partner’s Wealth Management Information, we will introduce our readers to the agribusiness fund which is the best-in-class fund in our opinion. Meanwhile, your client advisor at Kaiser Partner Privatbank AG is happy to be at your disposal.

Dr. Ingeborg Schumacher is the Director of Responsible Investing at Kaiser Partner.

Sources:

SAM Agrobusiness Study 09/2012
RepRisk Insight Issue #02: Food & Beverage

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