September 3, 2014

Desmond Sheehy
Chief Investment Officer, Duxton Asset Management

Assessing Direct Investments in Agriculture

The direct investment team at Duxton Asset Management (Duxton) has been working together to evaluate and invest in agricultural operations since 2006. Our investment strategy has been continuously developed and adapted, taking into account many years of collective experience as well as the unique knowledge gained by investing in over 19 companies in five continents – depending on how you define a continent – and assessing countless others. This is across a broad spectrum of commodities, operational styles and structures. It is difficult to distil this knowledge into a single article but we will try to give as much insight as possible.

Broadly speaking we have a top down (limited resources), bottom up (unlimited resources) approach. However, as an asset manager, we also have to take into account that we are looking to build a diversified portfolio for our clients and that our investment style is a private equity approach with minimum leverage. The resulting portfolio should therefore have a low level of downside risk and also be able to withstand the variability inherent in agricultural investment. In line with this, we believe a base portfolio should consist of at least 10 investments.

Top down analysis
As part of our top down approach, we undertake analysis of the global agricultural markets, commencing with the supply and demand dynamics of production. We determine the medium term opportunities in the most liquid markets around specific commodities, supply chains and companies. This feeds into our analysis of potential direct investments by helping to identify commodities which have a global pull. That said, local factors and demand also come into play and there are exceptions to every rule.

The top down analysis serves to narrow our focus. Any potential investment must meet the top down criteria or have a specific compelling case to be able to proceed to bottom up analysis.

Sourcing of transactions
We generally receive at least one transaction proposal a day from the market, due to our extensive network and reputation. Typically, the transactions that progress past the first step are received from trusted sources, where we have a history with or knowledge of the proposer.

Bottom up analysis
Before proceeding to a detailed assessment of the specific strengths of a project, there are four elements we consider, to see how it would add to overall portfolio diversification.

Geographic location: We aim to do ‘climate smart investing’. Put simply, we want to grow a commodity in a region where the current climate – and, so far as we can tell, future climate – is suitable for its production. In the majority of cases, if the region is already successfully growing the crop, this is a positive sign. Any introduction of a new crop to an area must be undertaken with great care. In addition, we assess the potential for disease. Even if an area is renowned for growing a certain crop, the potential for damage from disease is present. For example, a lot of cocoa growing regions are being threatened by ‘black pod’ disease. So for any investment in cocoa we would look for locations where this was not prevalent.

Political situation: This factor does not just cover the broad country risk or opportunity. There is often a misconception that politics is always a risk rather than an opportunity. It is true that Duxton does assess a country’s political risk and, unless there is an overriding factor, discounts certain regions. For example, the US and the EU are generally excluded from further analysis due to the presence of subsidies, and West Africa, Ukraine and Russia, due to political risk. However, Duxton also undertakes a deeper analysis of the opportunities that may exist. For example, we look to be able to sell produce where possible to the local markets, which will always pay a higher price for local produce than it will for unsubsidized exports. We also look to reintroduce old products to these markets if there is a rationale for doing so.

For both political and geographical situation, the availability of skilled labour, good governance and past performance are important factors.

Commodities: As an investor, we are a long term participant in a market. Our goal is to be the ‘lowest cost producer’ operating commercially in a specific market. It is important as a portfolio investor to diversify exposure. We also assess where a commodity is in a cycle and whether, if we purchase the land today based on an inflated output price, we would be paying too much. We don’t look to convert land from one use to another based on current prices. Further, we also review any inputs to production. These are often commodity based and also need, where possible, to be diversified.

Management/System: This is the most important element of both the bottom up analysis and the detailed assessment of the project. If we don’t have the right management team or partners or they are not applying a work system appropriate for the type of business, then we don’t invest in the project. We spend a lot of time ensuring we understand the management teams and their motivations.

Evolution
Duxton’s investment focus has expanded to not only include primary production but to also encapsulate primary production with value add, particularly in emerging markets. Our experience suggests that in developed countries with transparent pricing, we can identify good production-only assets. In emerging markets, however, this can be more difficult. As a result, we have begun to assess assets with some value add that also play a big role in the local community. This can help us to leverage small holder production, mitigate political risk as well as add significant value to an investment. Duxton also always strives to be at the cutting edge of environmental and social inclusion, as it has been proven to add value to the investments, both operationally and during a sale.

Desmond was on the speaking faculty for Global AgInvesting Asia at the Marina Bay Sands in Singapore, September 23-25, 2014. 

The opinions expressed in this editorial are the author's own and do not reflect the view of Global AgInvesting.