With an eye on sharply rising food demand, unpredictable weather patterns and the growing importance of biofuels, mutual fund giant Schroders is shifting its commodity portfolio away from traditional energy commodities into agricultural products such as livestock, corn, coffee and cocoa.
In January, the actively-managed Schroders Alternative Solution (AS) Commodity Fund cut its energy exposure from 41% to just under 25%, making agriculture, at 32%, its largest invested sector.
Christopher Wyke, product manager, Emerging Market Debt and Commodities for Schroders, is highly bullish on the sector for 2008. “Our biggest single exposure today is in agriculture,” he says.
Commodities – especially agricultural products – are cheap right now, he says, estimating agricultural commodities are only in year two of a bull market after nearly 20 years of bear.
Aside from short-term price factors, such as recent poor weather in China and India inflating oilseed prices, the heart of the agricultural bull is the unprecedented agricultural demand.
As developing nation diets shift from starch-heavy to protein-rich, the demand for meat and associated feeds is boosted, says Wyke. Meat consumption in Indonesia for example is just 6% of that in the US, while China’s per capita consumption is 40% of US levels and growing fast.
Furthermore, recent high grain and feed prices have led farmers to cut back on herds. “Farmers are not putting piglets in the pen, they’re selling off their breeding herds,” says Wyke. While the short-term herd sell-off will depress meat prices, longer term there will be a shortage raising prices further, he says.
Compounding the agricultural demand growth is the rapid uptake of biofuels as gasoline additive or replacement around the world. The quantities are staggering – the amount of corn needed to produce one gas tank of biofuel could meet a typical family’s corn demand for a year, says Wyke.
Finally, investment demand will further push up prices. “Most investors have had very little exposure to commodities over the last 20 years’ says Wyke, “because financial assets have done better than real assets.” But Wyke says money from both institutional and retail investors is pouring in. “Billions of dollars [invested] will help sustain the bull market,” he said.
China continues to be a driving force for commodity markets globally – for example, it uses 25% of the world’s copper, more than twice that of the larger US economy. “China is clearly growing very quickly, and has a huge influence,” says Wyke. “But it is a great mistake to think of the commodity story as the China story. If you look at the increasing use of commodities by all industrialising countries, whether it is Indonesia, India, China… the growth has been considerable.”
Only two factors could damage agriculture’s prospects, says Wyke – a spell of perfect weather for many years; and a major breakthrough in yield. “But as we’ve seen, the weather is not as reliable as it used to be,” he says. And historical yield spikes may have already exhausted the possibility of further improvements.
The growing interest of commodities as investment – right down to the retail level offered by funds such as Schroders Commodity Fund– is due in part to the excellent inflation hedge offered by these products.
Over the last year, says Wyke, investors will have seen their cost of living – fuel and food – go up while the value of their investments has likely gone down.
“But commodities are positively correlated with inflation,” he says, as opposed to bonds or equities which are negatively correlated. “War, political uncertainty, global warming, bad weather, these are all good for commodities, but bad for financial assets,” he says.
Retail investors are only recently waking up to the idea of investing in these instruments.
“When I use the words ‘commodities’ and ‘futures’ to my mother, she’ll hide her purse away,” says Wyke.
But funds such as Schroders AS products aim to make commodity future investing safe for the “man on the street”. The investment goal at Schroders is to outperform the composite benchmark with lower volatility – since its inception in October 2005, the AS Commodity Fund has returned 65% with a volatility of 12%, against the benchmark average of 25% return and 15% volatility.
“There are three ways to make money from agriculture,” concludes Wyke. “Buy farmland. Marry a farmer. Or buy our commodity fund.” And as Wyke points out, of the three options, only the fund offers the benefit of daily liquidity.