x Abu Dhabi, UAEThursday 18 January 2018

As prices rise, should food have a place in your portfolio?

Over the next decade, prices for maize, sugar and vegetable oil could rise as much as 20 per cent. While soft commodities are not long-term investments, there are still good returns to be had.

The global sell-off may have reversed recent food price rises, but any relief is likely to be temporary. While the cost of storing 'soft' commodities can make them counterproductive for investors, an expert says knowing how to predict bottlenecks is key. Harvey Jones reports

If you've been to the supermarket lately, you won't need to be told that food is getting more expensive.

Prices have soared over the past year, as droughts in Russia and floods in Australia wreaked havoc on harvests, and they look set to keep growing.

The price of corn has more than doubled in a year, wheat prices are up more than 70 per cent, and coffee and sugar have risen by more than 50 per cent.

Animal food is getting more pricey, forcing up the cost of meat, eggs and dairy products.

The recent stock market meltdown hammered the prices of commodities such as oil and copper, but "soft commodities" such as corn, coffee, soybeans and cotton proved more resilient. So far, the blight has been relatively minor.

In fact, corn futures could soon hit record highs, after the recent United States heatwave threatened this year's harvest.

Most of us will have seen the impact at the supermarket till, and on the news. Soaring food costs have contributed to unrest in some Arab cities and, in fact, nations worldwide. They also leave millions hungry and inflate the cost of living in both developed and emerging countries. Worryingly, they look like they are here to stay.

Over the next decade, prices for maize, sugar and vegetable oil could rise as much as 20 per cent, and that's on top of inflationary price increases, according to a recent joint report by the Organisation for Economic Cooperation and Development (OECD) and the United Nation's Food and Agriculture Organisation.

Poultry will rise by up to 30 per cent, butter by 45 per cent and ethanol more than 50 per cent, due to a combination of slow growth in the supply of food and rapidly rising demand.

Sharp oil price rises and competition for water and land will make it hard for farmers to boost the supply needed to meet rising demand from the vast, newly-wealthy urban populations of countries such as China and India.

It's a hungry world, and it is getting hungrier. In 1960, the global population was three billion. Today, it stands at nearly seven billion. By 2050, we will need to feed more than nine billion. Food is a growing market, but does it offer healthy returns for investors?

Over the short-term, say, the next six months, it may not add much fibre to your portfolio, says Kristof Bulkai, fund manager at Thames River Water & Agriculture Absolute Return fund. "I don't expect a big increase in corn or beef prices, in fact, I expect them to fall slightly."

Global food inventories remain tight. The world needs a couple of good harvests to rebuild them. "But as long as there is land and rain and sunshine, planting should increase and prices should recover. Food is different to oil, where there is only so much of the stuff, and we are using it up. There is enough land, we just have to seed and plant it," says Mr Bulkai.

You won't make money from "soft" commodities over the very long-term either. Investors never do. "They spend too much on storage. Storing grain, and keeping meat and orange juice refrigerated, costs too much money," adds Mr Bulkai.

But you can still make good returns from food, by catching what Mr Bulkai calls the agriculture super-cycle.

The spike in food prices over the last two or three years suggests we are in the early stages of that cycle. "This is a market signal that supply is not keeping up with demand, and means that prices must rise," he adds. "It is a bottleneck, a signal that there has been underinvestment in infrastructure. And it will take time to clear."

The oil bull market started in 2002 due to growing demand from China. It followed two decades of serious underinvestment in oil. "The agriculture bull market didn't start until 2007 or 2008, which isn't long enough to drag in the investment needed to boost supply. In time, countries such as Brazil, Russia and Ukraine, and parts of Africa, will invest in storage facilities, railway networks and port handling facilities. But it will take time," says Mr Bulkai.

That delay means the agricultural bull market is set to last for several years. "You won't see much growth over the next three to six months, but over five years, you will make money."

But it won't last forever. "Over 10 years, there should be enough investment in production to supply the global population. Once that has played out, prices will fall, but not until then," says Mr Bulkai.

Agriculture is notoriously cyclical. A bad harvest or two, and prices rise. This encourages farmers to plant more, attracted by bigger profits. They invest in new technology and kit, supply rises, and prices fall. Invest at the wrong point in the cycle, and your money could wither on the vine. Thames River Water & Agriculture is an absolute return fund, which means it uses complex financial instruments to reduce volatility and produce a steady positive return every year. It grew 8 per cent over the past 12 months.

