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Harvesting Gains From Global Crop Investments

As with many sectors, global agriculture can offer investors everything from a risky ride in pure plays that pin all hopes on a single crop or country, or a broader strategy that depends on multiple factors.

Recent headlines have borne out just a few of the risks inherent in the sector: China only just reopened its live poultry markets at the beginning of May after a three-month shutdown because of fears of the spread of avian flu. Livestock and meat prices have soared, influenced in part by a virus deadly to pigs that has shut down imports of U.S. pork products to countries from Mexico to France to Uzbekistan and in part by a global shortage of beef. Dairy prices, too, are on the rise around the world, and futures for global cattle and dairy products have hit records as demand outstrips supply.

Prices for commodities including sugar and soybeans are increasing, while wheat—first affected by fears of scarcity because of the turmoil in Ukraine, and now expected to give strong yields thanks to favorable weather reports—has seesawed. The price of coffee, beset by drought and disease in Brazil and Central America, has taken off, while cocoa beans in Ivory Coast and Ghana, which have already seen demand surpass supply in the chocolate industry, are under threat—not so much from weather conditions or pests, but from gold mining that threatens the very farmland on which they’re grown.

Then there are the predictions about El Niño and its potential effects this year on everything from cocoa beans in Africa to sugar in India, rice in Asia and wheat in Australia. What’s an investor to do?

Options available for those looking for sector exposure globally can take a number of different directions. There are global ETFs that have a broader focus than just crops—offering, for instance, exposure to chemical and farm implement companies, seed companies, food processors and/or large-cap firms that are involved in multiple areas within the sector. Several ETFs fit that category, such as iShares’ VEGI and COW, PowerShares’ PAGG or Van Eck’s MOO.

Then there’s the opposite approach taken by some ETFs and ETNs, which seek out pure-play investments or futures contracts in such things as coffee (iPath’s CAFE) or cocoa beans (iPath’s NIB or CHOC), sugar (iPath’s SGG or SGAR, Teucrium’s CANE), or livestock (UBS E-Tracs’ UBC, iPath’s LSTK).

Further there’s the middle-ground approach to the agribusiness sector taken by IndexIQ’s CROP, which narrows the focus a bit and predominantly seeks out smaller companies that concentrate on crops and/or farmland.

According to Adam Patti, IndexIQ’s CEO, CROP’s “construction is very simple. We look at the bottom 10% of market cap globally in SIC codes that tie directly to agribusiness, and we weed out those companies that are too small or don’t trade a lot. We end up with a portfolio of about 50 or so firms that are interesting companies in agribusiness.”

Pure play agribusiness, Patti said, is under bought by investors because it’s relatively scarce compared with other investable products. He said a couple of benefits to that. Constructing the portfolio out of small-cap firms can pay off, he said, because such agricultural firms aren’t being bought a lot by investors. Not only that, those firms that are “most attractive as merger and acquisition targets are the larger agribusiness firms in the world”—which, once they’ve been gobbled up by a larger firm, must leave the small-cap index.

Another advantage he cited is the specialization available through such small-cap firms. “Unless you’re really a dedicated stock picker in agri global securities, you’re not likely to get a standalone palm oil firm in Indonesia,” Patti said. In addition, CROP is more heavily weighted toward farmland and crop production rather than chemical firms, at 51%. MOO  is the opposite. “Farmland is probably the most interesting segment of the market,” he said, adding that it is becoming increasingly scarce in places like China, where cities are growing on land that once produced crops.

Patti said all those weather events hitting crops globally as pushing agricultural commodity prices higher. “That’s on the supply side. On the demand side, there’s the growing [world] population. Emerging market nations that typically were eating very simple crops are becoming wealthier, [developing] a more sophisticated palate and [increasing demand for those] food[s]. It’s a pretty dire supply and demand equation. It’s a long-term trend that investors should be aware of,” he said.

Patti also said that because the companies in CROP are smaller, though not small—they tend to have market caps of an average of $1.2 billion–$1.4 billion—they are less likely to be bought up by investors, who, when interested in a sector, “tend to all buy the same typically large companies.” That means that fund float can expand volatility when the companies are larger.

“Fund float, going in, extends valuations and extends volatility,” he said. “When [funds flow] out, it increases volatility on the down side. Small cap is typically 30% cheaper on price to book, and volatility is similar to large cap because fund flows don’t push the securities around.”

In addition, funds holding large-cap firms will have a much higher correlation within the sector, and not provide the diversification investors are looking for. “Twenty years ago they were more diversified. Now you have to look for smaller hidden gems.”

CROP has a sizeable focus on Asia in its country weightings, with Japan being the largest at 33%. Hong Kong, China, Indonesia, Singapore, Thailand and Australia boost the fund’s concentration in that part of the world, but there are also holdings in the U.S., Canada, Ireland, Spain, the Netherlands and the U.K.

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