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Bill Barbour believes that an agribusiness equities fund could turn out to be a cash cow for investors…

An Interview with Bill Barbour, Director Investment Specialist, Asia Pacific & Mena, Deutsche Asset Management (Australia)

Low inventories, severe food shortages and global warming paint a bleak picture. But for investors who decide to channelise a part of their investments into agriculture, such funds could well turn out to be cash cows. Bill Barbour, for one, believes an investment in an agribusiness equities fund would enable investors to profit from rising demand as well as supply shocks.

A look at your December 2010 portfolio shows that the US corners little above 30 per cent where country-wide allocation is concerned. Do you deliberately allocate such a high proportion of your portfolio to the US?
That’s not a huge amount, it is just a third. Around two-third of the portfolio is outside the United States. And if you look at the World MSCI index, which is this fund’s benchmark, it has a 50 per cent geographical allocation to the US. That means we are actually drastically underweight.
But that is a skewed way to look at it. If you are implying that most of the business is done in the US you are wrong. If you analyse the top 10 stocks, you will see that many may be listed in the US but their business revenue comes from various markets, which substantially includes emerging markets. For instance, Archer Daniels Midland Co. and Bunge Ltd., both global supply chain managers, are top holdings listed in the US. We also had companies like McDonalds, which are US listed, but are growing quickly in emerging markets as well. On the other hand, we do have others like Safeway Inc. and SUPERVALU Inc. which are more domestically focused US companies.
We presently invest in 32 countries, out of which 14 are from the developing world. We do not currently have any holding in India because the Indian agri-business market does not have much to offer by way of listed companies. Besides a few sugar companies, Jain Irrigation and Mahindra & Mahindra, there are few other stocks to invest in as most of India’s agribusiness sector is privately owned or are co-operatives like Amul. So a fund such as ours offers Indian investors the opportunity to invest in this large global industry which they cannot do so in India.

You invest in food production companies and go right up the value chain to consumption. Do you invest in farmland?
We do not directly invest in land. This is an equity fund. However, indirectly we do have exposure to land. For instance, one of our top 10 holdings is SLC Agricola S/A which is a Brazilian company that owns mixed farm land across approximately 250,000 hectares in Brazil.

How is your portfolio constructed? Do you have specific weights assigned to various subsectors like bio fuels, seeds and fertilisers, equipment manufacturing or aquaculture?
No. We define global agri-business as virtually everything from soft commodities to the consumer end product. We look at the entire supply chain. But the portfolio of around 100 shares is company specific. The geographical allocation, the sector allocation and the sub-sectors within it are all residual of the upside potential of the companies. We currently invest in 32 countries and 28 different sub-industries.
We start with around a thousand companies distributed all across the globe. We then eliminate some based on market cap; we normally do not invest in companies which have a market cap below $200 million. Then we cull it down based on various parameters like corporate governance, the amount of debt on the books, sustainability issues, political issues in the country where it is listed and also if there is a dominant family interest in the company which oppresses the rights of the other shareholders. And this does happen in some developing markets. Based on these guidelines, the list of 1,000 companies comes down to around 550 which the investment team thoroughly analyses. Then we look at the upside potential over the next few years. We also stress test the portfolio for about 70 different factors that include commodity prices, currencies, interest rates and the price of crude oil.
Companies that are impacted negatively by several of these factors or influences get their upside target downgraded. We use a form of optimisation to create the portfolio so companies with the most upside, after risk control, get the biggest weights. Once the company approaches that target we sell it and replace it with another company that has more upside. That is what constitutes the buy-sell decision.

The Covalence Ethical Index, brought out by a Swiss research firm, listed the 12 least ethical companies last year. Two that featured make an appearance in your portfolio. Monsanto was the worst and Syngenta was eighth in the list. Do you take such ethical views into account?
This is not primarily an ethics fund or a socially responsible fund. But we do take sustainability into account.
Let’s take a step back. India has had issues with Monsanto, the BT Brinjal issue. This was the vegetable brinjal which had been modified and apparently did not require pesticide. Naturally it would hurt certain parties which would lobby against such a development.
Monsanto is the No. 1 company in the world in terms of seeds. We have to get yields up or we are going to starve. India had a Green Revolution in the 50s and 60s, but like many countries, has not kept up in terms of investment and further productivity and development. Much of the world is underinvested in agriculture and the developing world is severely underinvested. According to the United Nations, in order to feed the world by 2050 we need to spend $9.2 trillion. This would work out to roughly $210 billion per year and we are currently only spending around $120 million.
According to the United Nations, if we stick with the current yields from arable land, we would require 750 million extra hectares of land to feed the world in 35 years time. This land does not exist. The total agricultural land on the planet is 1.5 billion hectares. To increase the agricultural land to the required extent we would need to destroy lowland rain and temperate forests which would be an ecological disaster. So clearly we need to get much more from the existing land. It is companies like Monsanto and Syngenta, which have the intellectual property and research backing them that can make a difference and help deliver the necessary yield gains.
In the case of Monsanto, the farmers have to keep buying the seed from the company so there are issues like that which also raked up a controversy. But the seeds were much more high yielding than the normal ones. In the US the farmers had to legally sign agreements when buying seeds from Monsanto and agree not to keep back seeds from Monsanto grown crops for replanting for the next crop. If farmers violated the agreement the company took them to court.
But these technologies are essential to feed the world or else we are looking at starvation.

