Knowledge

Investing in Agricultural Land Part IV

23/9/2020

Trusts

Good day All. Today we will look at Trusts, as an effective tool for managing agricultural assets. It is a fact that the key to investment success, is the effective management of an investment portfolio. For families, one of the key requirements is a multi-generational portfolio, this is a portfolio that is effectively passed from generation to generation.

Asset management is so critical and in every type of investment venture, the management system, philosophy and structure is even far more important than the ability to buy or sell individual securities. This is especially true, as algorithms have completely cornered the short term trading opportunities in the financial markets. Therefore, success lies in the ability of an investor to be broader and more strategic in their thinking.

I have said many times before, but it is worth repeating that it is critical to have an investment plan that includes goals, time frames, risk management, portfolio management systems and if an investor cannot do this themselves then it is important to seek professional advice, because one’s financial future must be correctly planned.

Having said that, I must also add that I do not believe in passive investment management strategies, because the phrase ‘passive investment management’ is an oxymoron, because the word ‘management’ and its synonym ‘stewardship’, are words that denotes control, responsibility and positive action to add value through hard work, knowledge, wisdom and experience, so that in the end, the value of what was given has dramatically increased.

The idea of added value - by being passive and simply following the market, then expecting to be handsomely rewarded for that. It is absurd to say the least and the fact, that this has become so acceptable is tragic. The investment management industry has lost its will to fight and to do right for its clients, but it is simply content for taking fees while doing the basic minimum.

There is something so liberating about hard work and having an ethic of excellence which has been lost in our society today, there is comfort in knowing that if I work hard and consistently improve my craft, I will be rewarded, this is my insurance policy. It works because most people only ever reach 40% of what they are capable of without giving up and by doing that little extra, one can become in the top 10% of any field, therefore I find passive investing to be an extremely intellectually lazy concept that does not accurately reflect the true essence of our industry to the general investing public.

What is a Trust?

A trust is a legal device that allows several entities to have ownership rights over the same property. A trust has three main parties: the settlor, the trustee and the beneficiary.

The settlor of the trust is the initial owner of the asset, he/she/they create a trust and selects a trustee to manage the trust, which includes the asset or assets known as the trust property.

The agreement between the settlor and the trustee is called the trust deed and it encapsulates the duties of the trustee to manage the assets in a certain way and according to various legal principles for the benefit of the beneficiary who is now the ultimate owner.

From a property and trust law perspective, at this point, the settlor does not have any more rights to the asset but the legal owner is now the trustee. This can be a bank, a law firm, responsible relatives etc.

The trustees will look to the trust deed, which tells them how to manage the assets and what to give to the beneficiaries and when to give it. In many cases, the settlor adds himself/herself as a beneficiary.

This works very effectively in a family setting, where a settlor is looking to put his estate in order. At this point, as soon as he puts it in a trust, the tax status for him, the trust property and the beneficiaries all change.

There are very different rules across common law jurisdictions and also civil law jurisdictions that have transposed trust law principles into their legal systems, but there are various principles and purposes, which are generally applicable to the creation and use of trusts:

1. The trust enables the separation of ownership and control with the trustee having control, while the beneficiaries have ownership based on the specific provision of the trust deed.

2. The trust is a separate taxpayer for tax reasons and it must file its tax returns yearly.

3. The disposition of the trust property from the settlor to the trust, is deemed to be a sale at fair market value, and a valuation must be done from the time the asset was acquired to the day it was transferred to the trust, and the settlor must pay capital gains tax and depending on the personal circumstances of the settlor, he/she/they could have various capital gains exemptions.

4. There are various tax mitigation rules and exemptions that vary in different legal jurisdictions and based on different types of trusts.

5. The main use of trusts, is tax planning. In jurisdictions, where one has graduated tax rates, whereby as one’s income rises, their tax rises. Trusts are useful, because the income can be split across the family including the farmer, his spouse and their children - as beneficiaries, and they can all be taxed at lower rates.

6. Inheritance Mitigation - upon the death of the settlor, the assets will not need to be reported and assessed for inheritance tax.

7. Creditor Protection. The property does not belong to the settlor, the trustee or the beneficiaries so the assets are protected from creditors.

8. Confidentiality is a benefit, as the trustee conducts business in the name of the trustee or the trust and the beneficiaries do not need to be disclosed.

9. Trusts help to protect against matrimonial claims, as they are ineligible to be considered as matrimonial property, as the beneficiary does not have any interest in the land, so farmland can be protected in case of matrimonial breakdown.

10. Discretion on vesting rights - the trustee is normally required to use discretion in cases where one child wants to keep farming, but the others do not, then the trustee decides which child gets which asset.

11. Protection of Beneficiaries. For example, where the trust vest when the beneficiary is over twenty one years.

12. Spousal Trusts. In instances, where the surviving spouse may not be able to manage the property correctly, so the farm is put into a trust, this can also be in cases where the spouse is a spendthrift or has medical conditions that has left them incapacitated.

13. Farm Purification is another useful use of trust, when excess cash is used to purchase non farming assets, which can disqualify it from various farming tax benefits. In such cases, the non-farming assets can be transferred to the beneficiaries directly or a sister company controlled by the beneficiaries.

