In the relentless search for assets that can generate a positive real return, wealth managers are increasingly turning to alternatives to identify new investment themes as traditional government bonds and other low-risk assets are providing very little, if any, positive real return.
One theme that has experienced a surge in interest is that of agriculture. Its positive correlation with inflation and a macro economic outlook of a growing world population, changing diets and scarcity of arable land make agriculture an attractive asset class for long-term investors.
While agricultural activities have historically been run as individual family businesses or companies, there is an increasing number of asset managers that see this as an opportunity and establish agriculture funds to meet demand, typically trying to apply a standard private equity fund model to this new asset class. This feels like déjà vu from the mid 2000s, where a number of banks, private equity houses and others rushed to the scene when investors started showing an interest for investing in infrastructure assets.
With only a few agriculture managers having a verifiable track record from predecessor funds, the asset class as a whole is still in its infancy, largely populated by first-time managers looking to bring together professionals from two different worlds. The first group of professionals come from an operational role, having managed or worked directly in farming operations, while the second group comes from the investment side, often from asset managers involved in hedge funds, private equity or perhaps commodity trading.
With the right structures, incentive schemes and governance mechanisms, these two worlds can be married, creating strong synergies.
The challenge from the perspective of the investor is however to make sure the right balance of power and incentives is struck between the operational team and the investment professionals, as the incentive schemes unfortunately seem to have been significantly tilted in favour of the investment professionals at the expense of the professionals from operations.
Investment professionals do have an important role in the structures, however so do the operations people as they are responsible for identifying and executing opportunities regarding operational improvements.
Having spent the past couple of years as a prospective limited partner, looking at a number of agriculture fund offerings, it has become increasingly apparent that the standard private equity structure of a 10-year term with a performance fee of 20 per cent and a management fee of 1.5-2.0 per cent, often based on net asset value, may not be suitable for agriculture, where the return from operations (ie excluding capital gain on land appreciation) may only be in the mid to high single digits.
Furthermore, a lot of time and effort must be invested into analysing and interviewing the organisation as well as scrutinising the incentive structure to ensure the right people are sufficiently tied in and motivated. Again, the standard private equity model may not provide the framework for the investors.
The wealth manager is consequently left with three options:
1. The investor accepts the terms and structures as offered, making it difficult to go back to the managers to change what has then become ‘market terms’ as the asset class matures
2. Actively engaging in negotiations with the fund managers, or acting as a seed investor in setting up a tailored structure for one or more like-minded investors. The draw-back of this option is that it is very time consuming and can be costly in terms of external legal and tax advisers. Even after many hours spent, it may become apparent that agreement with a particular manager cannot be reached. The attraction of this model is that in the situations where a mutually satisfactory agreement on the structure and fees can be reached between the manager and the investor, the asset class may be able to offer attractive returns, even on a net basis.
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| Table: Performance of Luxembourg-Domiciled Agricultural Equity Funds (CLICK TO VIEW) |
3. Deciding to stay out of the asset class until it is sufficiently mature and more transparency is available on which managers are top-quartile, and which are not. Again, it may prove difficult to change the terms.
Kasper Knudsen, Senior Portfolio Manager, Danske Capital
