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A Crop of Exchange-traded funds for Growing Appetites

Finance Blogger: Morningstar  Morningstar

There is no question about it: global food consumption is growing. By 2050 the world's population is projected to reach 9 billion, up from 7 billion today. The world will need to figure-out a way to feed these new mouths. On top of that, diets are improving and an increasing portion of the harvest will be converted into bio fuels, which means agricultural output will likely need to double by 2050 in order to meet demand.

Farmers will need to improve crop yields to meet demand because most of the world's arable land is already in use. While advances in technology will likely make this challenge more manageable, companies on the cutting edge of the agriculture industry, such as Monsanto (MON), Potash Corporation of Saskatchewan (POT), and Deere (DE), already provide solutions to help farmers improve their yields.

Commodity Prices and Weather Worries

Agricultural commodity prices have a significant impact on the performance of most agri-businesses because their customers' income and demand for inputs, such as tractors, fertilizer and seeds, are often dictated by these prices. Yet, commodity prices do not tell the whole story.

For instance, a drought can increase the price of corn but decrease the size of the harvest, which may reduce farmers' incomes and their demand for equipment and chemicals. Consequently, the performance of agriculture companies may diverge from agricultural prices.

Although the weather can have an unpredictable impact on the supply and price of agricultural commodities in the short-run, the long-run economics of the agriculture industry are compelling. Most of the population growth over the next few decades will come from emerging markets, where incomes are rising. As emerging-market populations become wealthier, they are projected to increase their consumption of meat, which will have a disproportionate impact on the demand for grain because corn and soy are common ingredients in livestock feeds. It requires an estimated 4.5 to 6.0 pounds of grain, such as corn, to raise a pound of beef. Therefore, small changes in livestock consumption can have significant impact on demand for grains. In the absence of advances in productivity and improvements in crop yield, these trends will push agriculture commodity prices higher.

However, rising demand is not synonymous with rising grain prices because advances in technology can improve crop yields. Fortunately, many companies in the agriculture industry provide solutions to help farmers improve their yields. This actually distinguishes funds tracking agriculture companies from pure commodities offerings and makes it a better access vehicle for investors who want to capture the benefits of demand growth.

In Europe, there is a handful of ETFs offering exposure to agri-businesses, which can be seen in the chart below:

These agriculture-focused funds are suitable satellite holdings for investors who want to profit from growth in global food consumption and are willing to ride out wild fluctuations in commodity prices that can erase value with little warning. The performance of agriculture funds can indeed be volatile and susceptible to adverse weather conditions. Operating leverage magnifies the impact of fluctuating grain prices on the performance of these fund's constituents. As a result, over the past three years, these funds experienced standard deviations of around 25%, while the S&P 500's was 15%.

This article was originally published on Morningstar under the title: A Crop of ETFs for Growing Appetites

Tags: agriculture , alternative investment , ETF , ETF & Indexing Investment Summit 2011 , global warming , investment banks , investments
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