When we founded Bonnefield ten years ago, we purposely set out to devise a business model that would create value for our investors by creating value for farmers. We believed then, and believe even more strongly now, that creating value for farmers naturally translates into value creation for our investors whose farmland portfolios we manage; a win-win for both investors and farmers. Value creation for farmers manifests itself in various ways: in financial flexibility, enhanced profitability, improved sustainability, and in contributions to local farm communities across Canada.
We codified our approach in a responsible investing policy (available here) and we actively monitor and track the environmental and social aspects of our investing activities on a property-by-property basis in our annual reports to investors. We have also tried to lead a broader discussion in the Canadian agricultural community on the benefits of responsible investing through public events such as local community town hall meetings, educational conferences, public speaking events, farm tours, documentary sponsorships and by participating in policy discussions with government officials and academics. In 2014, Bonnefield was the first Canadian farmland manager to become a signatory to the UN’s Principles for Responsible Investing.
Given this background, it has been gratifying for us to see evidence of other investors taking a sustainable approach to the agricultural sector. Over the past quarter alone, we have witnessed high-profile momentum in the sustainable agricultural investment space. There appears to be promising action being taken by investors to address some of the long-term sustainability issues facing the world’s food production systems, and we are hopeful that this emerging trend will become a broad movement. Some examples:
A group of influential investors including Bill Gates, Jeff Bezos, Ray Dalio, Richard Branson and Michael Bloomberg collaborated to form an investment fund named Breakthrough Energy Ventures (BEV). The firm offers patient capital to companies with high-impact potential and that aim to solve major, global issues. Last month BEV led an investment round in Pivot Bio, an agricultural company working on nitrogen-fixing microbes aimed at reducing fertilizer use and, thereby, environmental impacts and operating costs for farmers.
Jeremy Grantham’s Environmental Trust also led an investment round in the agricultural space. In October the trust invested in Land Life Company, a technology firm with the aim of reducing global soil degradation. They will continue to work on projects which meet their aims by offering technologies such as autonomous planting, remote sensing and blockchain verification. Grantham, co-founder of the $70 billion investment firm GMO Capital (and who I have frequently quoted in my blog posts), has adamantly expressed the importance of investing in sustainable agriculture as climate change, land scarcity and changing diets in the developing world are projected to threaten our global food system.
These stories are evidence of a growing trend: investors are giving greater consideration to environmental, social and governance (ESG) outcomes of their agriculture investments. According to the latest trends report from the Responsible Investment (RI) Association, more than half of the Canada’s investment industry considers ESG factors in their investment decisions, representing over $2 trillion in assets under management.
Impact investing takes the ESG mandate a step further by promoting investment-specific outcomes within a responsible investing framework. The Responsible Investment Association notes that impact investing in Canada has grown by over 60% (as measured by assets under management) over the past two years alone. Investors visibly aim to make a positive contribution to society while also generating attractive returns. Investors are aligning their portfolios with their values and allocating assets towards social and environmental progress as well as profit.
We are pleased to see that impact investing is being transformed from a soft, fuzzy platitude to its rightful place as a respected core principle of global financial best practices.
Canada’s farmers bring to mind the black knight in Monty Python and The Holy Grail. They keep on fighting despite being thrashed, again and again, by the seemingly endless series of challenges thrown at them over the spring and summer months: extreme weather patterns, NAFTA renegotiations, collateral damage from US-China tariffs, a diplomatic spat with Saudi Arabia and even a bizarre whodunnit relating to genetically modified wheat that mysteriously appeared in Alberta. Many of these issues remain fluid, but here is a brief mid-season summary of where things stand down on the farm:
Weather – No part of the country has had “normal” weather this growing season. The west has struggled with continued dryness all season, Central Canada had a cold wet spring followed by dry, searing heat punctuated with the occasional flooding rain storm, and the Maritimes experienced early season flooding and unseasonable heat over the summer months. Despite these challenges, our property management team reports that, for most Canadian farmers, the crops are looking quite good. Are this summer’s weather patterns an aberration or the new normal caused by climate change? The Economist recently published an excellent article on this debate here.