Who is the target investor of this fund in India? It would not be recommended to, say, a retired individual or someone with a low risk profile who would be better off with a stable equity diversified offering and not a thematic one.
There is no such thing as a stable diversified equity fund. They are all going to be volatile and go up and down, depending on the market.

I am referring to the degree of volatility. That of a thematic offering is much higher.
A thematic fund is not necessarily more volatile than a “normal” equity fund. There is risk and return. If you take no risk, you get no return. This fund has the potential to provide superior rates of growth over the next few years compared to the MSCI World Index. As on January 31, 2011, the 6-month return was 19.96 per cent and the return since inception, which was April 2010 in India, was 21.55 per cent as compared to its benchmark the MSCI World Index which delivered returns of 15.81 per cent and 19.59 per cent respectively, in the same period.
In most countries around the world people have around 20-30 per cent of their portfolio in global shares. They do not invest only in their home economy. India is behind in this trend of thought and is now only beginning to understand that diversification is a good thing. Sure the Indian market has historically outperformed but it will not be the best performing market every single year. No tree grows to the sky.
We believe that this fund can outperform the World MSCI index over the next five years given the tailwinds of the industry and the companies that we have invested in. This fund could be used as a subset of an investor’s international share allocation.

How do you see the fund performing this year? Did the extreme winter in the Northern Hemisphere give it a bad start?
The late planting will certainly affect commodity prices which in turn will affect the fund. Late planting will result in lower yields.
Last year we had many of such supply shocks: typhoons in the Philippines resulting in a loss of 2.5 million tonnes of rice, droughts in Russia and Ukraine around the Black Sea, then there were the bad monsoons in Punjab, floods in Pakistan, droughts in Brazil, Argentina, Paraguay and Uruguay. Recently we have had floods in Australia, from the highest rainfall recorded there in 200 years. All this has resulted in a huge rise in commodity prices.
We are faced with global warming and climate change, so such supply shocks may be frequent. Commodity prices and food prices are definitely going to rise. It won’t be sudden but more gradual. Food prices will gradually move upwards over the next 40 years, though there will be such supply shocks along the way which will create price volatility, as we have seen last year.

Don’t these supply shocks make the fund volatile?
They could. While they are uncontrollable, one can expect them. As I mentioned earlier, we invest across the entire universe of agri-business, upstream and downstream. When commodity prices are high, the resource owners like farmers and fertiliser companies are happy. But when commodity prices are high, the price of raw materials goes up and margins of some manufacturers get squeezed. So we decide whether to move downstream or upstream to reduce volatility.
In 2009, for instance, we had a negative view on corn, soy and wheat but a positive view on sugar. So upstream we only exposed ourselves to sugar companies and moved downstream, which benefited the fund.

Jim Rogers commented that inventories are at their lowest in decades and there will be severe food shortages in the next few years.
Grain inventories have fallen. We have gone from having 200 days supply to 30-40 and even 20 days supply for some grains. So we are consuming more than we are producing and this is going to get worse.
There is a soaring global population which means more mouths to feed while the agricultural land stays limited. Moreover, land is being used to produce bio-fuels which compete with food production.
If you earn less than $1,000/annum, you spend all of it on food and shelter. But as incomes rise in the developing world, the first thing people do is buy more and better quality food. This is the main driver of rising food demand as nearly half the world’s population moved from very low incomes. In much of the world diets are changing to more protein and away from cereals like rice and wheat. It would appear logical that this should free up demand for cereals but his does not happen because it requires even more cereal to produce the meat protein.
To illustrate this change, China has moved from an exporter of soybeans a decade ago to an importer of that product. Last year, China’s volume of imports of corn by May was equal to the entire import of 2009. This year, the corn demand is almost insatiable because it is being used as animal feed as demand for protein in China continues to increase.

What is the solution?
We have to get yield up from existing land or else we cannot feed the people.
The economist Malthus predicted 200 years ago that people would starve when the global population reached 600 million. That did not happen because we have always managed to increase the yield and the amount of farm land. But there is a huge gap which is growing significantly and posing to be a big challenge.
The seed companies and the companies producing sustainable fertilisers and pesticides are all helping bring effective remedies. Other gains can come from laser leveling fields so that water is optimally utilised. Monsanto is aiming at developing seeds over the next decade that have higher yields and utilise 50 per cent less water than currently. This is critical because due to global warming we are going to have more arid agricultural land. So if you can achieve higher yield using half the amount of water, that would help. It would also mean that more arid land may be turned into agricultural land.
It may also help if there was less speculative trading of soft commodities. Governments have a role to play by not putting export bans on food products which usually leads to immediate global price increases which hurts the world’s poor and starving. The Food and Agriculture Organisation last week issued a statement that pleaded with governments to stop using export bans.