Conclusion

Certainly trusts are as easy or complicated as the assets, family structure and advisors, who are structuring them, but they remain a very useful asset management vehicle.

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Investing in Agricultural Land Part III

14/9/2020

Good day everyone. Today, I will delve more into the concept of trust, as both an asset management and tax mitigation vehicle.

Tax mitigation is a crucial issue that in many cases can make or break an otherwise strong investment portfolio, especially now with governments around the world borrowing record amounts of money.

A wise man once said: “There is no such thing as a free lunch”. We will all do well to remember this, as people are gladly spending the so called “corona virus relief” because whatever the government gives, it will always take it back from us, our children and grandchildren.

I was asked whether I disagreed with the governments putting so much money into the system to help people at this time, my answer is that wrong fiscal and monetary choices has led us to this point, where most people, even in the so called ‘rich north’ , do not have enough savings to cover their outgoings even for one month.

This is partly to do with people’s irresponsibility, but it is also due to the fact that wages in real terms have stagnated for at least the last 40 years and has barely kept up with the cost of living. This has resulted in many people living from credit cards and short term loans from predatory lenders, which traps them and their families in never ending debt cycles.

This is the same for governments and companies. We have seen that many large companies could not survive for one month without government support, despite reporting large profits year after year for the last decade since the last financial crisis.

We have to become much more fiscally conservative as a society to be better able to manage unforeseen challenges like COVID 19. Therefore, I am advising my clients, both small and large, to pay more attention to tax mitigation, because taxes will rise dramatically whatever the governing philosophy of the reigning governments around the world.

This is especially true in the US, where there is a false narrative being peddled in political circles that one or more of the parties is for lower taxes. That is a mathematical impossibility as the alternative will be that the dollar will lose its global reserve status if it does not balance its books quickly.

There will be no V shaped recovery, we are seeing the Trump administration working with the FED to keep the economy afloat and recession at bay until the US election is over, as no US President has ever been re-elected during a recession. If he returns as the President (which I believe he will), he will have to govern in practical prose and not the poetry of election campaigns.

Many investment portfolios needs to be quickly rebalanced, especially now when we see three key themes playing out in the markets.

Firstly, unlikelihood of a V shaped recovery. Recovery will be prolonged and take between 3-5 years.

Secondly, large investors are taking profit with the market now in weaker hands, this is what we are seeing from the mass sell offs in various markets.

Thirdly, the markets are now seriously discounting the possibility of the Biden victory in November, as they see higher taxes under a Biden administration.

I have already said, that this is a false narrative, as taxes will rise dramatically under either candidate’s government and not just in the US but also in the UK, the EU and across the key economies of Asia.

A nasty side effect to higher taxes, especially corporate tax and capital gains tax, is that it will result in a dramatic fall in the prices of public market securities especially stocks, but more of this later.

This is why investment vehicles like trusts are very useful, this is something I will speak about in detail in this blog, especially in relation to farmland and real assets.

Private Equity
One of the main reasons that I am advocating, for investors to invest in farmland and other real assets. I see that many investors, including clients of ours, have an unhealthy fixation with public market securities.

I see that private equity will be the asset class that will have the greatest growth this decade closely followed by commodities, as demand for food dramatically increase.

Private equity, or more precisely, private capital investments into real assets will grow to fill the gap left by governments, as they cut spending dramatically and increase taxes to balance their books. We will see large swathes of sectors like healthcare, education, correctional facilities and the criminal justice apparatus which includes policing as well as infrastructure completely taken over by the private sector.

We will also see a wave of privatizations, particularly in Europe within the EU, especially in countries like France and Italy. In the UK, we will see the prized National Health Service (NHS) fall into private hands.

As government financial capacity dwindles, so will their ability to administer large parts of the economy and we will see recovery funded by private capital to sustain and revive Main Street.

The public markets will gradually fall into disfavour until it fundamentally changes its approach. We are already seeing this happen with newer exchanges like Long Term Stock Exchange (LTSE) and others. Currently, the information asymmetry gap between owners (shareholders) and the managers of publicly listed companies is very large and within this opaque system, the opportunities for abuse and conflicts of interest is very large.

Companies took many poor capital allocation decisions, such as engaging in massive share buybacks with borrowed money in an environment that is much more conducive to borrowing to invest, and when COVID 19 occurred, it emerged that they had no money to survive, let alone take advantage of opportunities created by the pandemic.

These excesses are tolerated by most institutional investors, because they are engaged in an incestuous relationship with these listed companies and regulators. This relationship has given birth to a financial system that breaks every principle of money, such as the mispricing of risk with negative interest that punishes the financially prudent and rewards irresponsible spending.

It is a system that rewards the few at the expense of many, with many pension funds practically insolvent with huge unfunded liabilities and the pensions of hundreds of millions of people around the world in major risk.

It has almost become a new form of feudalism with the peasants being the global population working for the lords of the manor, but the problem with this is, that our world will find ways to balance itself, as the gap between the rich and the poor continues to grow.

Some of the negative ways we will see this rebalancing manifest, will be higher global crime rates and civil disobedience, as disregard for authority grows and social unrest and the breakdown in the social fabric with addictions like alcohol, drug abuse and various forms of immoral behaviour - growing.

