Find the ASX's farm gate

PORTFOLIO POINT: Feeding emerging nations is a big and growing theme. Here are the entry points for investors.

Supplying food to the developing world, especially to China, is one of the biggest investment themes of our time. In Australia we have been preoccupied with selling hard commodities such as coal and iron to Asia, but elsewhere another game is being played in the big league: developing “soft commodities” for the next decade.

As always it’s the world’s wealthiest investors who are ahead of the curve, supported by some of the top researchers at investment bank: It’s why foreigners have doubled their holdings of Californian farmland in the past three years while British money is flowing into Australian and New Zealand land.

One of the issues driving the action is a growing sense that China will soon have much less arable land than previously expected.

The Chinese government says 120 million hectares of arable land is the “red line” that assures Chinese self-sufficiency in food. While official figures state that arable land has been flat at 122 million hectares since 2005, analysts at US investment bank Merrill Lynch beg to differ. Using time series satellite imagery for China’s 50 largest cities, Merrill estimates that creeping urbanisation has led to a decline since 2004, which may continue until 2015. In fact, they are convinced that China fell below the “red line” last year.

A November report from Merrill Lynch indicates that Chinese government policies driving their local governments to hit ambitious GDP targets may have been the culprit. Leading agri fund manager Eclectica believes official Chinese estimates of grain stocks are erroneous. Independent consultant contacts estimate that recent harvests were more like 140–153 million tonnes, not the 164–69 million reported by Beijing, suggesting Chinese corn stocks may be only half those suggested by official data.

Will we see a grain spike reminiscent of the famous oil spike of the 1970s that led to huge changes in global markets and a structurally higher oil price.

It is without doubt highly significant. Dylan Grice of Societe Generale in London sees this drop in Chinese arable land below the “red line” to being akin to the 1973 oil price spike that led to permanently higher real oil prices. He saw the OPEC 1973 embargo as the trigger for that spike, but the real cause was the surge in US reliance on foreign oil imports.

Leaving aside the geopolitical implications of rising food prices, what action can the ordinary investor take in order to avoid trailing in the dust of the super rich ?

For Australians, the local options are limited, as the acquisition by Canada’s Agrium of AWB demonstrated. Of course, there are a handful of mixed stocks: AACo, Elders, Graincorp, PrimeAg and Ruralco, together with the fertiliser plays such as Incitec Pivot (all benefiting from booming eastern states crops), but that hardly offers the sort of exposure investors may desire at this time.

It’s important to be able to participate in the soft commodity boom globally. London-based Hardman & Co believes the next “must-have” asset class will be direct agricultural investment. One $180 billion fund manager told Hardman of plans to increase its allocation to agri-business by 10–15%.

Hardman notes that average European farmland sells for $10,000 a hectare, with deals as high as $35,000; a major UK fund manager recently offered just over $32,000 a hectare for a large Lincolnshire property in recent months. This compares to North American farmland values of $4000–7000 while land in Africa – where political risk can be high – can be bought for anywhere from $200.

September’s World Agriculture Investment Conference brought together the first movers amongst the world’s wealthiest investors along with mega institutional investors in what sounds like the markets ringing the bell on the boom.

Elsewhere, commodity traders Louis Dreyfus and Olam are directly buying palm oil and sugar plantations in the emerging world, while billionaire trader George Soros and other Wall Street luminaries are backing a new upstart trader Gavilon, spun out of ConAgra in 2008, which hopes to buy a 300-million bushel capacity grain handler, catapulting it into third ranking in the US after ADM and Cargill.

However, buying foreign farmland directly, trading commodity futures or knowing which major agri-business multinational to buy is probably beyond the realm of most investors. This is genuinely one of those times when it may pay to buy some expertise.

Of course, one increasingly popular way to enter any market is through ETFs: Australian investors can access offshore ETFs though sites such as etfsecurities.com, and choose your agribusiness trackers on a broad range of agriculture and livestock plays. For direct equities, the Daxglobal AgriBusiness Index, launched in 2007, represents the 40 biggest and most traded companies in the soft commodity sector worldwide, including multinationals such as Agrium, Bunge, Archer Daniel Midland, Syngenta and Monsanto.

Thankfully, recent Australian tax changes have increased opportunities for Australian investors. The imminent abolition of the infamous foreign investment fund rules opens the world of offshore funds to the Australian investor. The soon-to-be-repealed foreign investment fund tax rules have, since 1993, transformed unrealised gains in overseas funds into taxable income at your top marginal tax rate, simply the worst case scenario for Australians keen to invest in international funds. While we’re still waiting on the details, from July 1, 2010, the best overseas funds should be open to locals.

Beyond simple ETF choices, a snapshot of promising fund options are:

• CF Eclectica Agriculture Fund, launched in 2007 and managed by George Lee, with about $200 million in agribusiness equities (its top holding is PotashCorp). It was up about 19% in the 12 months to the end of September.

• DWS Invest Global Agribusiness, up about 13% in US dollar terms for the 10 months to the end of October. This $2.6 billion fund, launched late 2006, is 89% invested in equities.

• Pictet Agriculture Fund, launched in May 2009, is up 17.3% in euro terms for the 10 months to the end of October and has 148 million euros in equities, with an emphasis on companies operating in production, packaging, supply and in the manufacture of agricultural equipment.

• BGF Blackrock World Agriculture Fund, a UK fund launched in February, with $60 million in assets, which holds at least 70% of total assets in agri-business equities, benchmarking against the Daxglobal AgriBusiness Index.

• Sarasin AgriSar Fund, which was up 10.1%, in sterling terms, for the 10 months ended October, investing across equities, land and commodities

• DB Platinum IVAgriculture fund, launched in March 2008, which has $118 million invested in seven highly liquid agriculture commodities: corn, wheat, soybean, sugar, cotton, coffee and cocoa. The fund tries to outpace the S&P GSCI Agriculture Tracker via Deutschebank research on expected supply/demand imbalances. In the past 12 months the US dollar class has done almost 9%, about half its index.

• Diapason Agriculture Fund, which debuted August 2006, and is up 17.8% in US dollar terms for the 10 months to the end of October. It tries to replicate as closely as possible, as a passive tracker, the 23-commodity Diapason index based on the broader agri commodity futures within the OECD.

• Diapason Roger Commodity Index, which passively tracks the 21-commodity agriculture segment of the Rogers International Commodity Index launched by famous investor and former Soros partner Jim Rogers. For the 10 months to the end of October, the US dollar share class was up 22.3%. The fund has been active since 2005.

Remember: these investments are highly volatile. Drawdowns of 50%-plus in a bear market for an equity fund in this sector are not unknown. Food and soft commodity prices may be moving to a new price level, but don’t expect those prices to be stable. That’s not the nature of agriculture.