By Hillary Jackson
Canadian hedge fund manager Sprott Asset Management aspires to be the biggest farm operator in its home country—and maybe even the world. The Toronto firm’s motto? “We believe that big can be good,” says Steve Yuzpe, chief financial officer of Sprott Resource, the firm’s natural resource investment arm, and its agricultural operation, One Earth Farms.
Launched in March 2009, One Earth Farms has already invested $27.5 million to lease 13,000 acres of land from First Nations, a group of Canada’s indigenous peoples. By the end of 2009, One Earth Farms had raised another $14 million, which it will use to expand its existing grain business and to launch a cattle operation. Yuzpe says the goal is to have some 200,000 acres by the end of 2011.
Sprott is not the only firm buying into the food sector, even if it is one of the most ambitious when it comes to acquiring land. Several other hedge funds are investing in food production in one form or another, either by purchasing assets such as farmland and grain elevators or by simply investing in agricultural commodities. Investors as diverse as George Soros, London commodities producer and hedge fund manager Armajaro, San Francisco hedge fund firm Passport Capital, Ospraie Management and others have gotten in on the act.
So why the big push into agriculture?
In a word: demand. The world population is growing fast—it numbers 6.8 billion today and is expected to reach 7 billion in the next two years and more than 9 billion by 2050, according to United Nations projections—and available cropland is declining because of degradation and development, according to the International Food Policy Research Institute. The rapid growth of the middle class in emerging markets like China and India translates into more meat eaters, which in turn drives up demand for farmland as well as water and grain supplies. The increase in the production of biofuels is also ramping up demand.
Meanwhile, food prices are rising. According to the U.N. Food and Agriculture Organization’s Food Price Index, food prices have shot up 24% from the end of 2006 to the end of 2009. The index reached its highest level in 15 months in December because of the rising prices of sugar, oils and fats, and dairy products.
In recent years, these increases have translated to riots, looting and even death. Some 75,000 Mexicans marched through the nation’s capital in early 2007 to protest the rising price of basic foodstuffs such as tortillas, following a surge in international corn prices. Later that same year, Italians staged a one-day protest over pasta prices when the country’s biggest milling group said it would raise the cost of flour by 50% because of high world wheat prices. Riots over rising food prices have torn through West Africa, India, China and other places in recent years, leaving people dead and injured and buildings looted and damaged.
“The world is absolutely going to need more food than it needs today,” insists Ejnar Knudsen, a portfolio manager at Passport Capital, which runs the Passport Capital Agriculture Fund.
This demand has made the global agriculture sector—previously viewed as an unsexy investment—hot again, and it’s attracted the attention of hedge funds, which have previously invested in this sector only via commodities.
“If you asked me five years ago if I would buy into farmland, I would have said no,” says Renatto Barbieri, portfolio manager of the recently launched Galtere Global AgriBusiness Fund. He says this is because farming has not historically produced high yields.
But the changing demand dynamics, coupled with increasing sophistication in the financial management of farming operations, have changed his view. “Today, land, and agribusiness in general, has become a very attractive proposition,” he says.
Barbieri is in the process of building his fund’s investment in farmland and food production-related entities, both in the South American countries of Brazil and Uruguay and in Australia, and the firm aims to have raised $1 billion toward the effort by the end of this year.
The fund has already invested $15 million in irrigated rice farms in Brazil, and has begun buying into an Australian livestock operation in New South Wales to produce boxed beef, or cuts of beef that are vacuum packed and boxed for shipment. Ultimately, the fund will allocate 70% to South America and 30% to Australia, Barbieri reports.
In Brazil, the fund plans to invest in agricultural infrastructure initiatives such as warehousing and irrigation projects. The Galtere Global AgriBusiness Fund is structured as a private equity fund and has a 10-year lockup because of the long-term nature of its investments, says Barbieri. It is the first private equity fund for Galtere, which is best known for its commodity hedge funds.
Agriculture is in Barbieri’s blood. His family runs a diversified agricultural business in Brazil that has interests in irrigated rice, soybean, beef cattle and sheep farming, and he holds a bachelor’s degree in agronomic engineering from his native country’s Universidade Federal do Rio Grande do Sul. He has spent more than 20 years in the commodities markets doing trading, structuring, financing, investment and business development. Barbieri calls farming a “very provincial business” and says having a background in agribusiness is critical to understanding how to invest wisely in the agricultural sector.