This is happening as more people feel that the system is rigged against them and that they do not have a stake anymore in legitimate and respectable society.

This has nothing to do with colour of one’s skin. Poverty and the destruction of the global middle class is an issue currently affecting people of all races, colours and nationalities; issues like childhood hunger and malnutrition is becoming as prevalent in London as it is in Lahore or Lagos.

It is not an issue of racism, it is ultimately about control of people, their minds and ability to become and contribute meaningfully to society, as the system is designed to only to produce masses of wage slaves that only do as they are told.

The media portrays these issues as being issues of race or the colour of one’s skin, which is a false narrative designed to divide people and distract them from the main issues, such as a broken financial system, broken social contracts between citizens and governments, broken relationships between large companies and their broader stakeholders, broken education systems, a broken global food supply chain, a fast disappearing global middle class, a global epidemic of fatherlessness and broken homes with divorce at all-time highs in every part of the world. These are million times worse than any pandemic, especially now we are living in a world full of information but very little wisdom.

These are the real challenges facing our world and while these are bigger than finance, those of us who consider ourselves financiers or finance professionals, have a duty to really examine the choices we make, as to how we allocate assets of clients to ensure that they really achieve positive outcomes.

We need to ask ourselves if this was my pension, how would I want it managed. We are not to buy assets because it fits into our institution’s strategic and capital requirements, but because it will have a positive impact on our client’s financial future. Managing money is not just a job but a high calling, because money managers look after the future of people, generations and nations. It is a grave responsibility that is owed to clients and also to the broader stakeholders in society.

Conclusion
Unfortunately, space does not permit me to discuss trusts and agricultural strategies as planned, which I will do tomorrow.

As I speak to family members, friends, government officials and colleagues, it is becoming more apparent to me that many do not understand the reason why things are the way they currently appear. Friends of mine that are traders, speak about technical analysis – support and resistance, dojis and so on, while the economists speak of velocity of money and real interest rates.

The financial markets is not a summary of the world. The global sentiment cannot be captured in a candlestick or an economic equation of the shifts in global supply and demand.

In Plato’s “Theory of Forms”, he spoke about a physical realm which we see and a spiritual realm which we do not see. The physical realm, is always changing and temporary, but the spiritual realm, the realm of the forms, of ideals, principles - are unchanging and permanent.

In the Bible, St Paul also expressed similar sentiments in his letter to the Hebrews, where he said:
“By faith we understand the universe to have been formed by the word of God, so that the things being seen have not been made from the things being visible”.
Financial markets and economic theory signals today, is a physical representation of forms or an unseen realm that is selfish, self-serving and wicked that shows all of the basest instincts of human beings. As financiers, we must change this, but this can only be changed in the spiritual realm, the realm of ideas, moral laws and principles.

When we do this, money can truly become a force for good in our world today.

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Investing in Agricultural Land Part II

8/9/2020

Once again, I welcome all of the readers of these blogs.

Today, I will like to look at some strategies to use when one is investing in farmland. However, before I do so, I want to speak a bit on key concepts of property rights and land law, to create a legal framework through which we can understand the strategies and cash flow.

If space allows, I may also briefly touch on trusts, as an asset management and tax mitigation tool that is very useful when investors are investing for the long term, especially in assets like agricultural land.

One of the reasons I like the farmland and forestry complex, is that it is such a fantastic asset to help families that want to grow and preserve capital for many generations.

Land Law

I will start with a brief discussion of land and property law from the English law perspective. These concepts has formed the intellectual framework of global financial investments for hundreds of years and English Law remains the most flexible, stable and mature legal system for building an international portfolio.

The basics of land law is to define the supply and uses of land. Therefore, it is about regulating issues of ownership, control and usage interests in the land.

Each person with interests in the land has a bundle of rights called titles and it works like a chain.
The greatest possible property right to land is the fee simple in possession. In such as a case, the holder of this right is the absolute owner of the land to do as he/she pleases with it.

This person has absolute control over the whole land and all of its fruits and is said to have absolute titles to the land.

The next level down is the leasehold title or estate. This is where someone else is allowed to take possession of the land and use it for a certain amount of time and when that time is finished, it reverts back to the fee simple estate.

Depending on the nature of the lease contract, the lessee can also sub lease part of the land to sub lessees for a shorter period of time.

The third level is the ‘easement estate’. This is simply created to give someone a specific right of possession to a part of the land for a specific reason such as when utility companies have to lay part of their infrastructure within someone’s land.

These issues of titles in land may seem trivial, but they are extremely important because they determine ownership of mineral rights and water rights.

I remember spending a lot of time last year with some oilmen from Texas who educated me on the process of how they go about aggregating drilling rights from landowners in areas where they knew oil was present and how they shared the proceeds, because generally, where there is a fee simple owner, he/she or they own the mineral and water rights in what is known as a ‘unified estate’.

This owner can split these rights and convey them through a sale or lease to other parties separately, as I remember that in various parts of Texas, while they were drilling, they came across a lot of water, but the water did not belong to them, so they could not bottle it and sell it if they wanted to, because they were only entitled to the mineral right, specifically crude oil and natural gas.

