With all eyes on Washington, daily distractions can divert even the most disciplined investors. Yet for the long- term investor, specialty assets provide an opportunity to drown out the noise and focus on fundamental global secular trends. In his newest paper, Joe Quinlan, Head of Market & Thematic Strategy, Bank of America Global Wealth and Investment Management and U.S Trusts points to how three themes, global food security, an emerging middle class, and rising urbanization pair well with investing in hard assets such as farmland, timberland and commercial real estate.
- Global Food Security:
As the global population rises, demand for food to provide for 2.3 billion additional people by the middle of the century is set to outpace agricultural supply. The challenge to achieve food security in the developing world will drive agricultural innovation and efficiency.
- Emerging Middle Class:
Bolstered by strengthening labor markets and higher levels of educational attainment, per-capita household consumption has soared among many emerging market economies. These shifting demographics and income trends have many implications for the long-term growth prospects of farmland investing. Timberland investors also have the opportunity to profit from cyclical factors as well, as upswings in the U.S. housing market create demand for lumber. Rising disposable incomes, growing populations, improving labor markets and urbanization are also favorable trends for commercial real estate investment.
- Rising Urbanization:
As residents of developing countries see improvement in their disposable incomes and migrate more toward cities, where meat consumption tends to be greater, agricultural imports will need to rise to meet growing demand. U.S. agricultural exports will likely be an influential force in matching food supply with demand.
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For The Long Run: Global Investment Themes For Specialty Assets
With all eyes on Washington, daily distractions can divert even the most disciplined investors. Yet for the long- term investor, focused on long-term investment themes, specialty assets provide an opportunity to drown out the noise and focus on fundamental global secular trends. These hard assets that are meant to be held over long time horizons—farmland, timberland, commercial real estate—pair well with themes of global food security, an emerging middle class, and rising urbanization. Below we outline how growing demand for hard assets (ignited by these investment themes) coupled with limited supply will drive up values over the long run.
A crowded planet
As the global population rises, demand for food to provide for 2.3 billion additional people by the middle of the century is set to outpace agricultural supply. As highlighted in the June Strategic Insights report, the challenge to achieve food security in the developing world will drive agricultural innovation and efficiency: According to the Food and Agricultural Organization of the United Nations (FAO), world agricultural production will need to rise 70% between 2009 and 2050 to meet rising global demand.i Furthermore, with the population increases expected to be concentrated in regions struggling with malnourishment and most vulnerable to climate change, global food trade will play a critical role in reducing hunger worldwide.
The evolving global middle-class
In addition to a growing global population, the agriculture industry is also responding to another changing dynamic: the rise of the emerging market middle class. According to the Brookings Institution, 3.2 billion people were in the middle class as of 2016, with 140 million people being added each year.ii Almost 90% of the next 2.4 billion entrants into the global middle class through the year 2030 will be in Asia, mainly due to rising populations and incomes in China and India (Exhibit 1). In terms of spending power, the middle class consumer market, already spending $35 trillion a year, is projected to almost double by 2030.
Bolstered by strengthening labor markets, higher levels of educational attainment, and growing urbanization, per-capita household consumption has soared among many emerging market economies. In China, household final expenditures per person in constant dollar terms have increased fourfold since the start of the century. Meanwhile, the figure in India has nearly doubled in just the past ten years, with room still to grow: At just $1,012 in nominal terms, India’s per capita personal consumption expenditure is roughly one-third of China’s.
These shifting demographics and income trends have many implications for the long-term growth prospects of farmland investing. Rising disposable incomes in economies such as India and China have led to a rise in global per capita caloric consumption, with the trend expected to continue. The Organisation for Economic Co- operation and Development (OECD) and FAO project that by 2024, global consumption of calories from crop and livestock products will be 14% and 15% greater than in 2015 respectively, with developing countries accounting for 96% of the additional crop consumption and 88% of additional livestock consumption. As middle class consumers shift to more advanced/diverse diets, U.S. agricultural exports will likely be an influential force in matching food supply with demand.
