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Scratch beneath the surface of the unrest that has plagued North Africa and the Middle East this year, and you will find that, of the many forces driving this turmoil, the rising price of basic foods played a key role. Food accounts for a much bigger proportion of inflation in developing countries, and food prices have been rising fast.
That's down to rising demand and limited supply - a worry for politicians and economists, but an opportunity for investors. Population growth, rising affluence, changing diets and the demand for biofuels are all driving agriculture demand and pushing up prices. It's an attractive narrative, and with relatively few agriculture companies listed in London, funds are the obvious way to play the story. Unfortunately, though, many have limited track records and high charges.
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Demand and supply fundamentals
Food prices, as measured by the UN's composite Food Price Index, recently reached their highest level since records began over 20 years ago. Price rises in foods such as corn, cocoa, wheat and coffee can mostly be attributed to poor harvests brought on by adverse weather conditions. Thesea are largely temporary, but there are bigger structural factors at work too.
Globally, the three key factors driving agricultural demand according to Renzo Casarotto, manager of the First State Global Agribusiness Fund, are population growth, improving living standards and biofuels. "Biofuels are the least important of these three," he says. "Urbanisation and rising affluence are pushing emerging market nations such as China, India and Brazil to follow in the footsteps of their Western counterparts, increasing their calorie intake and changing their diets, demanding more meat and dairy products."
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The demand for more protein has a multiplied effect on grain production. As livestock is reared on grain, feed production is heavily resource-intensive - it takes seven kilograms of grain to produce just one kilogram of beef.
While the demand fundamentals for agriculture are strong, there are considerable supply constraints, as Mr Casarotto points out: "Arable land on a per-person basis is declining, fresh water is becoming a scarcer resource and climatic events pose increasing risks to the production of field crops. In seven of the past 11 years the world has failed to produce sufficient grain to meet global demand and inventories are currently at very low levels. The challenge is to produce more food with fewer resources and this will require better seed, better nutrient application, mechanisation and larger-scale farms. This will need investment."
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Investment opportunities
After years of underinvestment in farming there is a need for significant capital injection into the agricultural sector in order to increase food production, according to a Fidelity report on food price inflation. That's an obvious opportunity for companies involved in the agriculture space. One of the first ways to meet the increasing demand for food is to increase crop yields by using fertilisers. Rising commodity prices mean that farmers are making better profits and can afford to buy fertilisers. Demand and prices are expected to grow strongly over the next decade.
And supply is constrained. "Given the fact that it can take several years to develop new potash sites, fertiliser supply is likely to be challenged by demand. This also helps explain the consolidation we are seeing in the sector, which I expect to continue," says Aris Vatis, manager of Fidelity's American Growth Fund. Companies such as Potash Corp are expected to be direct beneficiaries of the need to increase crop yields.
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The lowest-cost producers of food commodities tend to be in emerging markets, and this presents another way of tapping into the agriculture growth story. Nick Price, manager of the Fidelity EMEA fund, says: "The lowest-cost producers are well placed to benefit from growing demand as emerging consumers develop tastes much like their developed market cousins. For example, Clover Industries is the largest dairy company in South Africa and is well placed to benefit from growing demand for dairy products domestically and in other selected African countries."
Mr Casarotto says emerging markets such as Brazil, sub-Saharan Africa, Indonesia and eastern Europe further benefit from having land that can be brought into production in the future. "Brazil has the largest potential for increased arable land. With just over 70m hectares that are currently cultivated, a further 100m hectares out of Brazil's total of 850m hectares could potentially be converted from natural pastures to more intensive cultivated framing. This will take time, particularly because of the size of the country and the poor state of some of its infrastructure. But a number of nations seeking security of supply are already looking at Brazil. It is a long-term investment story."
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Caveats
Investing in agriculture comes with some risk warnings. Volatility is a major issue as agricultural stocks tend to be cyclical and heavily impacted by weather conditions. Of course, such factors are beyond the control of the fund manager and can significantly impact supply. The Castlestone Aliquot Agriculture Fund, which is purely invested in agricultural commodities, is a good example of the volatility characteristic of the asset class. Over two years, the fund's volatility, according to its February factsheet, is close to 30 per cent while over one year it is well over 20 per cent.
The volatility inherent in agriculture as an asset class and specialist funds more generally mean most financial advisers are cautious about recommending funds in this space. Justine Fearns of AWD Chase de Vere has a similar view: "We don't specifically recommend agriculture funds for most of our investors as they are very specialist.
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Some go further still. Alan Dick, chartered financial planner at Forty Two Wealth Management, says these funds are "an unnecessary bet against markets" and introduce an additional level of risk that would be best to avoid.
"Agriculture is already represented to some extent in overall world markets. Most of the funds I have seen don't actually invest in the underlying agriculture, but rather in themes that may benefit from it...I do not think there is sufficient evidence to suggest that they serve as a hedge against inflation even though the story sounds good.."
"My advice would be to stay clear of sector specific bets like this and own the whole market as cheaply as possible through well-diversified passive funds."
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Source: Investors Chronicle