While investing in farmland, these rights are extremely important. The most obvious is water rights, as in most circumstances one will need to irrigate the land, but also the issue of easements are very important if the access to an investor’s farm from the road, goes through another farmer’s land, then that easement must be investigated to see the terms even before buying, because that can significantly affect value.

Another easement that is becoming more important is ‘air easements’, especially when one is using drones to monitor one’s agricultural fields.

Especially important is to investigate all of the legal implications thoroughly, because rights and titles to land and even usage customs are very hard to change, especially when they have been established for years.

This can even affect the investor’s land, if they intend to plant organic products on their land in instances where the farm next to it is planting conventional products and using chemical fertilizers, which is draining into a shared water source.

An even more challenging is when investors are investing in farmland in developing economies, because in such countries, all of the various titles to the land may not be registered, so it can be challenging to fully investigate the ownership of different rights attached to the land, e.g. ancient animal grazing land or fishing rights when there are significant bodies of water attached to the land, or where access is through the investor’s farmland, like in the Great Lakes regions of East Africa.

This was quite a big problem in Africa, but the AfDB (African Development Bank) are hard at work with African companies to develop full registration of land across the continent. When this is complete, I have no doubt that it will unleash the full potential of African agriculture.

Additionally, there will inevitably be cultural and customary usage or access to water sources for communities, which the investor must take into account while making the investing decisions. It is always advisable to work with a top quality legal adviser in these cases; the money spent on excellent legal counsel is never wasted, especially a lawyer with good commercial awareness that tells the investor how to overcome the obstacles and manages the risks, not one that advises against taking the risks.

Ultimately, it comes down to the goal and strategy, because in any case, it is always good practice to integrate the considerations of the local community into an investing decision framework.

These titles or bundle of rights are the basis of asset creation and cash flow.

Strategies

Before looking further to the strategies, I will briefly mention the types of value drivers we discussed yesterday. If an investor is looking to develop a sustainable farming operation, his value drivers are: price premiums, market access, lower costs, risk mitigation, and consistent yield.

Virtually all of the investment strategies can be summarized under two investment theses, these are:

1. Create value by investing in efficiencies, especially within the ecosystem to enhance the performance of the land.
2. Focusing strategies on meeting the nuanced demands of the food industry e.g. organic food.
Under the first investment thesis, we have strategies like cover cropping, rotational grazing, ecological farming, vertical integration, irrigation, skilled management team and project contracts.

Conclusion

I will speak more about these in the next blog. I will also speak of the main management models and we will look at portfolio management and tax mitigation strategies using vehicles like trusts.
However, I will finish today with one thought:
‘’Farmland is not merely an asset, but it is the carrier of hopes, dreams, identity and future for all of us in some way or form, therefore great wisdom is necessary for those that invest in farmland.’’

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Investing in Agricultural Land Part I

7/9/2020

Investing in Farmland | Part I
Welcome to the next topic on our series of blogs on Food and Finance.

The farmland and forestry complex asset class is fairly young and is yet to become mainstream for two main reasons:
It does not lend itself so well to a ‘hands off’ or ‘mass investment’ model, because of its specific nature. There can be scalability issues, when it comes to amassing and managing enough farmland, to make it worthwhile for a significant investor.

Having said all the above, the benefit of its youthfulness is its dynamism, because it is evolving very quickly to reflect the diverse and nuanced demands of the global food and energy sectors.

Before starting, it is worth making a few remarks about assets and investments in general.

- Firstly, when we as financiers or investment professionals speak of assets, we are speaking primarily about a stream of cash flow. When most people think of assets, they think of ownership and/or control. While these can play a part, assets is all about cash flow.
An example of this, is a person that leases a whole building from the owner and subleases the building to tenants. Purely from a cash flow perspective, this will be an asset for the lessee as well as for the lessor.

Of course, in such circumstances, there are other considerations like the type of lease, cash flow consideration, but from a commercial perspective, as long as the lessee is making profit - that is an asset to him.

In looking at farmland, these concepts are very important, because in many circumstances, the cash flow arising from the land and the ownership is bifurcated and there are different streams of cash flow arising from the same land, which can belong to various parties.

- The second remark I will like to make, is simply to say that, investing in farmland is not for the disinterested investor, or those simply looking to balance a portfolio or hedge against inflation (both of which farmland does very well). You really need to love agriculture and love the land, because even if an investor is not managing the land, they have to think strategically about the highest and best use of the land and test that hypothesis continually.

- The third remark I will make, is that farm land investment is a LONG TERM investment. This type of investment is for the patient investors, but not necessarily the bigger investors. There are many avenues for investors with a modest amount of capital, to gain exposure to the ‘farmland forestry’ asset class, or more broadly, the ‘broader food supply chain’. It suits investors that want to invest in an asset with steady returns over the medium to long term.

- The fourth and final preliminary remark, is about yield. Many people try to entice or deter investors by throwing about various nebulous indication of yield.

However, I want to emphasize that there is no real indicative yield in farmland. Yield in farmland and in every investment class, is primarily related to the price of the investment, the method of financing, investment and operational strategies, and the rate of compounding, if any.

Farmland has the best yield in the hands of a passionate and knowledgeable strategic investor.

I will now introduce some topics, into which I will delve in much deeper in this series. My goal is to evangelize the benefits of investing in farmland, whilst also shining a light on some of the potential pitfalls to investing in this asset class.