NAFTA – The ongoing NAFTA re-negotiations have been front-page news for more than a year now, but despite almost 24/7 coverage, no details have been publicly revealed about the potential impacts that a new deal (if any) would have on Canadian farmers. One of President Trump’s favourite objects of scorn is Canada’s supply management system for dairy products. Putting aside the fact that the US also heavily subsidizes its dairy sector, it is likely that any renewed NAFTA will mean changes for Canada’s dairy farmers. Nonetheless, we do not believe these potential changes are a significant risk for Canada’s overall ag sector. Any changes to the current system would likely include generous transition assistance that would limit the impact of any changes for Canada’s dairy farmers. In the long run, we believe that any trade deal that increases Canada’s access to booming world dairy markets, would be a net benefit to Canada’s dairy farmers. Our current supply managed dairy system effectively shuts Canadian farmers out of the strong worldwide demand for dairy products (especially from China), so greater access to world markets would, in the long run, be an opportunity not a threat to Canada’s farmers. An excellent report by Al Mussel of the Agri-Food Policy Institute separates fact from fiction in the dairy dispute and can be found here.
China-US Trade War – Canadian soy farmers have been caught in the crossfire of a tit-for-tat tariff war between China and the US. In early July, China levied a 25% tariff on soy imports from the US. In anticipation of an expected oversupply of US soy on world markets, the price of soy has recently declined to USD$310 per metric ton, from USD$442 per ton in April. The weak Canadian dollar has insulated farmers in this country to a certain extent, but prices are clearly depressed from where they would be in the absence of the trade dispute. Our view is that the market has over reacted and in the long term, if the trade dispute is not resolved, it could represent a significant opportunity for Canadian soy producers. China, the world’s largest soy importer, has an annual shortfall of 90 million tons of soybeans and the U.S. supplies 39% of that shortfall. China, on the other hand represents 62% of US soy exports. Brazil, which recently surpassed the US as the world’s largest soy producer, will be the primary beneficiary of these tariffs. Canadian soy producers, however, are also well positioned to benefit from strengthened export demand. China’s massive appetite for imported soy, leads us to believe that current soy prices are a case of “short-term pain for long-term gain” for Canadian farmers.
Diplomatic dispute with Saudi Arabia – In early August, Saudi Arabia took offence to Twitter posts by the Canadian government that urged the immediate release of human rights activists. The ensuing backlash from Saudi Arabia saw, among other trade-related measures, a ban on imports of Canadian wheat and barley. Despite the publicity Saudi Arabia’s announcements have had, Canadian farmers will not notice much of a change. In 2017, Saudi purchased about 10% of Canadian barley exports – only 134,000 metric tons – and less than 1% of Canadian wheat exports. The volumes of grain impacted by the Saudi ban are not significant and so we do not expect a material impact on Canadian farmers from the Saudi measures.
GMO wheat mystery in Alberta – The most bizarre event to befall Canadian farmers this summer, was the mysterious appearance in July 2017 of an experimental strain of genetically modified wheat in a roadside ditch in Alberta. GMO canola, corn, soy and other crops are commonly grown in Canada and exported abroad, but GMO wheat is not approved for commercial production in Canada (or anywhere else in the world). The wheat was identified after it survived an application of Round Up weed killer and, when the discovery was announced by Canadian Food Inspection Agency (“CFIA”) early this summer, Japan reacted by suspending wheat imports from Canada. Japan buys roughly 1/3rd of all Canadian wheat exports so the implications were serious for Canadian wheat producers. Canadian wheat prices fell as a result. Fortunately, Japan resumed importing Canadian wheat on July 20th after it was shown that GMO strains had not infiltrated our supply channels. But the mystery remains: how did this experimental strain of GMO wheat find its way to a roadside ditch in Alberta? University researchers and the CFIA have reportedly ruled out all plausible explanations, leaving sabotage as the leading theory. Did an anti-GM lobby group or a Russian agent scatter some genetically modified seeds along a roadside, knowing that the discovery would seriously disrupt Canadian wheat exports? According to published reports, both these groups have a history of mischievous activities in modern agriculture systems, so the theory – though it sounds outlandish – is at least plausible. It is unlikely that we will ever know for sure, but the mystery is further investigated by the Globe and Mail here.
On the whole, Canadian farmers seem to be taking all of these short-term irritants in stride. Visits with Bonnefield’s farmers over the summer months have not revealed any serious issues of concern and most remain optimistic for a reasonable harvest over the coming months.
