AgIS Newsletter 101117 - · PDF fileMarket Retrospective 1 Volume II • Fourth Quarter...

MarketRetrospective

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VolumeII•FourthQuarter2017

©2017AgISCapitalLLCAllRightsReservedagiscapital.com

ReflectionsofanAssetClassPioneerAsapioneerinagriculturalinvestingforinstitutionalinvestors,JeffConradhasauniqueperspectiveonthegrowthandevolutionofthefarmlandassetclass.Whatfollowsareexcerptsfromaninterviewherecentlygaveonthetopic.

Q:Jeff,whatdoyouremembermostabouttheearlydaysoftheassetclassandhowitwasperceivedbyinvestors?

A:Icameintothesectorinthelate1980sonthelendingsideforJohnHancock.Even-tually,however,Iconvincedthecompanytoallowmetolaunchaninvestmentmanage-mentunit,theHancockAgriculturalInvestmentGroup,whichwouldmakeequityinvest-mentsinfarmlandforlargeinstitutionalinvestors.

Hancockhadsponsoredsomefarmlandequityopportunitiesforinstitutionalclientspriortomydirectinvolvement,but,thecompanyhadnotmadearealcommitmenttobuildingandmarketingadedicatedcapability.Ifeltthiswastheonlywayitcouldbesuccessfulinthesectorsotherewasarealfocusonevangelizingfortheassetclass—bothinternallyandexternally. Thishappenedrightontheheelsofthe“FarmCrisis”andIhavesome“interesting,”somemightevencallthempainful,memoriesofgivingpresentationsandmakingpitchestoprospectiveclientsduringthatperiod.

Then…andNow.Ontheleft,Jeffasa15-yearoldworkingonhisfamily’sdairyfarminPennsylvania.Ontheright,Jeffmowingpasturesononeofhisfarmpropertiesin2017.

AboutJeffConrad

Jeff Conrad, CFA, is the head of AgISCapitalLLC.Hewasformerlypresidentofthe Hancock Agricultural InvestmentGroup,whichhefoundedin1990.Jeffhasbeeninvolvedinfarminghisentirelifeandhasbeena recognized thought-leader inthefarmlandandagriculturalinvestmentsectorsince1987.

During his tenure with the HancockAgricultural Investment Group, Jeff builtthe organization, which eventually con-trolled more than $2 billion of invest-mentsandcapitalgloballyforanarrayoflarge institutional investors. He retiredfromthefirmin2011andlaunchedAgISCapitalLLCin2013.Sincethen,heandhiscolleaguesatAgIShaveraisednearly$1billionmoreincommitmentsfromsophis-ticatedinstitutionalclients.Together,theAgISteamisconstructingportfoliosofag-ricultural production and processing as-setsforclientsusinganopportunistic in-vestmentstrategy.

JeffwasbornandraisedonadairyfarminPennsylvania,wherehestillownscropandtimberproperties.HeisagraduateofPennStateUniversityandCornellUniver-sity, where he studied agricultural busi-ness management and agricultural eco-nomics.In1995,heco-chairedthedevel-opment of the NCREIF Farmland Index.Inadditiontohisfarmlandinvestmentex-perience,Jeffhasmorethanadecadeofexperience serving on the investmentcommittees of a multi-billion pensionfunds and foundations. The insights hehasgainedfrom“sittingonbothsidesofthe table” have provided him with aunique perspective on the role agricul-tural investments can play in an institu-tionalportfolio.

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ReflectionsofanAssetClassPioneer•VolumeII•FourthQuarter2017

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Truthfully, in theearly1990s, investorsand their consultantswouldpracticallyslamtheirdoorsinmyface.Iheardoverandoveragainabouthowfriendsorfamilymembershadlosttheirfarmsduringthe“FarmCrisis”—andifa“smart,hard-workingguylikeUncleBobgotburned,howcouldanyonemakemoneybyinvestingintheassetclass?”