Goals
As with anything, the goals are extremely important. Farmland investment is not for everyone, but for those who can realistically wait for a period of at least 10 years, to start seeing full yield. My idea of a full yield, is returns from a farm that has fruit trees, permanent crops and vegetables, grains or row crops.

Value Drivers
As an investor assessing a potential investment, this is the first question to ask oneself. I learnt this the hard way years ago when I pitched an investment opportunity to a VC firm. As an entrepreneur, I thought I had created value by combining three complementary companies into one entity and my figures were impeccable, but when the partners of that particular firm began to question me in depth about the value drivers, I was stuck because up to then, I had not really thought about it.

The value driver is like the engine of the car, it is what gives energy and impetus to the complete entity.

The business model and strategy are built around the value driver. Value drivers by nature are those key actions that drives the long term valuation of the investment, which is what we are looking for as investors, to eventually realize capital gains.

Value drivers could be access to cheaper or better sources of capital. We spoke earlier about, how the type of financing is one of the drivers of yield, and a prime example of this at work is Warren Buffett, who has access to extremely cheap sources of capital through the insurance operations of Berkshire Hathaway.

Other examples of market drivers are market strategy/branding and product service offerings.
Therefore, in assessing a potential agricultural or farmland investment; what are the value drivers that will differentiate us in the long term?

This value driver cannot simply be, that the land is very fertile. This is primarily the reason, why investors in the ‘Chernozem’ or Black earth farmland, located in various parts of the Former Soviet Union, failed. They simply thought, that just because the land was very fertile, the investments will be very successful.

The problem they faced, is that greater productivity does not necessarily mean success in agricultural investing, because correct management of the investment object is more important than simply growing more products. One still has to think about logistics, export quality, storage, land management etc.

We see this even today in the outrageous logistics prices exporters have to pay, to export grain out of the Ukraine. A senior official, in one of the international development bank, confided in me during an agriculture and forestry conference I chaired in London several years ago. He said, that the problem is that organizations like his, spent many years increasing productivity of the Ukrainian land, without paying attention to the infrastructural deficits in transporting products, especially during the export of grain.

Ukraine is a prime example of this imbalance with ports in cities, like Odessa and Kharkiv. Choke full of vessels waiting to exit and with badly damaged roads and an ageing railway infrastructure, which has a perpetual shortage of wagons.

This is the case also in the other Former Soviet States, especially those in the CIS, including Kazakhstan and Uzbekistan and of course without forgetting Russia, that has always had legendary logistical issues despite vast tracts of very fertile land and very able and knowledgeable people.

These challenges is also evident in Africa, which possibly has the greatest potential for agriculture anywhere in the world, but still remains bedevilled by structural challenges.

These challenges reduces the value of land, because in an equal world, Africa should have the most expensive agricultural land in the world, because unlike other regions, it also has the climate to potentially harvest all year round at much lower costs than any other region on earth.
Does this challenges mean, that as an investor, I should not be looking at agricultural investments in these regions? Definitely not, but one will be looking to adjust their risk/return profile accordingly.

The investor must look at all these risks and use wise risk mitigation techniques to reduce investment risks and also feed in these risks to the investment model, so it is accurately reflect in the terms of the investment and the financing, so that as the investor, one is not exposed to all the risks but the risks and returns are shared more fairly between the buyers and sellers.

This is also where value drivers come in useful, because a key value driver is the product offering, this could mean choosing to plant more valuable products, rather than simple commodities like wheat and corn.

It could also mean going fully organic or pursuing a vertically integrated strategy where you can plant, package, brand and sell, therefore capturing much more value across the supply chain, which is a good way to make bigger profits while having the disadvantages of poorer logistics and location.

I will speak more about these strategies and investment methodologies in the next several blogs and I will also speak more about how investors can use some of the same techniques used to assess and value commercial real estate to also value farmland.

Conclusion
In conclusion, it is worth noting, that investing is a business and a business is investment as the objective of both is the same which is sustainable profit.

As investors, one must understand marketing, sales strategy, management, accounting, operations and so on, because the yield even in farmland investing is hidden in how well these are done.

Too many times as investors, our mind set tells us to keep things in their boxes, but to succeed in farmland investing, you have to think in an integrated way, as there are no low hanging fruits in this business.

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Food Security 2/2

4/9/2020

Today, we will look at Part 2 of our Food Security blog, as part of our series on Food and Finance.

Today I will focus more on the financial part and how financing needs to change its focus, so we can truly have food security around the world.

When we study the story of Joseph and his plans for food security in Egypt, we see several nodes within the supply chain where financing could play a part in increasing food security. From these, we will tease out some lessons that is applicable as we work to create global food security. These can be categorized under the following 4 categories.

1. Agriculture
2. Transportation
3. Storage
4. Marketing and Distribution

Agriculture

Agricultural productivity remains extremely crucial to global food security. I plan to do a very extensive series on the various aspects of investing in agriculture, specifically investing in farmland, but in this blog, I will focus on a few key issues.

Firstly, we will look at demand. Various figures have suggested that as a whole, we will need to increase our agricultural output by 60% by 2050, because of several factors of which the most important is a growing world population.

