Harvesting Investment Funds for Sustainable Agriculture

Agriculture is a hot commodity, and investment funds have been buying up farms in developing countries like never before.   The International Institute for the Environment and Development explores this phenomenon — and what action can be taken to promote investment that genuinely supports locals.

This article has been adapted from the International Institute for the Environment and Development’s Global Land Rush January 2012 news brief.   You can read it in its entirety here.

24 February 2011 | Food prices surged in 2007–08,   and investors responded by putting their money in farmland across Africa, Asia, and Latin America.

These investors include financial players like pension funds and sovereign wealth funds as well as high net-worth individuals, and they are increasingly using investment funds as a vehicle to invest in developing country agriculture. Investment funds allow different investors to pool resources to increase their investment options, diversify their investments and reduce their transaction costs.

We’ve identified nearly 70 such funds already, and this sector is projected to grow fast.   An estimated US$14 billion in private capital is already committed to investment in farmland and agricultural infrastructure. Analysts expect this figure to double or even treble by 2015. Most of these funds are based in Europe and North America, but they are increasingly looking to acquire farmland in the developing world. A recent survey of investment funds suggests that Africa and Latin America in particular are attracting growing amounts of capital.

Investment Impacts

Different forms of involvement in agriculture — from acquiring farmland to buying shares in agribusinesses — will have different implications for recipient countries. In many African countries, the agricultural sector has long suffered policy neglect and underinvestment, and there is a real need for both money and expertise from the private sector.

But this does not mean that all investment is ‘good’. The quality of the investment is critical. Quality can be assessed based on core characteristics of the investment, particularly its degree of inclusiveness — the extent to which the investment incorporates local actors for positive sustainable development impacts.

Promoting ‘Good’ Investments

Given the weak land rights recognized to local people under many national laws in Africa, short of fully implementing free, prior and informed consent of local landholders and communities, there is arguably no responsible way of investing in farmland in Africa. But investment in agriculture, including by investment funds, can be structured in alternative ways that support, rather than marginalize, local farmers.

This includes a wide range of models, including various types of supply chain relationships and ownership of shares by local farmers, which would enable local people to have greater ‘ownership’ and ‘voice’.

There is an urgent need for effective policy measures to promote ‘good’ investments and discourage harmful ones. Such measures can be taken in investors’ home countries, for example by introducing disclosure and transparency requirements. They can also be taken in recipient countries, for example by creating incentives for more inclusive investment models that involve local farmers; and establishing disincentives for speculative land acquisitions.

Private sector operators can play an important role not only by fully integrating traditional ESG concerns into investment decision making, but also by going beyond those concerns to pay greater attention to issues of inclusiveness as measured against the ‘ownership, voice, risk and return’ framework.

There are plenty of strategies that development actors can use to influence funds to make fairer, greener investments. This includes research and advocacy work for asset owners, sell-side analysts and investment fund boards to ensure that ESG and inclusiveness concerns — including how they can be used as performance indicators — are fully understood and taken into consideration in investment decisions. Targeting sell-side analysts can be particularly effective because their advice is widely used.

There is also a need for greater public scrutiny to increase both government and investor accountability.

Greater scrutiny can improve public understanding of the sector, as well as private sector awareness of concerns about inclusiveness. Many investors would admit to knowing little about sustainable development and poverty reduction and would welcome evidence on improved ways to engage with local communities.

Risks and Returns

The rising interest in farmland investments has several drivers. For investors, who are principally interested in balancing risks and returns, farmland investments are seen as an opportunity for potentially high long-term returns and as a way of diversifying risks away from traditional assets such as equities and bonds.

High returns are expected to come from a combination of rising farmland values and increased agricultural productivity on acquired land. In the United Kingdom and the United States, farmland prices have outperformed stock markets in the past ten years. Potential for land values to rise is much greater in Africa, where farmland prices are comparatively low.

Some investors look for land with high yield potential and invest further in agricultural productivity to increase their annual returns. These returns are largely influenced by the prices of agricultural commodities in both export and domestic markets, which can vary greatly from year to year. But investors can protect themselves from short-term swings by leasing out land and transferring year-to-year production and market risks to the farm operator.