Thosewho didn't have direct, personal experiences like thathadinevitablyreadstoriesinTheWallStreetJournalabouthowfarmershadbeen ruinedbydebt, risingoperating costs, andfallingcommoditypricesduringtheearlyandmid-1980s.

In lightofall thisnegativity, gettinganyone interested in theasset classwasanexercise inperseverance. Strangely,how-ever,thatsuitedmeverywellbecauseIamafarmer,too,andwearealloptimisticandstubbornbynature!

Sincethattime,ithasbeengreattoseetheassetclassgrow.Italsohasbeengratifyingtoseemanyofthoseinvestorswhorec-ognizedtheopportunities itwasofferingprosperandbenefitfromtheirearlyinvolvementinit.I’malsoproudofthesustain-ablefarmingmethodswehelpedtointroducewithourinvest-mentprograms—andhowourdevelopmentactivities(plant-ingoftreesandvines)haveincreasedemploymentopportuni-tiesandthetaxbasesforthemany localcommunitieswherewehavebeenactive.Intheprocess,I'dliketothinkwehavelearnedsomeinvaluablelessons.

Q:Likewhat?

A:Well,overtheyears,I'veheardseveralprivatemarketman-agerswhoareactiveinagriculture,timberlandandotherhardassetsectorsbegintheirpresentationsbyindicatingthattheirassetclassis“special”or“unique,”asifitweresomehowlesssusceptibletocompetitiveforces.Forsomereason,thisispar-ticularlytrueinthefarmlandspace.

Allassetclasseshavedifferentriskandreturncharacteristics,butnoneofthemare“special”or“unique”enoughthattheycan’texperiencemajordownturns.Thisnarrativeoftenreflectsa rear-viewmirrorperspectiveofhowone typeofassetper-formedoveracertainperiod.Itdoesnotdemonstratearecog-nitionofhowtheassetclasswillperformgoingforwardunderanevolvingsetofeconomiccircumstances,whichisessentialtohaveifoneistoreallyunderstandhowaparticularassetclasswillenhancetheperformanceofaninvestor'sbroaderportfo-lio.Frankly,Ihavetoadmit,Iusedthissamenarrativeearlyinmycareer.

Farmlandprovidessomeveryattractivebenefits,suchascom-pelling, risk-adjusted returns and portfolio diversification. Itcan also help hedge inflation. But other asset classes havetheseandstillotherattractivefeaturesaswell.Sowhatdoesthatmeanfromtheperspectiveofan institutional investor?Ithinkitmeans,“I'mhappytohaveyoueducatemeaboutthecharacteristicsofyourassetclass,butpleasedon’tinsultmyin-telligencebytellingmeyoursectorisspecialorunique.ItisjustdifferentfromtheassetclassI'mgoingtohearaboutinanotherpresentation from another investment manager 45 minutesfromnow.”

“I’m proud of the sustainable farming methods we helped

to introduce with our investment program.”

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ReflectionsofanAssetClassPioneer•VolumeII•FourthQuarter2017

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Q:So,lookingatfarmland,inparticular,whatisthebestway to explain its characteristics and benefits to a pro-spectiveinvestor?

A:Itellinvestorsandprospectiveclientsthatcomparingandcontrastingfarmlandtootherassetcategoriesandunderstand-ingitsspecificvaluedriversisessential.Farmlandlooksandbe-havessimilarlytotimberlandandcommercialrealestate,butitmay provide stronger current income than these other assetclasses.Fromacapitalplacementstandpoint,individualfarm-landinvestmentsalsotendtobesmallerthanthosecommonlyseeninthetimberlandandrealestatesectors—andthiscanmeanthatitmaytakelongertofullyinvestanallocation.

