A funny thing happened on the way to the stock exchange: A decade of data has come to light challenging the supremacy of holding stocks as a way to build a fortune. What’s more, major hedge funds are — wait for it — plunging major money into farmland. Yes, soil and crops appear poised to rival stocks as leading investments.
Let’s begin with the doctrine of investing in stocks. Jeremy Siegel, author ofStocks for the Long Run, a book revered as one of the best guides to capital markets ever written, demonstrated that equities generate a return of about seven per cent over the long run, bonds half that, and gold barely makes a gain over inflation. His data set goes back to 1800. It’s mostly American, but it has been highly persuasive.
“Stocks are your bet for the long run, even though they come with a lot of volatility. Bonds are a surer bet for the short run. But if stocks are a challenge for investors to hold in periods of high volatility, remember that they have never produced a negative return for any 30-year period. While bonds, had you bought them in the 1950s and sold them in 1980, would have left you with a 50 per cent loss,” he said in a recent interview.
We can accept the idea that stocks are great for very long periods, but for significant chunks of a lifetime, they may be flops. The past decade, however, has inverted Siegel’s findings. According to theEconomist,for the 10 years ended June 18, 2010, stocks in developed markets produced a cumulative return of minus 7.9 per cent. But U. S. Treasury bonds with maturities of 10 to 20 years returned 95.3 per cent and junk bonds 102.2 per cent. In the same 10 years, Canadian data shows stocks returns of plus 4.7 per cent, a good return in comparison to U. S. data, likely due to Canada’s powerful resource-based economy and the conservative nature of our banking system — a lifesaver in the global credit meltdown in 2008. But even with our relatively better stock performance, bonds and high yield debt appear to have beaten stocks.
WORKING THROUGH THE PUZZLE
What does all this mean going forward? The general rule for all capital markets is that returns to investment work out to a rate that adjusts for risk. Bonds, though, are less risky than stocks, for bondholders get paid contractual interest and get first crack at corporate assets in any insolvency. That bond returns beat stocks, which only get residual payments after bondholders and other creditors are paid, is out of character. How did it happen?
A partial answer is that at the start of TheEconomistsurvey period, Dec. 31, 1999, stocks were trading at 44 times next year’s earnings. The historical average is a relatively modest 15 times forward earnings. Today, the ratio stands at 20, implying that stocks’ forward earnings have a way to go to catch up.
What to do? If stocks collectively are still overpriced by the historical average, should one plunge into bonds? Government of Canada bond interest rates are about zilch for periods of one day to about a year, then barely more than 1.5 per cent for up to two years, and then not much more than 3.7 per cent if you go out to 30 years. U. S. rates are a little higher for periods over 10 years, but no matter — with bond returns anchored at near zero for short terms by order of central banks that want to stimulate corporate borrowing and very low all the way out to three decades, why put a lot into such slow-moving investments? Even corporate bonds, which add a couple of per cent to government yields, don’t seem to compete with Siegel’s long run seven per cent. Moreover, when interest rates rise, bond prices, which move inversely to interest rates will fall. Bonds, starting with today’s very low interest rates, seem a long-run sure loser.
BACK TO FARMLAND
The question of whether to buy overpriced stocks or overpriced bonds, has driven U. S. and European pension funds to buy farmland. Their theory is that a growing world population, limited fresh water resources, and finite or even declining amount of land that can be cultivated should make farm crop prices rise and, as a result, the value of farmland too.
Reuters news service has reported that one of the biggest U. S. pension funds, TIAA-CREF, has put about US$2 billion into farmland. That’s a tiny fraction of the US$236 billion it has under management. But it is significant nonetheless as a footstep to what could be a fine asset class if global warming, which will raise sea levels, drown coastal farming areas and perhaps warm the Prairies, continues as threatened. Canada has one of the world’s largest areas for growing wheat, and a tolerable political climate.
TIAA-CREF prefers to own agricultural land directly rather than through hedge or other managed funds. It likes to buy in places that are politically stable as well.
In the U. S., where pension funds have been investing, the average price for land in the corn belt is US$9,562 per hectare or about $3,870 per acre. That’s about the going rate is Iowa and perhaps four times the average rate for farmland on the Canadian prairies. The implication: Canadian land is a good deal for investors and a good a buy and hold asset for farmers already using it. But it varies with location: In Winkler, Man., a centre for special crops as well as a grain, land prices compete with those in Iowa, while in Manitoba’s Interlake region, land sells for as little as $200 per acre.
It is an old and very wise saying in finance that if you can manage your risks, the money will take care of itself. In the case of judging off-farm vs. on-farm investments, low-risk investing surely has a base in relatively low-priced agricultural land. Bonds have more risk, for they are vulnerable to inflation and, these days, are priced at interest rates that are far below historical averages. Stocks, which provide a return commensurate with risk, should be the long run winners, of course. But, as the saying goes, stocks (or any assets for that matter) can take a lot longer getting to the price they should be at than you can wait for your money.
The end of the story is really one of wisdom. Farmers know land values better than most speculators and often as well as hedge fund managers thousands of miles away. Betting everything on land and crops is as foolish as putting everything into any other single industry like steel or pharmaceuticals. But retaining farmland in a portfolio of diversified investments is simply smart.
BALANCING THE RISKS
How much farm value should be in the portfolio is a tougher question. Unlike stocks and bonds, which can easily be hedged in the options market to limit losses or guarantee returns, farmland can only be hedged indirectly via crop prices. In risk management, therefore, farmland values are intrinsically chancier than stocks and bonds.
Age comes to the rescue. Young farmers tend to have less equity than older farmers who have paid off their mortgages and built up their equity. Over a few decades, farmland should appreciate, rendering options that typically run for 90 to 180 days, useless. Young farmers can rationally hold most of their asset in their land. As they do anyway.
Older farmers who want liquidity and need to consider stabilizing their total wealth should therefore add off-farm assets. For the farmer over age 50, a move to putting 50 per cent to 60 per cent of portfolio value into government and investment grade bonds not for growth, but for certainty of income, still makes a lot of sense. Finally, if a farmer or anybody else is in his 70s, stocks are too risky altogether to make up much of a portfolio. They can take a few business cycles to recover from losses and, contrary to what experts say, nobody really knows much about cycles over periods of many years when short ones overlap long ones.
AndrewAllentuck’slatestbook,WhenCanI Retire?PlanningYourFinancialLifeAfterWork, waspublishedin2009byVikingCanada.