×

An Agricultural Affair

The agribusiness theme is one that can be intuitively understood because food and water are basic necessities. Unlike other industries or businesses where a host of factors must be analyzed when making investment decisions, in agribusiness, the most important factor is demand and supply conditions.

Population and income are two important factors underlying the demand for food and agricultural products. When a population grows, this drives a similar increase in demand for food and agricultural products. When the income of consumers rises, their food intake often tends to increase too.

Within developing countries, the lower-income population will likely consume more grains, while populations from the middle-income class spend more on meat and poultry. These two factors will cause the demand for agricultural products to increase.

Another interesting factor recently thrown into the agribusiness mix is increasing demand for biofuels. Biofuel has come under the spotlight, especially with the price of oil coming close to $100 a barrel at one point this past November. As corn and sugarcane are mostly used in the production of ethanol, this translates into greater demand for corn. This has had the knock on effect of increasing the prices of other grains used to replace corn as a feed grain.

Factors such as the above, have contributed to making agribusiness a very attractive investment. Funds investing in the agribusiness sector look at companies that operate at different points of the food chain. These include companies involved in the cultivation, harvesting, planning, production, processing, service and distribution of agricultural products (forestry and agriculture companies, tool and agricultural machine manufacturers), and companies in the food industry (such as wine, cattle and meat producers and processors, supermarkets and chemical companies).

Potential Risks

As with most thematic funds, the universe of companies that an agribusiness fund can invest into is limited, relative to that of global equity funds in general. The risk level of a thematic fund also tends to be higher relative to that of a global equity fund. A risk that investors should take note of is that climate changes potentially affect the production yields of crops, and thus affect the earnings of companies involved in the agribusiness sector. Global warming has become a major issue for countries. Droughts in some countries like Australia, have severely affected agricultural output. In such situations, although the prices of agricultural products could rise, the companies affected by drought may find face supply difficulties.

The cost of oil is another key risk that investors have to take note of. Increasing energy costs have provided an incentive for many governments to encourage the production of petroleum substitutes from renewable agricultural crops. If petroleum prices drop in the future, this will affect the commercial viability of petroleum substitutes and thus, the earnings of companies involved in the different phases of biofuel production will also be negatively affected.

Thematic Thoughts

The demand and supply conditions make investing in agribusiness an attractive proposition. Growing population, increasing income, intensifying water shortages, climate changes, farmland loss and degradation, the proliferation of livestock feeding, and an increasing push to divert food supplies into biofuel mean the world is in the initial phase of an intensifying food shortage. Although agribusiness funds have a more limited investment universe relative to global equity funds, they can still offer geographical diversification compared to sector funds such as technology, with the latter typically be skewed to investments in the U.S., South Korea and Taiwan. In addition, some sub-sectors within the agribusiness theme exhibit a low correlation with global equity markets, which helps to reduce the volatility of an investor’s portfolio.

Send us your questions and comments to us at fundaffair@cnbc.com.