The case for diversification
Modern Portfolio Theory (MPT) is a widely used tool for optimizing portfolio diversification. At its core, MPT examines the historical returns of an asset or asset class and the correlation of those returns with that of other assets. By spreading capital across a portfolio of assets with low correlations to each other, investors can help reduce the impact of risk (or the standard deviations of returns from an asset) on a given portfolio.
Investors can measure the correlation of different asset classes going back several decades to see which mix may be appropriate for them. Here’s a map of correlations between a number of major asset classes between January 2008 and April 2023:
Source: Portfolio Visualizer
Institutional investors and hedge funds use correlation matrices like these to strategically allocate assets to minimize correlations. For instance, real estate showed a correlation of just -0.04 with medium-term Treasury bonds (1-3 years) during this period, while small-cap stocks showed a correlation of 0.0 with gold.
MPT seems to hold up when we compare returns in the first four months of 2023. Commodities and micro-cap U.S. stocks have been the worst-performing asset classes so far this year, losing 6.22% and 2.24% respectively. Investors focused exclusively on either of these assets would have lost money, even as every other asset class gained value. Some of these losses could have been offset with uncorrelated asset classes such as gold and long-term U.S. treasuries, which were up 8.94% and 7.24% respectively over the same period.
Put simply, a portfolio with a broad mix of 25% each in long-term treasuries, gold, commodities and small cap stocks would, in theory, have seen a total return of 1.26% in the first four months of 2023.
Niche, alternative assets are less likely to be correlated with mainstream assets like stocks, bonds and cash. That’s why a growing number of institutional investors and sovereign wealth funds are diverting capital to alternative assets.
Allocations to alternative assets rose from $7.23 trillion in 2015 to $13.32 trillion in 2021 and are expected to hit $23 trillion by 2026, according to investment data company Preqin.
One specific alternative asset has become increasingly popular because of its historically high yield, low volatility and lack of correlation with most other asset classes: farmland.
The benefits of farmland
Source: FarmTogether — Introduction to Farmland Investing
Farmland can be an attractive asset class in large part because of its historical lack of correlation with common investment options; farmland has had a negative correlation with U.S. stocks and bonds, low correlation with private real estate and ultra-low correlation with publicly listed Real Estate Investment Trusts (REITs) over the past three decades.
Farmland has been uncorrelated to other assets for a few reasons. While the value of stocks and bonds are impacted by market cycles, credit risk or corporate earnings, the value of farmland is shaped by unique influences like the demand for food and the availability of farmland itself.
Food demand, unlike many other commodities, remains relatively inelastic due to the fundamental human need to eat. This inherent necessity can help ensure a stable demand for farmland, even during times of economic upheaval.
Farmland values continued to steadily rise between 2020 and 2022, even as stocks and bonds completed a full cycle during that period.
Furthermore, projections suggest the global population is expected to grow to 9.7 billion, causing the total global demand for food to increase by 35% to 56% by 2050. Simultaneously, the amount of arable land per person is expected to dip to 0.37 acres — less than half the amount available in 1970. As a result, what land is currently in use is steadily increasing in value.
These long-term factors have helped make the value of farmland reliably stable for investors. Cropland value has gradually risen year after year since 2008, with minor dips along the way.
Source: USDA Land Values 2022 Summary
Consider, for comparison, the volatility of stocks and bonds. Bond values have plummeted in recent years as interest rates have climbed, while stocks have completed a full bear-bull market cycle since 2020.
The standard deviation — that is, how much value moves around — for farmland was 6.64% between 1992 and 2022. By comparison, U.S. stocks and real estate were far more volatile with standard deviations of 17.8% and 7.62%, respectively.
Source: FarmTogether — Farmland: A Superior Asset Class
The resilience of farmland was further cemented during the COVID crisis.
Between 2020 and 2022, farmland had a standard deviation of just 3.39%, compared to 8.39% for real estate and 24.6% for the S&P 500.
Source: FarmTogether — Farmland: A Historically Stable Asset During Uncertain Times
While farmland might be considered “boring” compared to other offerings, investors have not had to sacrifice returns for this level of stability; farmland has demonstrated remarkable growth during the past three decades.
A $10,000 investment in U.S. farmland back in 2000 would be worth $96,149 by 2020. That’s a compounded annual growth rate of 12.24% over two decades. By comparison, the Nasdaq QQQ Index delivered just 12% over the same period.
Farmland can also offer yield; the average cropland rented out for $148 per acre and cost $5,050 per acre to purchase in 2022. This implies a cash yield of roughly 2.9%. By comparison, the S&P 500’s dividend yield is just 1.66% at time of writing.
To sum up, farmland has historically struck a solid balance between low volatility, low correlations and attractive returns.
Here’s how adding farmland to a hypothetical, traditional portfolio mix of 60% stocks and 40% bonds might have shifted the risk and reward profile in recent years:
Source: FarmTogether — Introduction to Farmland Investing
As the data shows, adding a small 15% allocation to farmland could have lowered the standard deviations and raised the average returns and Sharpe ratio of a typical 60/40 portfolio.
How to invest: Why FarmTogether?
FarmTogether is a farmland investment manager that enables accessibility to farmland through a variety of investment products, including crowdfunded deals, bespoke offerings and its Sustainable Farmland Fund. The firm also facilitates 1031 exchanges.
The platform has more than 40 properties in its portfolio, spread across 4,200 acres, with over $170 million in assets under management.
Investors have access to an array of different crops, geographies and deal structures, which offers yet another layer of diversification. Listings range from pistachio orchards to organic vineyards.
For those seeking diversification amid today’s uncertain environment, FarmTogether might be worth exploring.
This communication is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation, or needs of any investor. All investors should consider such factors and risks in consultation with a professional advisor of their choosing when deciding if an investment is appropriate. Historical data is not indicative of future results and may not reflect fees which may reduce actual returns. Any historical information is illustrative in nature and may not represent future results, therefore any investor investing through the FarmTogether platform may experience different returns from examples and projections provided herein.
Data representative from January 1992 through December 2022. Sources: Privately Held U.S. Farmland - NCREIF Farmland Index; Privately Held U.S. Commercial Real Estate - NCREIF Real Estate Index; Stocks - S&P 500; Bonds - Bloomberg Barclays U.S. Aggregate Index; Gold - Federal Reserve Bank of St. Louis Economic Data (FRED). Indexes are unmanaged and not available for direct investment.