Itrytoemphasizethatfarmlandisanadaptableandflexibleas-set class that canbeused toaddressa varietyof investmentneedsforaclient. For instance, ifan investorneedscurrentincomeandhasamoderateriskprofile,attainingexposuretomaturepermanentcrops,likeestablishedwinegrapevineyardsand nut orchards,may be an attractive investment strategy.However,aninvestorthathasastrongerappetiteforriskandisinterestedinsignificant,long-termcapitalappreciationmayfind “greenfield” permanent crop development investmentsmoreappealing. Theseentailplantingtreesorvinesthatwillincreaseinvalueastheymaturebiologically.

Q:Talkingaboutrisk,whataboutcommodityrisk?Thatseemstobeanareaofemphasisforalotofinvestorsthatarelookingatfarmlandandagriculture.

A:Itisimportanttounderstandthatcommoditypricestendto be cyclical around long-term trends and that asset pricesdon'talwaysbehaveaccordinglyinthenearterm.

Irecentlyattendedawell-regardedagriculturalinvestmentcon-ferenceafterhavinghadlittleconferenceexposureforafewyearsandIwasstruckbyhowtheinvestmentmanagerswhowerepre-sentingwereessentiallyusingthesamepitchforfarmlandthatI

used20yearsago.Basedonthedataandanalysestheyprovided,itsoundedlikethisfarmlandstuffwasa“surebet.”Theywereallemphasizing positive, long-term fundamentals like populationgrowth,acceleratingincomelevelsandimprovingdietsinthede-velopingworldtosubstantiatetheirfarmlandinvestmenttheses.Thetakeawayforanyonesittingintheaudiencewasthatfarm-landwasalmostguaranteedtobeawinner. However, it is im-portanttorecognizethatthesesamefundamentalshavebeeninplaceformorethan30yearsandthattheydon'tassuresuccessforanyonewhoparticipatesintheassetclass.Thefactthatlong-term fundamentals are favorabledoesn’tmeanyou can’t haveshort–termcyclesinwhichfarmlandpricesarebiduptothepointwhereinvestorscannolongerattaintheirrequiredreturns.Con-versely, compelling long-term fundamentals do not precludefarmlandpricesfromfalling.Agoodexampleofthisiswhatweareseeingrightnowintherowcropsector,wherevalueshavebeen falling for some timebecause land valuationshadgottenwayaheadofincomeandearningsfundamentals.We'reconfi-dentthattherowcropsectoreventuallywilladjustandthatvalu-ationswillreboundasfarmearningsandincomelevelsbegintogrowagain.Meanwhile,however,thisscenarioprovidesareallygoodillustrationofwhatIwasjusttalkingabout.Youcan'tplacetoomuchstock inthe importanceof long-termcommodityriskfundamentalswhenassessingthefarmlandassetclass—oreventheattractivenessofaparticularinvestmentopportunity.

Q:WhatisyourviewoftheNCREIFFarmlandIndex?Isitanaccurateandreliablebenchmark?

A:TheNCREIFFarmlandIndexisn'tperfect,butitisasoundmeasurement tool and the best barometer we have for as-sessinghowtheassetclassandthemanagersinvolvedinithaveperformed.I'dsaymybiggestfrustrationanddisappointmentisnotwiththeindexitself,butwithhowitisused.

“Comparing and contrasting farmland to other asset

categories and understanding its specific value drivers is essential.”

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Intheearlydaysofeducatingthemarketplaceaboutfarmland,I got significant feedback about the asset class not having abenchmark.Irememberonemeetingwithalarge,publicpen-sion fund executive who was seriously considering investingwithus,buthewasconcernedabouthowhewouldmeasureourperformance.Irecallhimsaying:“Ifyouproduceatenper-centreturnforme,isthatagoodreturn?CouldIdoevenbetterbyinvestingwithoneofyourcompetitors?”Icouldn'tanswerhisquestionsandthistypeoffeedbackmadeitcleartomeandothersinthesectorthatweneededtocreateacrediblebench-mark.Asaresult,in1995Ico-chairedthedevelopmentoftheNCREIFFarmlandIndex.Myhopewasthatitwouldfostercon-fidenceintheassetclassandthoseinvolvedinit.FromwhereIsit,ithashelpeddothat.Itcurrentlyconsistsofdatafrom743propertiesthathaveatotalmarketvaluationofnearly$8billion(asof12/31/16),soitoffersagoodrepresentationofU.S.farm-landperformance.Withthegrowthoftheassetclass,NCREIFalsonowoffers sub-indexes that capture theperformanceofpropertytypes—specificallyannualrowcrops(corn,soybeans,etc.) andperennialpermanent crops (trees, vines, etc.)—aswellascommoditytypes(almonds,walnuts,etc.)—andman-agementstyles(leasedordirectlyoperated).