Investors are often more interested in the long-term trends affecting commodity prices — and these suggest growing returns from agriculture. Growing populations, rising incomes, changing consumer preferences and urbanization, among others, will increase demand for food and raise agricultural commodity prices, fuelling increased returns from farmland.

Farmland investment can also help investors hedge against inflation and is seen as an important contribution to a diverse portfolio that does not entirely rely on volatile equity markets. Diversification is considered key to managing risk.

Of course, farmland investments are not risk free. Starting a new large plantation in often difficult terrains poses major challenges — in terms of agronomy, logistics, bureaucracy or relations with local groups — and the risk of failure is high. For this reason, some investors prefer to take over management of existing farms, perhaps privatized state farms, and increase productivity by changing management, technologies and agricultural practices.

External risks affecting farmland investment include bad weather, fluctuating commodity prices, changes in regulations or trade policy, and currency risks that affect land prices. Investments in emerging markets, such as Africa, are also thought to be more susceptible to political risks and negative economic conditions.

In general, investors assess the risks and weigh them up against expected returns, taking higher risks for higher potential returns. Investing in farmland in Europe is less risky compared with investments in Africa, but the potential to generate returns is lower. This is because land in Africa is cheaper and there is more scope for increases in land values.

A Mix of Investors

The decision to invest in farmland and agriculture depends on the asset allocation strategy and targeted returns of the individual fund. In these respects, investment funds are extremely diverse — each has its own risk-return profile, time horizon and governance structure that determines what investments are made where and how.

Many of the funds investing in farmland are private equity funds, which are not listed on a stock exchange. Private equity funds include both institutional investors — who manage money for a wide pool of clients — and wealthy individuals, who can afford to commit large sums of money over a long period of time, for example to allow for a turnaround of an underperforming company.

Publicly-available information about these funds is limited, but analysts estimate that around 190 private equity firms are investing in agriculture and farmland today. This is a small proportion of the thousands of private equity firms that exist but is still significant — some 63 of these firms are alone trying to raise US$13.3 billion to invest in agriculture. Of the 44 agricultural private equity funds in our analysis, a third focused on Africa. In addition to capital, many of these firms offer agricultural management services, technical assistance, business development advice and expertise in improved agricultural practices.

Institutional investors such as pension funds or life insurance companies control huge amounts of money and often aim for long-term growth. Pension funds tend to be the largest institutional investors in many industrialized economies and they increasingly make agricultural investments. Such investments now total US$320 billion, compared with just US$6 billion a decade ago. Agriculture accounts for a small but growing share of pension fund activity: of the US$32 trillion of assets managed by pension funds, an estimated US$5–15 billion goes directly into farmland investments.

As pension funds essentially manage the public’s money, they are highly regulated and information about their investments is more readily available compared with capital held by rich individuals. For the same reasons, they are under more pressure to reflect environmental, social and governance (ESG) concerns in their investments. In September 2011, a group of pension funds launched a set of ‘Principles for Responsible Investment in Farmland’, which sets out guidelines for considering these issues.

Another type of investor increasingly involved with farmland is, according to media reports, the hedge fund.   Hedge funds are similar to mutual funds in that investments are pooled and professionally managed. But they are much more flexible in their investment strategies and generally adopt an aggressive approach with high levels of speculation. For the most part, hedge funds cater to the ‘super rich’ and are often outside of conventional regulatory constraints, lack transparency and are less interested in ESG issues.

Sovereign wealth funds — state-owned investment funds that hold or manage public assets for financial objectives — also deserve a mention, though their role in farmland acquisitions in Africa seems to be overstated in public perceptions. They are commonly established from balance of payments surpluses, official foreign currency operations, the proceeds of privatisations, fiscal surpluses and receipts from commodity exports. These funds are unusual as government institutions, in that their management is largely market oriented and separate from other government funds. But they are also unusual in the financial sector because of their government ownership.

Abbi Buxton is a researcher in IIED’s Sustainable Markets Group.
Mark Campanale is an investment professional specializing in environmental markets.
Lorenzo Cotula is leader of the Land Rights Team and the Investment Team at IIED.

This article originally appeared on the IIED Web Site.   Please cite the original in references and consult them for information on reprinting.

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