This less-known asset class offers a range of promising characteristics that can help pension funds navigate a challenging macro environment
Canadian farmland is an embryonic asset class, and many investors are unfamiliar with its core characteristics. As the manager of the Veripath Farmland Fund, I have seen firsthand how useful this asset can be to investors.
To start, it cannot be overemphasised that farmland is not a real estate investment. Farmland is a unique, non-depleting commodity capital asset that discounts the production of an infinite series of crops with highly inelastic demand and low stock-to-flow and is completely consumed with no recycling.
The best way, therefore, to discuss farmland as a portfolio addition is to summarize how its unique features lead to a core of useful behaviours, particularly for long-duration investors like pension plans.
Firstly, farmland is a diversifier with low long- and short-term correlation to public equities and bonds. Simply put, it diversifies when you need it most during public market events. For example, because of its limited correlation to bonds and nominal interest rates, prices were unaffected during COVID and during the recent rate-hiking cycle.
Farmland also dampens volatility while providing market-like returns. Over the 60-year period from 1954 to 2021 farmland had approximately the same IRR as the S&P, but with ~50 percent less volatility. It has also shown strong upside and downside capture ratios.
Using the 30-year period from 1992 to 2022, Canadian farmland has provided strong positive returns in both S&P down and up markets (upside capture = 39.1, downside capture = -44.1). Farmland outperforms many other conventional and alternative asset classes in both this defensive and upside performance versus public equities.
It also can be categorized as a “safe haven” in the strict meaning of the term in that it enhances the geometric mean return of a portfolio. Based on Veripath’s modelling using a 100 percent S&P portfolio at the 95 percent confidence level, Canadian farmland, weighted pursuant to Veripath’s portfolio construction tools, was a safe haven at the modest allocation level of four percent.
Canadian farmland has a strong and non-linear correlation to inflation. During the 1970s’ inflation episode, farmland in western Canada appreciated over 400 percent nominal and over 200 percent real, providing protection from the real loses experienced in stocks, bonds, and commercial real estate.
On the flipside, farmland can also protect against recessions. Simply stated, during recessions consumers tend not to change food consumption patterns which makes farmland highly resistant to recessionary forces.
There is also a value opportunity in Canadian farmland now. Canada has fundamental land mispricing that can be captured by an experienced manager. This is because Canada has low penetration of irrigated land but with large acreage suitable for irrigation by surface water. Canada also has low productivity-adjusted land prices.
By 2050 emerging markets will have an extra two billion people to feed, and billions more middle-class consumers. This will require global crop production to double, assuming current dietary behaviours are maintained. Farmland in an export-oriented country like Canada is a way to capture this growth, but expressed in a politically safer jurisdiction.
This asset class also captures the global demand for water. One tonne of wheat requires 1,000 tonnes of water. Exporting wheat is therefore an efficient proxy for exporting water. Canada, in effect, is exporting its water surplus when it exports crops to markets like India, China, and the Middle East, which have structural water shortages. Water is not an investable asset class, while Canadian farmland is.
Leverage in the Canadian farmland sector at <30 percent LTV is low (land/collateral based) compared to many other parts of the economy. We believe low aggregate sector leverage contributes to farmland’s low volatility and lack of cross correlation. That allows managers to use modest leverage but still provide competitive returns.
The 15-year return profile of the Canadian farmland benchmark (excluding rents, which average three to six percent pa) was nine percent IRR and, perhaps more importantly, featured impressive risk moments, with SD of 3.2 percent, skew of 1.3, and kurtosis of 0.3.
There is also a large, liquid market. The market capitalization of Canadian farmland is more than $750 billion (~1/3 of TSX) with more than $20 billion pa of turnover (~1/2 of Canadian CRE market). Farmland is one asset that truly deserves the label “liquid alternative.”
I hope this was a useful introduction to the asset class and provides an overview of the many reasons why you may want to consider farmland for inclusion in your long-term asset mix.
Stephen Johnston is a director of Omnigence Asset Management, an alternative asset manager with almost $1 billion in AUM. Stephen has a BSc. and a LLB from U of A and an MBA from the London Business School.
