While this blog is about investing in farmland, the aim is to present all the pros and cons fairly. As we have detailed before, one of the benefits from investing in farmland that is often overstated is the diversification benefit of owning farmland as part of a broader portfolio that includes other asset classes like stocks and bonds.
Some big investment funds like TIAA-CREF and the University of Illinois have agriculture investments as part of their holdings. It makes sense for long term investors to get returns from a wide variety of asset classes, which can diversify their risk. Many of these funds, and the consultants that advise them are becoming more quantitative in nature and like to look at risk, return, and asset correlation so that they can construct optimal allocations to different asset classes.
Unfortunately, the sophisticated calculations require very uncertain inputs. Most commonly, historical inputs are used, however even are guesses at best and may be wildly inaccurate. A good example of this was just brought to light in the recent annual report released by Harvard University’s endowment. Harvard wrote down their ‘natural resources’ investments by more than 25%, from $4 billion to $2.9 billion. This portfolio consists mostly of timberland and agriculture holdings.
How did this part of the portfolio lose more than 25% in one year? The answer is…that it didn’t, really. The valuation is subjective, and the new managers of Harvard Management Co. do not think it is worth as much as the previous team. Both of the estimates might be justified, especially for a collection of assets that is very hard to sell. For some specialty assets it might take years to find the right buyer, who is willing to pay a high price.
Earlier this year Harvard attempted to sell some of the assets, for example a dairy farm in New Zealand, and presumably couldn’t find a buyer willing to pay the value that they assigned to it. This doesn’t mean that the dairy farm is not worth as much, it could just be that it is just really difficult to find someone willing and able to invest close to $100 million in a dairy farm in New Zealand. Especially with the buyer knowing that Harvard was an eager seller.
On paper, an asset will looks much less risky if no one really knows how much it is worth and each year the subjective guess is close to what it was for the previous year. This makes historical calculations of risk and return very misleading.