by Oliver Hanke - CIO for Market Magazine
December 29, 2016 - Time and again it has been proven: to drive change in an industry, it requires the power of the markets. Whilst for years it has been clear that mankind will somehow need to grow 50% more food to feed the 9 billion people expected to live on our planet in 2050, it is much less clear how this can be achieved. Hence, considering its fundamental importance to everyone’s daily live, the lack of attention paid to agriculture by investors was somewhat surprising.
This has changed in recent years and climate-smart agriculture is gaining momentum as an investment. Most investors have realized that the post-crisis investment environment has led to paradigm changes and have sought to rebalance their portfolios; of great interest are real assets that are broadly non- correlated with traditional assets such as food, energy and water, as well as of course infrastructure, real estate and precious metals.
Investors are betting farmland will yield good long-term returns as global food demand rises with growing populations and wealth in Asia, Africa and elsewhere. The amount of arable land is expected to increase only modestly, at best, due to urbanization and a lack of acreage suitable for crops. Farmland also generates steady income, leading some to call it “gold with a coupon”.
But there are crucial aspects to be considered when it comes to the way how an investment in agriculture is conducted and the environmental and social impacts of an investment in farmland can be fundamentally beneficial to local communities or have disastrous effects from extensive monocultures that do not leave room for wildlife, degrade soils and leave local workers earning effectively less than minimum wages and labouring under harsh working conditions.
Reality is that more than 500 million family-owned farms are responsible for roughly 60% of the world’s food production. Major food producers are waking up to the fact that change needs to happen there as their production relies on the smallholders to secure their supply chain and that more and more consumers demand certified and organic products.
Socially and environmentally responsible investors have taken a lead and demonstrate in many innovative projects around the world that investments in agriculture and forestry can be commercially attractive whilst improving the livelihoods of local smallholder farmers - offering new sources of income and increasing climate resilience. Making these models work commercially though often is a challenge as they typically lack scale and involve complex interaction with many stakeholders. Lack of scale is frequently cited as a key obstacle for impact investments to take off.
For all of this the cocoa industry is a perfect example. This is a USD 100 billion industry but since the early first half of the 20th Century there had been little new investment in cocoa production. More than 70 percent of the global supply of cocoa currently comes from smallholder production in West Africa, where in recent years there has been an average annual decline in production due to many reasons. These problems are further exacerbated by ongoing child labour practices.
Since a few years though investors take strong interest in cocoa production again and they are looking in particular to establish certified or organic premium quality production. It is estimated that new projects exceeding 50,000 hectares are now seeking funding with a requirement in excess of $500m, mostly in more stable Latin American countries such as Ecuador, Colombia, Peru or NatureBank’s latest cocoa investment initiative in the Dominican Republic - the world’s largest producer market for organic cocoa.
Projects like that of NatureBank take a new large-scale approach to the production of so called fine or flavour cacao varieties. It produces in efficiently organised clusters using latest research and modern processing facilities whilst implementing credible ecologically-sustainable management practices and working in biodiverse agroforestry systems. This approach delivers competitive returns from farming operations and investors will also be hoping for uplift in the value of the land. In an environment that shows prices trending upwards professional producers can operate with the prospect of a 50% gross margin. All of this sounds attractive but cocoa plantations are also capital intensive. Development cost per hectare range from CHF 10 - 20,000 with development to maturity at year 5.
This is exactly what responsible investors have been asking for years – scalable investment opportunities with attractive returns in relatively low-risk markets that deliver tangible social and environmental benefits. The challenge though is to design these projects in a way that they do not repress the smallholder producers that make up 95% of production today but instead help and teach them to increase yields and quality by providing working capital, quality planting material and access to state-of-the-art processing facilities and connecting them to the world markets. Such inclusive models deliver the much needed economies of scale to satisfy future demand whilst helping to alleviate small farmers out of poverty.
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