In addition to direct human consumption of crops, U.S. exports of animal feed are also projected to rise as consumption patterns change with a larger middle class. Take China, for instance. Per capita meat consumption in the country has more than doubled since 1989, resulting in a surge of soybean imports (fed to livestock and chicken) from major producers such as Brazil and the U.S. In fact, at $17.2 billion, agriculture is the second largest category of U.S. goods exported to China (after transportation equipment), and soybeans make up 82% of that total (Exhibit 2).
Even though meat production is projected to decelerate, following the 20% growth seen during the last decade, per capita meat consumption in emerging markets is still less than half of that in developed markets, signaling an opportunity for other emerging countries to follow China’s lead and adopt more protein-filled diets. As residents of other developing countries see improvement in their disposable incomes and migrate more toward cities, where meat where meat consumption tends to be greater, agricultural imports will need to rise to meet growing demand. Over the past ten years agricultural exports to India have increased almost fourfold to $1.0 billion, yet this is still a fraction of agricultural exports to China, which registered at $17.2 billion in 2016. Currently, U.S.- India agricultural trade is relatively small, partly due to Indian policies protecting local farmers; however, looking over the long-term, exports to the country are positioned to improve if the country is unable to satisfy a booming population and shifting appetites.
Another entry point for investors to take advantage of these shifting consumption trends is through timberland. U.S. exports of forestry products to emerging markets have been rising as an expanding middle class spends more on manufactured goods and housing. With China now the number one producer of furniture in the world, annual exports of U.S. forestry products to the country are now over $1 billion, up from an annual average of approximately $200 million last decade. This is still a relatively small figure, but rising incomes indicate that this number will continue to climb. Also, as the world goes digital, timberland assets do not entirely miss out on this opportunity: The surge in ecommerce and delivery services has led to a growing market for packaging products.
Timberland investors have the opportunity to profit from cyclical factors as well, as upswings in the U.S. housing market create demand for lumber.
Rising disposable incomes, growing populations, improving labor markets and urbanization are also favorable trends for commercial real estate as a direct investment. While we remain neutral on the medium-term outlook for the asset class given valuations in the current phase of the cycle, these social and economic factors could underpin demand growth in the long term. Also, as emerging market residents accumulate wealth and look for places to invest, demand for U.S. hard assets like commercial real estate will remain healthy.
The supply side
Supply factors will also drive farmland values higher as world arable land per capita continues to decline (Exhibit3). Rapid industrialization and climate change would only intensify this downward trend as more frequent droughts, rising sea levels, and changing temperatures threaten the world supply of arable land. Constraints on the supply side reinforce the importance of global trade to provide food to countries with arable land scarcity and rising populations. Timberland availability in the long run may also decline due to increased urban development/deforestation, government regulations and natural causes, driving land values higher.
Risks to this macro picture cannot be overlooked. Continued economic stagnation could weaken middle class spending power. And even in a high growth environment, if economic growth is not inclusive, but rather concentrated at the top, the natural progression to more advanced diets by low- and middle-income consumers could come more slowly than anticipated. Additionally, increased protectionism could disrupt global agricultural supply chains that are central to achieving worldwide food security. If emerging economies continue to focus on agricultural self-sufficiency to protect local growers, or if a trade war with China or Mexico materializes, U.S. exporters could quickly lose their ability to profit from these evolving emerging market spending habits.
Notwithstanding these risks, the combination of an expanding middle class, population growth, urbanization, and declining supply will support hard asset valuations in the long term. We also hold the view that these secular trends will overpower the short-term risks associated with recent high production levels and supplies that have been depressing commodity prices.
Specialty asset investments have other advantages to consider when viewed in the context of an investment portfolio, primarily: diversification, attractive risk adjusted returns, inflation protection, and relatively low volatility if held over a long time horizon. Also important to consider is the investments’ ability to generate cash flow, protect capital against geopolitical risk, and provide tax advantages for high-net-worth investors. Additionally, timberland offers a unique advantage of optionality, as trees provide investors the flexibility to sell timber when prices are high or hold off harvesting during a low-price environment. These portfolio considerations, combined with the assets’ ability to capitalize on an emerging middle class, make investments in physical assets a favorable positioning for those willing/able to sacrifice some liquidity.
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