Watching Agriculture Themes Evolve

by: Roger Nusbaum

Another assist today from Market Folly as they review an agricultural fund [James Cunningham and Ejnar Knudsen's Agriculture Fund] from Passport Capital. In the report that Market Folly published, Passport disclosed being up 10.3% in the period reported versus 66.6% for Market Vectors Agribusiness ETF (NYSEARCA:MOO). I recently added this ETF to client accounts.

With these sorts of things you can only find out what they are willing to tell you, so only a few of the holdings were disclosed. Those holdings were Imperial Sugar (NASDAQ:IPSU), 12% of the fund; CF Industries (NYSE:CF), 10% of the fund; Pilgrim's Pride (NYSE:PPC), 5%; and Makhteshim-Agan Industries (OTC:MAIXY), which is an Israeli company, at 5%.

Also disclosed were the sub-industry allocations, which were: Ag processors (sugar, corn, ethanol, and oilseed processors) 21% long exposure; protein processing and production (poultry, beef, and dairy) 21% long exposure; and ag inputs (ag equipment, fertilizer, seed and crop protection) 23% long exposure. I've worded it as it was in the report. The fund can go short, but I am not sure what portion of the fund is in cash or in short positions - there was mention in the commentary that attributed some (maybe all?) of the lag to the expectation of a big market correction in 2009 that never came (the fund was implemented on March 1, 2009).

There are all sorts of things to learn here. I may be wrong, but it seems like the lag was a market call that was wrong, not poor stock selection within the theme. Indeed, although we don't know when things were bought and sold in the fund, the holdings disclosed ranged in performance from just fine (relatively) to outstanding (yes, there could be window dressing, but I am giving them the benefit of the doubt).

The incorrect market bet cause the fund to not be a proxy for the space in which it invests. If you are inclined to ever seek out a fund like this (it is not a mutual fund that you buy at a brokerage), it is worth making sure who the asset allocator is, you or the fund manager. I've talked about this before in a slightly different context. When a person has a broker (a rep at Merrill or Morgan) place money with active managers, those managers need to assume that the asset allocation decision has been made and stay close to fully invested at all times. This creates problems when the client does not realize that the manager won't go on defense but that the broker needs to pull assets back which is a rare thing--at least this is how it was at the start of the decade when I spent about ten minutes working at Morgan Stanley (NYSE:MS).

For anyone interested in thematic investing, either in an undiversified way or closer to what I do in embedding a few themes moderately into the portfolio, this raises other questions about just how to add the theme in. Even if the result had been inline with MOO or better than MOO, a read of the report tells you there is a lot going on under the hood--far more moving parts than just buying an ETF (MOO is not the only one). At some subjective point an investment product or strategy goes from being sophisticated to overly complex.

Whatever the agriculture theme does in the next few years, I would expect that an ETF would easily capture it. A fund like this could certainly add value versus an ETF, of course, but the nature of the theme in the last couple of years has been to add volatility to the portfolio in both directions and I would note it has a nice fundamental tailwind. If you sniff around the Market Folly site you will find a much more detailed report on the theme (as opposed to the fund) and the research is compelling. In addition to per capita incomes going up in quite a few emerging markets, so is protein consumption. Passport notes that the world's population is on pace to grow by 50% in the next 40 years, and research from EG Shares notes that a huge portion of the world's births are occurring in emerging markets.

Like with other themes, this is going to happen, diets are going to improve, but it will require a lot of things to click and it seems logical that the stocks will benefit from this.

In this context, buying fertilizer companies makes sense, as do seed companies. They will have to be part of the solution. Certain food producers and farms are interesting and would seem to be logical to include, but I am still trying to figure out what to make of them. Some farm stocks that I have mentioned in past posts have had a wide mix of results.

MOO's result for six months has been up 11%, for one year up 60% and down 25% for two years. Black Earth Farms (OTC:BLERF) has been down 2% for six months, up 35% for one year and down more than 60% for two years. Trigon Agri (OTC:TRGAF) for six months has been down 20%, up 70% for one year and also down more than 60% for two years. New Britain Palm Oil (LON:NBPO) for six months has been up 30% but does not go farther back than that. Lastly New Zealand Farming Systems has been down 15% for six months, down 20% for one year, and this one too has been down more than 60% for two years.

In looking at the six-month chart comparing all of them, New Britain looks most like the ETF in terms of volatility; the other stocks all appear to be far more volatile. Perhaps this is attributable to the floats on these being small or is just a sign of the times, but as interesting as these might be, and if you look you will see they are interesting, they are probably not quite ready for prime time.

As more and more people like Barton Biggs, Marc Faber and Jim Rogers keep telling us to buy farmland, I will be curious to see if that benefits stocks like the ones mentioned above.

One thing that hopefully this post conveys is that with themes there can be many ways to build them into a diversified portfolio. I would also add that themes evolve and the best way in today may not be the best way in two or three years from now. Part of the job with buying a theme is staying current and also exploring new ideas within. Similar to what I mentioned the other day I am putting in some time on these farm stocks but still; not quite ready for prime time.