Contrasting this backdrop of short-term challenges are the long-term trends that will continue to benefit Canadian farmers over the coming decades. These realities are pointedly summarized in the latest quarterly commentary from Jeremy Grantham, co-founder of Boston-based GMO, an investment firm with $71 billion in assets. I urge you to read it. His commentary puts into stark perspective the urgent threat climate change and soil erosion pose for the world’s food supply. It also highlights the serious role that we, as both investors and long-term stewards of Canadian farmland, owe to current and future generations. Grantham’s article, available here with a free registration, is a remarkable summary of why we do what we do here at Bonnefield, and why we are so focused on soil health and agrology.
My apologies for the cheeky “FAKE NEWS!” reference, but it does seem appropriate under the circumstances.
The Standing Senate Committee on Agriculture and Forestry just released a report entitled “How to Keep Farmland in the Hands of Canadian Farmers” and the few news outlets that noticed the report, seem to have widely mis-quoted its conclusions. The National Observer, for example quoted a Committee member as saying “…financial institutions, investment funds and foreign multinational companies [are] buying up Canadian farmland, which drives the prices up more and turns farmers into employees rather than owners of their land.” And Agri Investor carried the headline: “Canadian lawmakers warn against investment funds targeting farmland”.
For the record, the Committee’s report carries no such warnings and makes no recommendations against foreign ownership or investment funds.
While the report does acknowledge that some of the witnesses that appeared before the Committee in its 18 months of hearings expressed such concerns, the Committee’s report refrained from recommending measures that would limit either foreign ownership or institutional investment. The report also mentions other witnesses (such as Bonnefield’s Tom Eisenhauer, Farm Credit Canada, several academics and others) who found no evidence that foreign ownership or institutional investment in farmland are problematic in Canada. Indeed, the report sites examples of Bonnefield and other investors playing a positive role in providing financing alternatives to Canadian farmers and helping them reduce debt, grow their operations and transition their farms to the next generation.
While the Senate Committee’s report was not the anti-business manifesto that some news articles might lead you to believe, it was also not the call to action it could and should have been. In fact, it represents a missed opportunity to provide clear direction to lawmakers with firm recommendations for ways to ensure that Canadian farmland is protected and maintained for farmers and farming.
The report’s five recommendations range from soft (gather more data, better cooperation between levels of government, more funding for research) to downright bizarre. The report’s number one recommendation for keeping farmland in the hands of farmers? Increase the lifetime capital gains exemption for farm property. In the Committee’s view, increased capital gains exemptions will somehow help new farmers acquire farmland. Just how is unclear, as the report does not explain the connection between an increased tax exemption on the sale of a property, and easier acquisition of property by new farmers. Increased capital gains exemptions would certainly be good for retiring farmers. But new farmers? I don’t get it. New farmers need new forms of financing to build their businesses, not tax exemptions upon retirement.
Sadly, I don’t think Canadian farmland is any more protected from development or urban expansion, nor young farmers any better able to grow their farms, as a result of this Senate Committee’s report.
Note: the text of Tom Eisenhauer’s presentation to the Senate Committee, and Bonnefield’s recommendations for protecting Canadian farmland can be found here.
Note: this article first appeared in PEI Agri Investor February 13, 2018 www.agriinvestor.com
US farmers have had a tough time since 2013 when net farm incomes reached a record $135.6 billion after a stunning increase of 82% in just 4 years. Since those heady days, US net farm incomes have been in decline, and the USDA recently predicted further declines in 2018 – to levels not seen since 2006.
North of the boarder, the story has been very different. Canadian net farm cash receipts have enjoyed an 8-year run of continuous increases. Since 2013, net cash receipts have increased 27% in Canada, even as they have declined by 28% in the US.
DIFFERING FORTUNES – Canadian vs US Farm Profits (2000 = 100)
Sources: USDA – Net Farm Income; and Statistics Canada – Net Cash Receipts
It is a testament to the attractiveness of farmland as an investment asset, that US farmland values have not declined significantly since 2013, despite big declines in farm incomes. Farmers, after all, don’t react to short-term commodity price swings by selling land that is the cornerstone of their long-term business. According to USDA figures, average cropland values across the US are largely unchanged since 2014. In Canada, however, steadily increasing farm incomes have led to steadily increasing farmland values since 2014, in line with long-term historic averages of 6% to 8% per year.