The complicating factor is, we must increase agricultural output while we are losing arable land to the average annual rate of about 10 million hectares per year. While some of it is lost to development, others are simply lost because of unsustainable farming practices.

The huge demand for food, makes investing in farmland and agriculture a very attractive prospect indeed, but like every other investment, professional management is key to a long and profitable investment.

In the story of Joseph it was said, that the land produced massive harvests over the first seven years, therefore, it stands to reason that they paid attention to farming practices that will give the highest yield, as they only had a seven years window to amass as much food as they could.

In my opinion, the most effective way to preserve the soil and sustain high productivity levels, is crop rotation, whereby farmers rotate the crops that are planted because each crop has a different effect on the soil, as they all add and subtract different minerals from the soil.

The challenge of implementing crop rotation in the scale, necessary for to preserve the soil and sustain high productivity is financialization, which is the process by which agriculture has become completely linked to the financial markets, and farmers take signals from the financial markets on what to plant, not based on what the soil needs, but what crops will they be able to sell for the highest price by the next harvest.

Farming must be done within a sustainable balanced system, such a system, depending on the location, will include permanent crops - like fruit trees, row crops - like vegetables, grain, as well as some elements of animal husbandry, which will add profitability and will also give manure which reduces the need for fertilizers.

Another element is good water management and soil irrigation, which we will discuss in a later blog.

This must also be done within a local community development model that integrates generations of family into agribusiness and strengthens local institutions and infrastructure like schools, hospital, roads, churches and civil society.

This is not the popular view that many prospective agricultural investors want to hear, because many subject themselves to financial models like standard DCF and IRR, which does not take into account many of the factors necessary to assess a profitable investment, let alone an investment in agriculture.

Allied to this is the climate change benefits, research has shown that land and forest resources managed correctly can deliver up to 37% of cost effective CO2 mitigation needed up to 2030. In other words, only with correct land management systems can we hope to realize the full potential of agriculture and significant reduction in CO2 emissions.

There are only two ways nations can continue to increase their output of precious agricultural goods without converting the valuable ecosystems critical to meeting their climate change commitments. The first is by exploiting already converted but abandoned land, while the second is by increasing the intensity of production on currently used land. Both of these approaches require significant capital investment and the payback periods are often long.

The short term need for yield and returns inevitably causes many investors to make mistakes which they live to regret later. Agriculture needs to be classed and assessed, like a 30 years fixed rate bond, because maturities would typically be 7-30 years reflecting the timescale that investments in sustainable land development might take to fully realize.

Longer term agriculture and climate change mitigation bonds are very useful for patient investors, like family offices, pension funds and insurance companies. Especially when for the most part, they are uncorrelated to the rest of the financial markets, but for them to work well, the key is management, management and management; prudent land management.

This type of strategic long term financing that includes an attractive yearly coupon and a long maturity is exactly what the agriculture industry needs to prosper.

Transportation

Transportation was a key element of Joseph’s plan, because the food needed to be transported from the farm to the local storage facility.

This is a key aspect of investment in agriculture, because transporting products safely to avoid wastage is extremely important. Studies have shown, that 14% of total global agricultural produce is lost, because of wastage, this amount higher in Sub Saharan Africa, where it could reach up to 40% in some places.

Storage

This is linked with transportation to avoid wastage, but good storage facilities, a prudent agricultural storage and produce preservation policy, will give the farmer the flexibility of when to sell the produce for the best prices and will also allow the farmer to utilize crop rotation much more effectively.

Good storage practices can also include various basic food transformation process, such as cleaning, packing and freezing when necessary.

Within all of these supply chain nodes, there are opportunities for investors to get involved with various types of financial instruments, but as I said earlier, it must be part of a complete system.

Marketing and Distribution

Within the framework of the ‘Joseph food security model’, a key part would have been the marketing and distribution network. It is important to note, that when we speak about marketing, it is more than advertising as many people assume, but marketing encompasses all of the business operations and supply chain, from production all the way to the point it reaches the customer’s hands.

Most investors that buy agricultural land or farms, do not tend to think of marketing and distribution, but the food supply chain of today includes traceability standards, the demand for organic produce, safety of the products (which are increasing all the time), and much more.

All of these standards start with the land and agricultural production. Questions needs to be raised, such as: whether pesticides will be used, what fertilizers will be used, how the harvest will be handled and preserved etc.

These and many more questions need to be answered before agricultural production, but they can only be answered based on the specific marketing strategy, i.e. is it organic or conventional, local or international market, and if international, what are the export requirements.

Investors, that choose organic production, will have higher upfront costs and lower yield, but will benefit from higher sales prices. They can also boost profitability, if they create vertically integrated food value chain systems, which is basically a ‘farm to fork’ approach, and they can compete and achieve greater economies of scale and profitability, even their lower yield and more specialized and sustainable agricultural production methods.

These are examples of some of the considerations that makes marketing and distribution a key consideration for agricultural producers and investors.

Conclusion

This concludes our initial discussion on the ‘Joseph Food Security Model’. I will be doing much more extensive work on this model in the future, both in writing and in courses, where I teach about food investing.

However, it is worth noting, that there is a huge gap between the past models of investing in farmland and the present and future models.

