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Global farmland: diversification and ESG investing

Sherilee Mace
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One year on from the LGPS (Management and Investment of Funds) Regulations 2016, LGPS investors continue to seek investments that offer diversification and take into account environmental, social and governance (ESG) considerations.

The regulations, which came into force in November 2016 for funds in England and Wales, included the requirement to demonstrate investment across a wide range of assets, alongside guidance on responsible investing. This placed a stronger emphasis on the extent to which ESG considerations are taken into account when investing.

Global farmland investment could offer a way to achieve both objectives – along with the potential for income and real returns – which can help LGPS investors to manage their cash flows and realise long-term stability in contribution rates.

Farmland: the investment opportunity

A farmland portfolio will typically invest in agricultural businesses, aiming to generate investment returns from a combination of income as a result of selling produce, and capital gains from developing the business and land over time for eventual resale. The long-term case for investing in farmland is based on the expectation that demand will increase while supply growth remains constrained. The demand for agricultural commodities will grow as world population continues to expand, but supply growth is expected to struggle to keep pace, due to a combination of short-term limits to growth, less availability of high quality land as climate patterns shift, and resources such as water become scarcer. We expect these dynamics to place a premium on quality land in regions with a comparative production advantage. We believe investors in those regions, holding the right assets, will be rewarded.

Investing in farmland could also offer other appealing characteristics, including:

  • Diversification: Farmland investments are less correlated to economic growth than other real assets.
  • Inflation protection: The asset class has historically had a positive link to the level of inflation through long-term adjustments in land prices and short-term sensitivity to commodity prices.

Why responsible investment matters to farmland investors

With agricultural producers facing a number of challenges, including deforestation and water scarcity, a responsible approach which addresses these challenges offers the potential for adding value to a farmland investment. Agricultural producers using a responsible investment approach employ the latest technologies to maximise the output of their farms and their profitability, while at the same time aim to achieve best in-class sustainability. This enhances the long-term value of their operations.

How responsible investment in farmland could add value

Investing responsibly in farmland is a multi-faceted process. Before constructing a portfolio, it is important to consider one’s ability to farm sustainably in a particular geography or product segment. As a starting point, the investment process might consider each potential holding against a variety of indicators, including its fit with the broader investment strategy, financial and operating performance of the investment, the quality of assets and infrastructure, the potential for productivity enhancement and/or development, industry viability, customers and markets/supply chains, operational and commercial risks, and environmental considerations.

Once an investment has been made, following a responsible approach means adapting the approaches to the specifics of each investment. This can include a variety of different practices depending on the challenges that agricultural producers face. For example, businesses may adopt different approaches to soil conservation such as conservation tillage (a practice designed to conserve soil, water, energy and protect water quality) or cover cropping (a farming practice where crops are planted primarily to manage a number of factors such as soil erosion, soil fertility, soil quality and weeds). In the case of managing livestock, investors may seek to improve the health and welfare of cattle in order to have a significant impact on how a business performs.

In combination, robust practices such as these can contribute materially to the sustainability of farming businesses and, in turn, impact the long-term profitability for investors. We believe a holistic approach to sustainable farming will combine the best of traditional methods with beneficial modern technologies and global best practice to achieve high productivity and minimal environmental impact, in order to ultimately drive value creation for investors.

A different approach to generating returns

We believe a farmland portfolio that follows a responsible investment approach will be best placed to exploit the characteristics offered by the asset class. A well-managed farmland portfolio can therefore help LGPS funds to manage their cash flows and stabilise contributions, while also fulfilling their obligations to further diversify their portfolios and to demonstrate they are taking ESG factors into account when investing.

Sherilee Mace, institutional business development director, Insight Investment 

Column sponsored and supplied by Insight Investment

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