From the 1960s to the end of the last century, food prices were in steady decline. They started rising at roughly the same time China joined the World Trade Organisation (WTO) in 2001, and dropped its tariffs on agricultural imports. It has been a major net food importer ever since. Prices spiked in 2008, and are spiking again now.

The growing wealth of emerging countries such as China, India, Brazil, Russia, Indonesia and Turkey has added to the pressure on prices.

Middle-class urban consumers in these countries don't just eat more, they eat differently, says Dan Dowding, chief executive officer (Middle East & Asia) at independent financial advisers Killik & Co in Dubai. "In Asia, consumers are shifting away from traditional staples such as rice, and eating more meat and dairy instead. That puts even greater pressure on land and food prices." So does the fashion for turning food into biofuel, which sees governments effectively subsidising high food prices. "Higher oil prices, water shortages, rising life expectancy and explosive population growth are all adding to the pressure," says Mr Dowding.

Speculators have added fuel to the fire. Last year, French President Nicolas Sarkozy made a doomed attempt to curb speculation in agricultural commodities, which he blamed for the "plague" of record food prices, and said was plunging entire populations into famine and poverty.

Speculation is difficult to tackle, Mr Dowding says, given that many farmers and food producers themselves have a legitimate need to hedge, to protect themselves against price swings. Some argue that speculation is caused by price volatility, not the other way around. Either way, it doesn't help.

In the UAE, the government has responded by capping food prices.

Steve Gregory, managing partner at financial services company Holborn Assets in Dubai, applauds the UAE's attempts to keep staple foods affordable, but says the policy isn't sustainable. "Higher food prices and volatile commodity markets are here to stay, and there is nothing governments and regulators can do about it. Global food production must by increased by an estimated 40 per cent by 2025, which means that prices are likely to increase relentlessly."

One way for investors to benefit is to choose a specialist mutual fund investing in agriculture. "DWS Global Agribusiness has been successfully investing in food production from field to fork, including distribution, sales, preparation and packaging." The fund grew 22 per cent over the past 12 months, but is down 8 per cent over three years, which shows how volatile the sector can be.

Mr Gregory also recommends Thames River Water & Agriculture Absolute Return. "As an absolute return fund, it is able to short commodity prices as well as going long, which means its returns are less exposed to the huge swings and volatility you often find in agriculture."

He also rates the IQS Fund from AMT Futures. This trades a diversified range of 14 liquid futures markets, including soft commodities such as coffee, soya beans, soybean oil, cotton, sugar and wheat, as well as crude oil, natural gas, gold, copper and certain currencies. "It is more risky than a typical mutual fund, and has made significant gains and losses over the years. But over 15 years, investors have seen an average return of 33 per cent a year."

Mr Gregory says these funds are available through insurance brokers and financial advisers in the Middle East, but investing in one particular sector can lead to greater volatility, and you shouldn't commit more than 10 per cent of your portfolio.

Sheridan Adnams, investment adviser to UK-based stockbrokers The Share Centre, says investors who want exposure to agriculture and farming stocks should consider First State Agribusiness fund. "It has a short history, as it was only launched in May 2010, but it is managed by an experienced team. Provided you are willing to accept the extra risk of investing in a sector specific fund, it should give good global coverage of companies in the agricultural industry," says Mr Adnams.

The fund, which returned 24 per cent over the past 12 months, invests globally in fertiliser, equipment, livestock, seeds, supply chain and food processing business. "Many of these companies are seeking to enhance yields, streamline production, replenish raw materials and reduce water wastage. This can help protect your investment against variables such as weather, disease and drought," hey says.

Perhaps the biggest problem isn't that we don't grow enough food, but that too much is lost. It is a long journey from harvesting the crop to packaging, storing, transporting, marketing and selling it, and a lot of produce perishes along the way. Food chain failures are more often to blame for shortages than low yields or poor farming techniques, according to the Worldwatch Institute.

The world needs to invest in that food chain. You might find it profitable to do so. Just make sure you invest at the right point in the cycle.

If the crisis forces down soft commodity prices a bit further, that point could soon be upon us.