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Food is a great asset, minus the fund manager

Food is a great asset, minus the fund manager
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First Published: Thu, Feb 21 2008. 12 12 AM IST
Updated: Thu, Feb 21 2008. 12 12 AM IST
Investors can’t afford to ignore food. As a hedge against a possible US recession, and direct exposure to rising urbanization and wealth in Asia, it’s an asset class that’s tailor-made for the present times.
As Jim Rogers of New York-based investment firm Rogers Holdings puts it, “If you’re in agriculture, you don’t know that there is a recession, you don’t care.”
That may be as true for investors in agricultural commodities as it is for farmers, provided the former don’t rely on the expertise of fund managers to beat the futures markets.
The worldwide boom in agricultural commodities, fuelled partly by the growing use of food crops as alternative fuel and partly by soaring Asian demand, is proving to be a hard nut for professional money managers to crack.
According to a report last week by Merrill Lynch and Co. commodity strategist Francisco Blanch and other analysts, many of the actively managed funds focused on agriculture are failing to outperform gauges such as the S&P GSCI Agriculture and Livestock Total Return Index, which, when tracked passively, returned an impressive 28% last year.
By comparison, the Barclay BTOP50 Index, which monitors the performance of the largest traders, gained 8% in 2007.
“The promise of generating total returns by investing in agricultural commodity-related instruments has up to now failed to significantly differentiate from passive rule-based indices,” the Merrill analysts noted. “Fund managers are likely to find increasing competition from low-cost, rule-based investment strategies.”
Active versus passive
For now, money is rushing towards a perception of competence, regardless of eventual performance.
The “managed futures” business already has about $190 billion (Rs7.5 trillion) under supervision, almost a fourfold gain since the beginning of 2003, according to Fairfield, Iowa-based Barclay Hedge, which researches the industry.
But where is the compensation for investors for hiring the skilled fund managers, paying them hefty management charges (1.5% of capital) and performance fees (a 20% cut of profits)? Relatively inexpensive exchange-traded funds, which even retail investors can access, seem to be making more money.
The PowerShares DB Agriculture Fund, which tracks a Deutsche Bank AG index, gained 32% last year. Such bumper returns are only to be expected. Global food inventories are running thin. The amount of wheat, rice, corn, barley and other grains stored at warehouses around the world is enough to meet less than 60 days of global demand, a 35-year low, according to Merrill’s analysis.
High returns
Shortages are also emerging in the supplies of soya beans, palm oil and other oilseeds. Slaughter rates are rising as cattle-feed prices soar.
All this should mean tidy profits for those investing in agricultural commodity futures, provided they have the appetite for the higher risk of price volatility that’s often seen in commodities where the stockpiles are small.
Gary Gorton, a University of Pennsylvania finance professor, recently demonstrated that inventories play a significant role in determining returns on commodity futures.
Gorton and his colleagues studied the performance of futures contracts on 31 commodities from 1969 through 2006, grouping them in portfolios of lower-than-normal and higher-than-usual inventories; the former returned more than 13% annually, while the gains from the latter were less than 5%.
‘Chindia’ effect
Eventually, food supplies will rise to match the present elevated levels of demand. But it may take time because of the “Chindia” effect.
Millions of Chinese and Indian households are becoming a little more prosperous every year, and demand for protein is very income-sensitive.
That’s bound to put further pressure on stretched food supplies. Investors have a chance to profit from agricultural commodities because their prices are still “relatively low,” Marc Faber, the Hong Kong-based investor and publisher of the Gloom, Boom and Doom report, said earlier this month.
To extract the excess returns for agricultural commodities, investors may have to bypass the active fund manager and find an exchange-traded fund that tracks an index passively.
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First Published: Thu, Feb 21 2008. 12 12 AM IST