Institutional Investors

The search for alternative assets by institutional investors has resulted in a fresh look at agricultural assets. Farmland has received a high level of study, particularly by TIAA-CREF¹.  However, farmland is illiquid, and unless you have a 10 to 20 year investment horizon, the prudent investor interested in the ag sector needs to look elsewhere.

The profitability of an investment in feeder cattle is linked to income levels and population growth.  As incomes in China have grown, so have the demands for animal protein.  This is a fundamental dynamic across all cultures. As incomes cross over from poverty to prosperity, people demand more animal protein. Further, feeder cattle do not share the demand link to industrial production as do metals such as silver and copper, or energy such as oil and gas.  A long term investment in feeder cattle production is a play on global income and population growth unrelated to the economic cycle.

An investment in feeder cattle provides much higher liquidity than farmland. An investor also receives gains due to management skill, and uncorrelated returns with the stock market. There are two ways to invest in feeder cattle: via the CME using futures and options, or by owning the actual commodity on the hoof. The former is pure speculation. The latter provides returns from management skill in the buying, feeding, nutruing and selling process, as well as gains from capital employement inherent in holding a commodity over time. There is a sea of difference between investing in a CME contract and actually owning feeder cattel on the hoof. By owning and feeding calves, an investor can increase yield at each step of the value chain: buying calves at an economic price, buying feed below market through local sourcing, the efficient use of feed by cattle due to their genetics, using the most efficient nutrition and veterinary care, and selling wisely. This enhanced yield cannot be obtained with futures or options.

Owning feeder cattle provides a yield comparable to the stock market but without correlation to it. This can assist in increasing the Sharpe’s ratio of the portfolio. Numerous studies have indicated that return on investment in cattle feeding compares favorably and has a low or negative correlation with returns to other investments (e.g. , Dodson and Elam;, Jones, Mintert, and Albright). Kastens and Schroeder (1995) used a Capital Asset Pricing Model (CAPM) framework to conclude that expected returns for live cattle futures funds should be somewhere between T -bill returns (risk-free) and stock market returns. Research by Vanguard has also shown that commodities provide returns equal to or better than the stock market, but with less volatility.²

Commodities have been shown to have the lowest integration with stocks of all industries ³. Further, feeder cattle have been shown to be among the least correlated assets with the GSCI Index. Most commodities are highly integrated with GSCI index except for feeder cattle, live cattle, lean hogs and coffee which are least integrated with other classes with adjusted R-squares less than 1%.⁴. A portfolio of stocks and commodities should provide the highest diversification benefit.

These results are explained by the small (near zero) CAPM beta coefficients, which signal low correlation with the stock market. Risk in cattle feeding can be largely diversified away. Since cattle feeding risk is largely unsystematic, cattle feeding investments may enhance the performance of well-diversified portfolios without increasing portfolio risk⁵.

An investment in feeder cattle – yearling calves that are weaned and on a nutrious solid diet – is an attractive means to maintain portfolio yields at long-term stock market levels while decreasing the volatility of your portfolio and increasing your Sharpe’s ratio.

If you are ready to talk, let us know your Investment Criteria

1. Investing in Agriculture, TIAA-CREF A13717 12/13   Investing in Agriculture, TIAA-CREF A13717 12/13

2. Bhardwaj, Geetesh. “Investment Case for Commodities? Myths and Reality.” (2010), p13    Bhardwaj, Geetesh. “Investment Case for Commodities? Myths and Reality.”

3. Arouri, Mohamed, Duc Khuong Nguyen, and Kuntara Pukthuanthong. “Diversification benefits and strategic portfolio allocation across asset classes: The case of the US markets.” Unpublished working paper, IPAG Business School (2014), p10.    Arouri, Mohamed, Duc Khuong Nguyen, and Kuntara Pukthuanthong. “Diversification benefits and strategic portfolio allocation across asset classes: The case of the US markets.” Unpublished working paper, IPAG Business School (2014), p10

4. Arouri, Mohamed, Duc Khuong Nguyen, and Kuntara Pukthuanthong. “Diversification benefits and strategic portfolio allocation across asset classes: The case of the US markets.” Unpublished working paper, IPAG Business School (2014), p11.   Arouri, Mohamed, Duc Khuong Nguyen, and Kuntara Pukthuanthong. “Diversification benefits and strategic portfolio allocation across asset classes: The case of the US markets.” Unpublished working paper, IPAG Business School (2014), p11.

5. Hampel, F. A., T. C. Schroeder, and T. L. Kastens. 1998. “Risk and Expected Returns in Cattle Feeding.” Proceedings of the NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management. Chicago, IL.    Risk and Expected Returns in Cattle Feeding.” Proceedings of the NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management. Chicago, IL./span>