A valid criticism of the index is that it is appraisal based.Over time many managers have shifted to more frequentexternal valuations with most reporting annual third-partyvaluations.Clearly, thishasmadethe indexmorerobust,butwehave to recognize that it isaprivatemarket toolandwillneverhavetheimmediacyandcomprehensivenessofapublicmarketindex.

Gettingbacktomyoriginalpoint,however,mygreatestsourceof frustrationwith the index has been how it is used by thefarmland investmentmanagementcommunity. Managersei-ther don’t have the resources to use it effectively or theychoosenottoforcompetitivereasons.Overtheyears,Ihaveseenmanypitchbooksandperformance reportsof farmlandmanagersand I’malwaysstruckbythefrequencywithwhichtheyprovidestaleinformationanddonotuseadequatefoot-noting. Some also tend to select inappropriate sub-index

benchmarksagainstwhichtogaugetheirperformance.Forin-stance,I'veseenmanagerscomparetheperformanceofarowcroplandportfolioagainsttheperformanceofthetotalFarm-landIndex,whichisclearlylikecomparingapplestooranges.Ihavealsoseenmanagersuseimproperregionaldatasetsandirrelevantmanagementstylemetrics(leasevs.directlyoperate)tomake the case that their performance has been superior.Anymanagershouldbeabletodevelopcustomizedindicesthatgive investors an accurate view of their investment perfor-mance.Thiscanbedonesimplybyre-weightingthecrop-typemix (row vs. permanent) and operating style designations(leasedvs.operated).

Allthatbeingsaid,Ialsothinkfarmlandinvestorsandtheircon-sultantshaveadutytobeinvolvedwiththedevelopmentanduseoftheindex.Ioftenhearinvestorslamentthefactthattheycan'tgetanaccuratepictureoftheperformanceoftheirinvest-mentmanagersbecauseeveryoneshowsthemdatathatsug-geststheyhaveoutperformedtheindex.Thesurestwaytode-bunkthatmythisforinvestorsandtheirconsultantstobecomemoreknowledgeableabouttheindexandinvolvedinitsevolu-tion.Ibelievethatistheonlywaytoensurethatmanagersarenotinappropriatelymanipulatinghowtheindex'sdataisbeingusedandrepresentedtoenhancetheirprospectsofattractingandkeepingbusiness.

“Farmland investors and their consultants have a duty

to be involved with the development and use

of the index.”

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ReflectionsofanAssetClassPioneer•VolumeII•FourthQuarter2017

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Q:Arethereanyothercompetitivemythsthatyouthinkneedtobeexposed?

A:Yes.Imightcharacterizeoneofthemthisway:Afarmlandwhitepaperisnotaninvestmentstrategyorevidenceofone'sabilitytodevelopandoperateacrediblefarmlandinvestmentprogram. I have been around for a long time and it is verysatisfyingtowatchtheassetclassgrowandmature.Italsohasbeen interesting to watch new managers enter the spacebecausemanyarepushingtheboundarieswithmorecomplexandsophisticatedstrategiesandapproaches.Thedownsideofthisgrowth,however, is that the farmland investment sectorhasattractedopportunistswholacktheknowledge,skillsandexperience one needs to be successful in this space.Many slick Power Point presentations have been developedwithlittlethoughttothemoremundane,butgreatlyrequiredskills, of how to effectively acquire and actuallymange farmassets.Thesepresentations,andthemanagementteamsthatusethemtomarketthemselves,extolthevirtuesofincludingfarmlandinaportfoliobasedonattractivefundamentals,butthey often fail to highlight the critical acquisition and assetmanagement phases of an investment strategy. Those twophases of the investment process will make or break anyfarmlandinvestment.