Several years of belt tightening have deteriorated the balance sheets of many US farms, whereas most Canadian farms have maintained low debt levels and good liquidity. Farm Credit Canada (“FCC”) recently concluded that the “overall liquidity position of Canadian agriculture is strong”. The average current ratio (current assets divided by current liabilities) of all Canadian farmers was 3.0 in 2015 (the latest year for which figures are available), with the grain and oilseed sector especially strong at 3.6. By comparison, US farmers have experienced a decline in their current ratio from 2.87 in 2012 to 1.55 in 2016, according to FCC.
So, what explains the differing fortunes of US farmers and their Canadian cousins?
Exchange rates are a big factor. Declining corn and soy prices since 2013 coincided with a surging US dollar – a double whammy for US farmers. In Canadian dollar terms, corn and soy prices have not deteriorated to the same extent.
But beyond exchange rates there are important structural differences that have given Canadian farmers a significant advantage. Most investors don’t realize, for example, the extent to which the fortunes of US farmers are determined by just two crops – corn and soy. A stunning 55% of all US farmland – an area the size of France – is annually seeded to just those two crops. By contrast only 13% of Canadian farmland typically grows corn or soy each year in Canada. Far more Canadian farmland is used to produce crops which are not widely grown in the US, and which continue to enjoy strong demand (and prices) on world markets, such as canola and lentils. The result is a Canadian agriculture sector with a more evenly diversified mix of products that makes it better positioned to withstand declines in prices for any single crop.
Even within the corn sector Canadian farmers appear to have an economic advantage over many US producers. Using corn planting budgets and prevailing yield data from USDA and OMAFRA, we estimate Southwest Ontario corn producers have a 32% economic advantage over producers nearby in the US Mid-West, owing primarily to differences in land and input prices in local currency terms. Economic advantages like those can mean the difference between a profit and a loss when corn prices are low – like now.
Will the fortunes of Canadian and US farmers continue to diverge? In the short-term, corn and soy prices will determine the answer. But in the longer-term, Canuck farmers have some powerful structural advantages that should help them continue to prosper. Unlike most US farmers, Canadian farmers will see net benefits from a changing climate. While most US farmers are facing increasing heat and drought, Canadian farmers will benefit from more heat units, a longer growing season and access to plentiful stores of clean, renewable water. Most importantly, Canadian farmers are world leaders in sustainability. The Economist Intelligence Unit’s 2017 Sustainability Index, ranked Canada’s primary producers 2nd only to Germany, and 1st amongst the world’s major exporters. By comparison, the US ag sector ranked 19th behind the likes of China and Ethiopia. In an increasingly hot, polluted and dry world, sustainability will be the most important competitive advantage any farmer can have.
The current market environment is creating a dilemma for investors. On one hand, the economic picture remains bright: corporate earnings appear strong, unemployment is low and inflation, while rising, remains benign. On the other hand, warning signs abound:
We are in the midst of one of the longest bull markets in history: stock markets have enjoyed a 10-year upward run with few interruptions.
Stock prices, by almost any measure, are more expensive than they have been at any time in history other than just before the 2001 “Dot Com” crash.
Bond yields are rising, and interest rates are headed up (which is bad for stock prices).
Individual debts are at all-time highs and, more worryingly, margin debt (debt borrowed to buys stocks) is at unprecedented levels.
Bitcoin, blockchain and cannabis stocks are clearly in speculative bubbles.
Geo-political and international trade uncertainties abound, and (to put it mildly), the response of world leaders to any potential shock cannot be predicted.
In the last 34 years we have experienced five significant bull-market runs, four of which ended in large stock market declines or crashes. The first began in 1984 and ended on Black Monday in October 1987. The second started in 1994 and ended with the Asian Flu currency crisis in September 1998. The third began in late 1998 and ended in the Dot Com bust of 2001. The fourth started in March 2003 and ended with the Global Banking Crisis of 2008, and the fifth began in March 2009 and has continued until today, more or less uninterrupted for much of the past decade.