In the past, the food market was very homogenous, therefore no consideration was given to issues of marketing, distribution, sustainability, suitability, and in some cases – safety. However, at this present time and increasingly in the future, these considerations will be paramount, especially in the agricultural production phase, as the food market has become highly fragmented as food needs are changing with lifestyle choices, like increasing and decreasing meat and dairy consumption in different parts of the world. At the same time, increasing veganism, traceability requirements, increased rates of food allergies, climate change concerns and a whole host of other challenges that are emerging within the framework of an increasing global world population and rising demand for food.
To further develop the themes we have begun, in the following blogs, I will start another topic, which is investing in farmland and agriculture.

For food investors, I will quote Charles Dickens from the book ‘a tale of two cities’.

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way – in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only”.

Happy Reading!

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Food Security 1/2

31/8/2020

Good day everyone!

Out of many requests from investors, on how to invest in global food sector, I have decided to launch a new series of blogs called ‘Food and Finance’.

In these blogs, we will have the opportunity to discuss the intersection and interaction between the finance industry and the global food industry.

This symbiosis is not new, but is as old as agriculture itself, because the beginning and end of food production, manufacturing and supply has always been finance.

This symbiotic relationship has been parasitic in the sense that up to now, the financial system has sucked life from the food industry and in many cases, reinforced global structural market inequalities because it seemed to be more profitable.

However, we find ourselves at a critical point in history where the two respective industry have to have a mutually beneficial relationship whereby finance becomes a more benevolent investor into the food sector for all of our collective benefit.

While we have seen the challenges to the global food supply caused by the COVID 19 virus, in the grand scheme of things, it pales into insignificance when compared to the challenges we will face in feeding our world if the current relationship structure is maintained.

In understanding the food industry today, the key driver is the phrase ‘food security’. There is an account in the Bible that perfectly encapsulates some of these challenges we face going forward.

This is the story of Joseph. The Bible asserts that he was sold by his brothers to the Ishmaelites. They sold him because they hated him, as he received preferential treatment from their father Jacob despite being the second youngest son and having 10 older brothers.

He was sold as a slave to a kind Egyptian master called Potiphar, who was said to be the head of the Pharaoh’s guard. He distinguished himself and became the head of Potiphar’s household.

He was falsely accused of rape by the wife of Potiphar after he rejected her sexual advances and was thrown in jail where he was of such excellent character and capability, that the prison warden entrusted to him the administration of the prison.

It was during this time, that he encountered the Pharaoh’s butler and baker, who were in prison accused of an attempted assassination of the Pharaoh.

They both had bad dreams and Joseph correctly interpreted their dreams, which resulted in the butler reinstated to his position of trust and the baker executed for treason.

Despite the urging of Joseph for the butler to help him plead his innocence to the Pharaoh, he was forgotten in prison for two more years, until the Pharaoh himself had a bad dream for which he could not get a correct interpretation from all of the wise men from Egypt.

The butler remembered Joseph and mentioned his encounter with Joseph in prison, after which Joseph was swiftly summoned to the Court of the Pharaoh to help interpret the Pharaoh’s dream, which he did successfully.

The dream itself was in two parts. In the first part, the Pharaoh was standing by the river and out of the river came seven beautiful and well-kept cows feeding on the meadow.

Next, he saw another seven cows came out of the river, but unlike the first seven, these seven were very thin and neglected. These thin cows ate up the seven fat cows.

The Pharaoh woke and went back to sleep and this time, he saw seven healthy ears of corn upon one stalk and after this, he saw another seven ears of corn but these were very diseased and like the first dream, these diseased ears of corn ate the first seven healthy ears of corn.

Joseph interpreted the dream by first saying it was one dream not two, it was just repeated. The seven healthy cows and the corn represent the next seven years within which the land will be very prosperous and the seven poor cows and ears of corn represented the following seven years, where there will be a very grave famine in the land.

Understandably, for Pharaoh, this was very troubling news, he realized how food insecure Egypt was and this is the reality, that leaders across the world are facing today, when they look at the projections going forward, but this time it is not because of natural phenomena, but a crisis of man’s own making.

Currently, it looks like a time of plenty, but the world is facing a food insecure future. According to UN figures; currently more than 690 million people face chronic hunger, which is defined as:
The distress associated with lack of food. The threshold for food deprivation, or undernourishment, is fewer than 1,800 calories per day.
Undernutrition goes beyond calories to signify deficiencies in energy, protein, and/or essential vitamins and minerals.

Malnutrition refers more broadly to both undernutrition and over nutrition (problems with unbalanced diets).

While these are typically understood to be problems, in what is known as the global South, which is broadly most of Africa, some of the Middle East, South and Central America and most of Asia, we are also seeing this increasingly in what is known as the global North, where there is relatively more affluence.

Increasingly, we are also seeing food insecurity across the world, this is not just talking about agricultural challenges, but also looks at other challenges to get nutritious food three times per day, in adequate portions in every plate.

Food Security is defined as “Food Availability, Access and Utilization”
When a person always has adequate availability and access to enough safe and nutritious food to maintain an active and healthy life, they are considered food secure.

Before, we return to the story of Joseph, I will hasten to add that food insecurity, or famines have never had anything to do with the amount of people but with faulty food systems.