Barbieri declines to project returns from the fund’s investments, but he maintains that the strategy is a long-term investment rather than a get-rich-quick scheme. “People need to be happy that they can make 15%. They don’t need to have a 25% to 35% return,” he says.
As Sprott expands its farming operation, Yuzpe says the firm will look at swaths of land in both the United States and eventually in South America. “We really have the opportunity not just to build a big farm but to change the approach to primary agriculture or to farming,” he says. Sprott’s investments may seem ambitious, but Yuzpe says the firm is just getting started.
“We’re in discussions with a number of First Nations already representing a million and a half acres of land, but we’ll scale this up in an operationally conservative way,” he says. “We believe that through massive economies of scale we can have a dramatic price advantage over the average farmer.” He estimates that this will translate to a 10 to 15 percentage-point increase over the industry’s standard net operating income of 22%.
Passport Capital takes a broader approach to the sector and doesn’t limit its exposure to farmland. “Our goal is to achieve 20% to 30% returns per year, and farmland just by itself will not achieve our investment return expectations. We can own tangible hard assets further up the chain to achieve the 20% to 30% that we expect,” says Passport’s Knudsen.
Passport isn’t ruling out owning physical farmland, but it will buy only into an operation that also includes processing facilities, thereby reducing its exposure to food prices while maintaining its exposure to expected increases in the volume of food production, Knudsen explains. He refers to the strategy as “dirt-to-dinner table” investing. The Passport Agriculture Fund, which launched in March 2009, gained 10.28% through the end of that year and was up another 2.20% in January.
Knudsen also grew up in the agriculture business; his parents owned a dairy company, and he raised cows as a child. He says Passport also is interested in hard assets such as grain elevators and fertilizer distribution businesses, as well as other food production entities. Passport is in the process of closing an investment in a 24,700-acre Malaysian palm oil plantation that Knudsen expects to grow to 74,100 acres. The operation includes a processing plant to produce palm oil, which has no trans fats and is forecast to be the world’s most produced and internationally traded edible oil by 2012. He declines to say how much Passport is investing in the operation but estimates it will offer Passport’s projected investment gains.
Passport is playing the food shortage theme another way by investing in fish, fish meal—a fish food supplement—and fish oil companies, which Knudsen expects to benefit from an increase in fish farming that will result from global quota restrictions on wild-caught fish.
“The fishing industry is very attractive to us, as more and more people won’t be able to drastically expand fishing without aquaculture,” he says, referring to the fish production industry. He points out that aquaculture operations need fish meal to feed their livestock. Many of these same companies also produce fish oil, he notes. “As people think about health care costs and life extension, they realize they need fish oil in their diets.”
Passport is also looking to the poultry industry for returns as the world’s growing appetite for meat and protein is increasingly answered by fast-food restaurants like KFC. “There is one new KFC being built every day in China; KFC means poultry,” Knudsen says, adding that poultry consumption is growing at twice the rate of pork consumption. He notes that KFC fries its chicken in palm oil, which supports Passport’s other food-related investments. The firm has also taken a passive stake in Imperial Sugar, one of the country’s largest refiners.
London’s Armajaro, a commodity producer that also runs a commodity-related hedge fund business, Armajaro Asset Management, and a structured products division, is also playing the dirt-to-dinner table theme. The firm is in the process of performing due diligence in Africa, where Anthony Ward, firm co-founder and portfolio manager of the firm’s soft commodities-focused CC+ fund, sees big opportunities. Armajaro’s plans include setting up a private equity fund that would invest in a range of assets including ports and roads, farmland and storage facilities, and schools and other infrastructure. The firm also invests in soft commodities via its other hedge funds. Its sugar trading fund, CZAR+, gained 20.85% in 2009.
Ward says the firm is planning to structure these investments in a private equity format because of the long-term nature of the investments. The new vehicle is expected to launch later this year. For equity hedge funds playing the food theme, Ward recommends investing in fertilizer, seed and water companies as well as the big food groups like Archer Daniels Midland.
“Food will go to a price where it encourages these developments,” Ward says of the trend toward farmland acquisition and food-related investing. “If you’re long food, it will give you good returns.”