Just how exceptional has our current bull market been? Figure 1 provides some context. The previous 4 market cycles lasted an average of 29 months and saw the S&P 500 rise by an average of 97%. In comparison, our current bull market run has, so far, lasted an incredible 107 months and seen the S&P 500 rise by 354%
Figure 1: our current bull run is the longest in decades…
Figure 2: …and it takes a long time to recover after long bull runs
As Figure 2 indicates, it typically takes a long time to recover losses incurred in stock market crashes that have followed long bull runs. In the previous four cycles, the recovery period (ie. the length of time it took to fully recover the losses incurred from market declines) lasted 77% as long as the preceding bull market run – an average of 43 months. Recoveries from the Dot Com and Global Financial Crisis took significantly longer – 81 and 65 months respectively.
Simply put, it took between 5.5 and 6.7 years for investors to make up the losses they incurred in the previous two stock market declines.
What conclusions can we draw from these historic patterns?
We are surely in the latter stages of one of the longest bull markets in history, and the longer it goes on, the greater the risk of a significant decline.
At current equity valuations, future market gains will, almost certainly, be less than those of recent years and with interest rates increasing, bond returns are likely to decrease from recent levels as well.
As the prospect of further returns diminish, market risk is increasing – creating a poor risk/return outlook for both stocks and bonds.
Figure 3 illustrates how the current risk/return pattern has significantly changed from the past few decades. Using historic annual returns since 1990 for the S&P 500 and 10-year Treasury Bonds (all figures in US dollars without currency conversion into CAD), we estimated the stock-and-bond portfolio mix that would have produced a similar 10% total return as that generated by Canadian farmland over the same period.
During the 1990s, it was possible to replicate farmland’s 10% total return (through capital appreciation plus dividends and interest) by investing 39% of one’s assets in 10-Year Treasury Bonds and 61% in the S&P 500. Moreover, this strategy required no debt leverage and had a modest level of volatility at 11.6%
The Dot Com bust of the early 2000s created an entirely different story for investors during that decade. The only way an investor could have generated a 10% return from 2000 to 2010 would have been to put all of one’s portfolio into Treasury Bonds, lever it by 300% and buy the S&P with the proceeds of the debt leverage. No sane investor would have done this, and even if they had, they would have experienced a ridiculous level of volatility (69%).
The Goldilocks bull market run that we have experienced since 2010 changed the portfolio mix again. Declining interest rates and strong stock returns meant that an investor could have put 76% of their portfolio in Treasury Bonds and just 24% in the S&P 500 and still generated a 10% total return with a volatility of just 8.2%
Figure 3: portfolio mix required to match Canadian farmland’s long-term total return of 10%
This historic what-if analysis puts the changing risk/return environment in perspective. Looking forward, however, is trickier. 2018 consensus estimates for the S&P 500 and bond returns, suggest that, in the current environment, one would need to put 88% of their portfolio in the S&P and just 12% in bonds to generate an anticipated return of 10% in the coming year. But this assumes that we do not experience a significant market correction in 2018, and, as I have argued above, the likelihood of a significant correction occurring is increasing with each passing month. Clearly, the classic portfolio of 60% equities and 40% bonds no longer generates an attractive risk/return for investors.
So, what is a prudent investor to do? Moving to cash is the obvious option for capital preservation, but at the cost of low-or-no real returns. How can one protect their capital while still generating an acceptable long-term return?
Increased market and geo-political risks for future stock and bond returns, stand in stark contrast to the prospects for continued steady returns to owning Canadian farmland, all of the core investment themes for which remain intact:
a growing global population, significant portions of which face serious food insecurity;
a changing climate that is benefiting Canadian farmers and challenging most other food producing regions of the world;
plentiful access to water for food production in Canada while much of the world faces drought, water shortages and water quality challenges; and
Canadian farmland prices that have not increased significantly relative to Canadian farm earnings (in contrast to rising valuation metrics for public equities).
Is Bonnefield predicting an imminent market collapse? Certainly not. We are neither skilled enough nor smart enough to call a stock market top.
There is no doubt, however, that the lessons of history and the precarious risk/return profile of current markets are clear signals to investors seeking capital preservation and steady returns: now is the most important time in recent memory to rebalance away from public markets into alternatives like Canadian farmland – a proven steady performer, with low volatility and bright prospects for continued steady returns.
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