Whatever the population of the earth, it has the capacity to feed all of its inhabitants, but the misalignment of priorities due to economic incentives are the main reasons why we have not yet witnessed full food security and the global obliteration of world hunger. This is why I started this blog, with a necessity for the symbiosis between finance and food to be a mutually beneficial one and less of a parasitic one, because the issue of food security is of paramount importance.

Joseph correctly identified, that while it is a challenge, it can be overcome with a strong system where everyone cooperates. This is why I said, hunger is not a capacity issue whether of natural resources like land, water, knowledge, people etc.

Rather it is a systemic and structural problem reinforced by the financial system.

His recommendations to the Pharaoh were as follows:

Find a wise and discreet man to act as the Prime Minister;
This man will appoint regional officers over the whole land;
These officers will take up a fifth part of the harvest in the seven plenteous years and store it for the years of famine.

Pharaoh realized at this point, that Joseph was the best man to carry out this task and he was appointed as Prime Minister of Egypt, to make Egypt food secure.

The system Joseph built is very instructive for us to use today, as a playbook to achieve food security.

He built an integrated system, that started with the agricultural land and what it produced. As a fifth is about 20%, it conceivably was part of a taxation system, where farmers gave 20% of all they produced to the Pharaoh as a tax, which was then saved in storehouses, while the people kept 80% of all they produced.

This issue of saving and investing for the future, is very instructive for the role of governments, in creating food security. Governments must tax to save and to invest not just to fund current programs.

Part of the tax from the participants in the food sector, should go towards investing in the food sector, whether it is research, infrastructure, education of farmers, strategic reserves etc.

This brings me to the next part of Joseph’s plan. He built huge local storehouses in every city and a logistics system for transporting the food to the storehouses from the surrounding villages and farms.

He went about filling the storehouses, and the account in the Bible said, that he gathered corn without numbers, it was as the sand of the sea.

During this time, the famine began and the Bible says, that it was all over the whole earth and everyone came to Joseph to buy corn, and it is said that with this, Egypt became very prosperous.

The people of Egypt came to buy corn with their money and when that was finished, they sold their livestock and land, to buy corn and when this was finished, they said they had nothing left, so Joseph made a contract with the people saying, that they can cultivate the land after the famine, but have to give twenty percent to the Pharaoh and keep 80% for themselves and with this agreement, he was able to feed everyone for the duration of the famine and afterwards.

What we see with this system Joseph created, is that it was mutually beneficial, because the initial 20% of the produce that was the taxation, was stored to feed the people afterwards and when they could not buy anymore, they were given a fair deal by Joseph in exchange for more corn.

In the second part of this blog, we will examine the respective role, that the various parties played in securing the food supply of Egypt and the world, but in this part, we see that the answer for the impending food crisis was a systematic approach to increasing the capacity of the system to withstand shock and stress.

Our current food system is very fragile and not resilient and capable enough to withstand shocks.

This is for three reasons that I will briefly address:

Misalignment of objectives;
Over efficient supply chain;
Underinvestment into the supply and value chains.

Misalignment of objectives.

The global food supply chain is not working towards the same purposes.

An example of this in action.

The cocoa or cashew nut market. While these unfair relationships exist in every food supply chain, the cocoa and cashew markets are probably the worst. International companies and traders will descend on local farmers in the global South and bid down the price of the raw material to its minimum price (whether it is cocoa or cashew), and then they will go on to sell it with huge margins.

Raw unshelled cashews can cost $900 to $1000 per MT to buy from Nigeria and Tanzania, but when it is processed and packed into retail packs, it can cost a minimum of $25,000 per MT.

The profit margins are enormous, and while profits are important, we can still share more of the profit margins across the supply chain if not for altruistic reasons, but for pure business sense.

One of the reasons, is the fact, that most of the farmers are growing older. They do not have the capital or strength to renew their plantations and their children refuse to carry on the work, as it is so low paid and without more investments and a better structured system, this system is not sustainable and in the long term, the whole supply chain will suffer from lower productivity and yield levels.

Over efficient supply chain.

Those of us in the global North, have mastered just in time production and delivery terms, which makes the whole supply chain very fragile indeed, as in many cases, delivery times are so tight that there is no margin for error.

However, when there are supply or delivery shocks, the system breaks down very quickly. To resolve this issue, the whole supply chain has to be recalibrated in such a way that it can be scaled up when necessary and wound down as appropriate. Additionally, more emphasis has to be placed on forecasting, storage solutions and scenario planning to add resilience to the system.

Underinvestment in the supply and value chains.

This happens primarily because of short term thinking, with companies unwilling to tie down capital for an extended period of time, which is in turn driven by the investment community’s overemphasis on short term profitability and fast growth at the expense of long term investments, which in many cases can help a company consolidate or grow its market share.

In conclusion, the untold story of most of the challenges we have discussed above is driven by financing decisions, which includes cost of capital, risk, duration, profitability.

Further on, in part two, we will discuss this in more detail and conclude, on how finance can become an enabling partner for investing and financing the long term resilience and robustness of the global food supply chain.

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Food Finance Series

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Investing in Agricultural Land Part IV

Investing in Agricultural Land Part III

Investing in Agricultural Land Part II

Investing in Agricultural Land Part I

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