Living off the fat of the land

Emma Dunkley charts the rise of agricultural ETFs – a sector that is thriving, despite the economic crisis

Emma Dunkley charts the rise of agricultural ETFs – a sector that is thriving, despite the economic crisis

Agriculture has emerged as an attractive investment proposition in the last year, providing low correlation with other cyclically oriented assets which have been adversely affected by the economic downturn. Proponents of agriculture suggest it has fared better largely because it is subject to demography and population growth above economic movements, with the rising global need for food and fuel rendering it a viable investment in the long term. 

Macquarie commodities analyst Kona Haque explained that the financial events of the last 12 months have had a greater effect on the supply side of agriculture relative to demand, compared with other commodities. “Those markets where income growth had an effect on food consumption – and a changing food consumption pattern, like China – seem to have weathered the economic storm better than most,” she said. 

Agriculture is considered a safe-haven at present, or at least a defensive play, with inventory levels at historical lows and strong long-term fundamentals, according to ETF Securities head of research and investment strategy Nicholas Brooks. “There have been strong flows into our agricultural exchange traded commodities (ETCs) this year, which have seen $325m in inflows year to date, boosting the AUM by 62% YTD,” he said. “This contrasts what’s happening in other financial markets, so agriculture is very popular at the moment.” 

The ETFS Leveraged Agriculture DJ-AIGCI ETCs denominated in euros and US dollars were among the top performing in terms of three-month daily total returns, achieving 33.54% and 32.75% respectively, according to Morningstar data.

Structural differences

However, investors should note the difference in structure and risk between ETFs and ETCs. As ETFs are governed by Ucits regulations, the funds must comprise a basket of assets and must track more than one security. Conversely, ETCs do not fall under Ucits regulation and are able to track a single asset. Both ETFs and ETCs can gain exposure to commodities via traditional replication or physical purchase, or through a swap or a note issued by a counterparty.

“We have collateralised all of our index-tracking ETCs, to ensure that they are more than 100% backed by collateral and marked to market daily,” said Brooks. “The collateral is held by BNY Mellon as an independent custodian, which removes counterparty risk to the swap provider.” 

Similarly, Invesco PowerShares executive vice president, global product development, Benjamin Fulton, said investors need to understand that many agriculture and commodity-based products will be exchange traded notes (ETNs) and ETCs, rather than ETFs. PowerShares works with Deutsche Bank to offer both ETFs and ETNs which replicate future-based indices. In terms of one-year total returns, the PowerShares DB Agriculture double short ETN and short ETN were the best performing, at 55.25% and 46.05% respectively.

“The primary difference is that our ETNs are DB debt offerings that track the returns of the index and take on the credit quality of DB,” said Fulton. Conversely, the ETFs invest in the actual futures contracts and therefore do not carry counterparty risk, he says. “There are also tax issues specific to futures contracts that commodity ETF investors should be aware of.” He also warned that the underlying securities – futures – tend to be volatile, meaning the commodity ETFs can also be volatile.  

Knowledge and experience

Aside from structure, investors should also look at the ETF issuer and consider what their expertise is, whether they are an investment bank, an asset manager or firm riding the ETF wave, said Matthew Carr, BNP Paribas managing director, ETFs. “This type of due diligence should be one of the keys in selecting a suitable tracker,” he said. 

The EasyETF S-Box BNP Paribas Global Agribusiness ETFs, denominated in US dollars and euros, generated the best six-month total returns, reaping 60.74% and 60.70% respectively. “The S-Box BNPP Global Agribusiness index has had exceptional results – since April 2004 it has outperformed the MSCI World Index by 179%,” said Carr. The index is based on four fundamental building blocks, focused on increasing demand for agriculture, decreasing supply, limited farmland and the need to develop new techniques in order to increase productivity. The index comprises 23 stocks from 13 countries, selected according to liquidity and capitalisation, and economic and fundamental analysis. 

In the short term, the Horizons BetaPro DJ-AIG Agriculture Grain Bull ETF achieved the highest three-month daily total returns of 41.39%, by leveraging exposure to the upside in the grains market. Conversely, the Horizons BetaPro DJ-AIG Agriculture Grain Bear ETF was one of the better-performing funds in terms of one-year total returns, at 41.25%. 

While the DJ-AIG commodity index range changed to the DJ-UBS range in May, the indices are still being referred to under both terms for a short time, said Brooks. 

The performance of the bull and bear ETFs based on the DJ-AIG Grains index reflect the leveraged performance of the grains sector over the last three months and a year respectively. “There’s been a rebound in grains – they’ve gone up by around 30% in the last three months – and have outperformed soft commodities in this time,” said BetaPro Management president Howard Atkinson. Hence the leveraged bull ETF has capitalised on the grains rebound and outperformed in the last three months.

“However, grains fell over the course of last year, after experiencing a high in the summer of 2008,” said Atkinson. As a result, providing twice the downside performance on a daily basis of grains via the Horizons bear ETF provided among the top one-year returns. Many institutional investors implemented the bear grains ETF to hedge the risk in their agriculture business stocks to provide downside protection, while others took a bet that grains were falling, said Atkinson. 

A bigger umbrella

However, BetaPro Management is calling on shareholders to approve a change in four of its ETFs, including the two grain ETFs, to broaden the coverage. Rather than invest just in grains, the ETFs would track an S&P global agriculture index in order to invest in agriculture businesses and companies, if approved by shareholders at the end of July. 

“The grains-based funds have been two of our less popular ETFs. This is partly because the dynamics which drive soybeans, corn and wheat are different, as grains is not a homogenous group like oil,” said Atkinson. Consequently, if an investor is bullish on wheat, neutral on soybeans and bearish on corn, for example, the grain ETFs are too diversified to employ these different views, he said. 

Yet Haque at Macquarie highlighted that investors have tended to clump commodities together as a single asset class, while their commodity weights are often dictated by an industry benchmark such as the S&P GSCI or the DJ-UBS indices. “This meant that returns in the agricultural sector in the second half of last year were driven lower by a combination of high volatility across all asset classes and correlation, forced into all investible assets by the negative returns occurring in equities,” she said. 

Atkinson added that ETFs in Canada are structured as mutual fund trusts, although BetaPro also employs a forward structure on top of this, which differentiates their funds from standard ETFs in North America and Europe. “There is an element of counterparty risk in our structure, which would only affect the mark to market gain if the counterparty, National Bank, was to default on the forward.” He explained that the forward agreement is also reset each time there is a subscription redemption in the ETF. 

Looking to the long term

While agriculture is an attractive investment at present, the outlook in the longer term is also promising. “Agriculture will continue to be a viable industry globally as long as countries become wealthier and the population continues to grow,” said Fulton. “An increase in demand in an ever shrinking and flattening world may be an ideal environment for agriculture to flourish in.” 

Carr added: “Agribusiness is a long-term play, an investment in the future, in a sector that has to grow to cater for the demands of an ever increasing global population.”