There is nothing glamorous about doing a "frost watch" todecidewhetheritisnecessarytoturnonthewindmachinestoprotect a vineyard's newly-planted vines— or whether it isnecessary to irrigate a tract of soybeans on a particular day.Thesearethetypesofground-leveldecisionsthathavetobemadeeverydayforafarmlandinvestmenttobesuccessful—and they are decisions that can only be made by a teamofknowledgeableprofessionalswhohaveexperiencemanag-inglarge-scale,high-valueagriculturalassets.Theslickpresen-tationmightresultinamanagerreceivinganinvestmentallo-cation,butthatclient'sultimatesuccesswillbedeterminedbythe manager's ability to source, analyze and price attractiveinvestment opportunities; to develop and implement soundmanagement plans; and finally, to liquidate assets. In otherwords,itisnotthesizzlebutthesubstancethatwinsthedayinthisassetclass.

Q:OK…Lastquestion.Whatisoneofthebiggestmiscon-ceptions investors have about the farmland asset classandhowdoyouaddressit?

A:Imentionedthisearlier,butIwouldsayitisthesizeofsomeoftheinvestmentsthatarebeingmadeontheirbehalf.

Someinvestorsareverysurprisedtolearnthenumberoftrans-actionsthatmightberequiredtofullyinvestalargeallocation.Comparedtotimberlandorcommercialrealestate,theunitsofinvestment in this asset class tend to bemuch smaller. Formanyyears, timberlandandrealestate investmentmanagersbuiltlargeportfoliosfortheirclientsbysnappingupindividualassetsorentireportfoliosvaluedathundredsofmillionsofdol-lars—andinsomecase,evenbillionsofdollars.Withtheex-ceptionofafewrecentportfolioofferings,itisextremelyraretoseeaninvestmentinagriculturethatexceeds$100millioninsize.Infact,basedontheNCREIFFarmlandIndexdata,theav-eragefarmlandassetisvaluedatslightlymorethan$10million.Consequently, the time it can take to build a large farmlandportfoliobyaggregatingacollectionofsmaller-scale,diversifiedassets has led some institutional investors to view the assetclassasunattractive.Clearly,ittakeshardworkandpatiencetosuccessfullyconstructsuchaportfolio,but Ihavebeen in-volvedinassemblingseveralfarmlandseparateaccountsthatarenowmore than20-years-old—and the clientswhoownthem are still smiling because of the performance they haveproduced.Whenthisissuecomesupwithaprospectiveclient,Ialways liketosaytothem:“Well, ifthiswaseasy,everyonewouldbedoingit!”

“A farmland white paper is not an investment strategy...”

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ReflectionsofanAssetClassPioneer•VolumeII•FourthQuarter2017

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ContactAgISCapitalLLC

745BoylstonStreet,Suite207Boston,Massachusetts02116

617-350-9891agiscapital.com

FormoreinformationontheinvestmentservicesofferedbyAgISCapitalLLC,pleasecontact:JeffreyA.Conrad,CFA,PresidentandFounder

617-350-9891jconrad@agiscapital.com

Disclaimer:Ourbeliefoffuturemarketperformanceisbasedonexpectationsthatmayormaynotcometrue.

Investorsshouldperformtheirownduediligencebeforeundertakingfarmlandinvestments.

ThismaterialiscopyrightedbyAgISCapitalLLCandcannotbeduplicatedorusedforanypurposewithoutpriorapprovalfromAgISCapitalLLC.

©2017AgISCapitalLLCAllRightsReserved