Reuters recently reported that Canada Pension Plan Investment Board (CPPIB) has decided against making further farmland investments.  Is CPPIB’s decision an indication that farmland is a poor investment, or were other factors at play?  In this note I’ll look at what went wrong with CPPIB’s farmland strategy and what lessons can we learn from its experience.

Firstly, let’s appreciate the enormous task CPPIB set for itself when it decided to begin investing in farmland more than 5 years ago.  CPPIB manages almost $300 billion of assets (as at year end 2016). To make a meaningful impact on overall returns, they presumably need to deploy a minimum of 1% to 2% in any given asset class, maybe more.  So by implication, they needed to deploy $3b to $6b in farmland and continue to increase that investment over time as CPPIB’s assets continue to grow.  To put that task in perspective, it has taken a decade for TIAA-CREF the world’s largest farmland investor, to deploy that much on behalf of itself and approximately 20 other large pension funds. Given the amount of capital CPPIB hoped to deploy and the relatively small number of mature markets it was targeting for investment, CPPIB’s goals were aggressive – perhaps even unprecedented.

CPPIB set an added goal for itself to deploy a minimum of $500mm in Canadian farmland.  Institutional investment in Canadian farmland is still relatively new. Bonnefield is the largest institutional investor in farmland in this country, and it has taken us 8 years to build the necessary specialized teams, investment processes, local knowledge, sourcing and property management systems, as well as the third-party appraisal, agrology and support networks necessary to meet the institutional-grade governance, reporting and oversight standards required  to deploy at this scale across such a large geography as Canada. CPPIB’s goal was to deploy more than twice what all pension funds had invested to date in Canadian farmland in just a few years.

Complicating the deployment challenges CPPIB set for itself was its decision to build an in-house team of finance professionals based in Toronto and London to deploy its farmland allocation.  This decision is perhaps understandable given the amount of capital CPPIB hoped to deploy, but it undoubtedly delayed their farmland investment program and increased the risk of success.  By comparison, TIAA-CREF began its farmland investment program by committing capital to specialized farmland investment managers with deep experience and local knowledge. Only once TIAA-CREF had experience with the asset class and had deployed significant amounts of capital did they acquire a 3rd party farmland management company to bring their operations in-house.   Farmland is a highly-specialized asset class requiring a rare mix of farming and finance expertise as well as “boots-on-the-ground” in local farm communities.  People with these unique mixes of skills are in short supply on Bay St. and the City of London.

Owning farmland and leasing it to farmers has historically produced returns in the 9% to 12% range, mostly from long-term capital appreciation and the remainder from a small cash yield.  While these historic rates of return are modest compared to expected returns on private equity, they tend to be much lower risk, lower volatility and highly correlated to inflation.  Farmland’s attractive risk-adjusted-returns make it an ideal asset for pension plans looking to match long-term liabilities.  It is not clear, however, that CPPIB’s return expectations were in line with these historic farmland returns – especially as regards cash yields.  Like any asset, to achieve higher returns you need to take on higher risks and it appears that CPPIB’s $2.5b acquisition of a 40% interest in Glencore was a move in that direction.

Most critically of all, CPPIB repeated a mistake that several other Bay St. investors have previously made when investing in this sector – they approached farming and farmland like any other business and any other financial asset.  Farmers do not view farming as just another business, and they certainly don’t view farmland as just a financial asset.  There is an emotional attachment that farmers, farm families and farm communities have to their life’s work and the land they farm that goes well beyond typical businesses and typical financial assets.  In Bonnefield’s view, the only way to successfully invest in Canadian farmland is to form long-term partnerships with farm families and to support local farm communities.

When CPPIB bought a $120mm farmland portfolio in Saskatchewan in 2013, they did so over the objections of many members of the farm community and over the objections of the provincial government.  Rather than take a consultative approach and seek a mutually acceptable arrangement, CPPIB armed with legal opinions and M&A lawyers, concluded the transaction despite substantial concerns in the farm community.  The resulting backlash was severe, prompting the Government to introduce legislation preventing any further pension funds or other institutional investor from owning farmland in the province.  This legislation has undoubtedly hurt Saskatchewan farmers by cutting off their access to institutional capital that could help them grow their businesses, reduce debt and help transition farms to younger farmers. This legislation has also diminished the long-term value of the very farmland CPPIB bought in the province by reducing its liquidity. One wonders what would have happened if CPPIB had taken a more sensitive approach and worked with local Saskatchewan farmers and their communities to find an acceptable arrangement that would have minimized the concerns of those opposed, while creating a precedent for additional (and badly needed) institutional investment in Saskatchewan’s agriculture sector.

Farmland’s attractive risk-adjusted investment prospects have not changed from the time CPPIB decided to enter the asset class. The Reuters article suggests that despite its farmland investments in the US and Saskatchewan, CPPIB’s new Chief Executive Mark Machin became frustrated with the lack of progress in meeting deployment targets and ordered an internal review that concluded farmland “was not sufficiently scalable to justify further investment”.  In retrospect, it is hardly surprising that CPPIB’s overly aggressive deployment targets, its decision to build an in-house team from scratch, unrealistic investment hurdle rates and its failure to recognize the unique sensitivities of local farm communities, all conspired to slow deployment.

When all is said and done, it appears that CPPIB’s original decision to invest in farmland was sound (attractive risk-adjusted returns with low volatility), but how it went about doing so was flawed.

In retrospect, CPPIB would have done well to heed General Dwight D. Eisenhower’s words – words that are written in huge letters on Bonnefield’s boardroom wall: