Agricultural ETFs : an adequate investment for private banking clients ? The Case of BEMO EUROPE : Banque Privée

Details

Supervisors

Grégoire, Philippe

Faculty

Louvain School of Management

Degree label

Master [120] en sciences de gestion

Abstract

Agricultural ETFs - An adequate investment for private banking clients? The Case of BEMO EUROPE - Banque Privée Summary CONFIDENTIEL Promoteur : Philippe Grégoire Mémoire-projet présenté par Pit Schram - 5871-10-00 en vue de l'obtention du titre de Master en sciences de gestion ANNEE ACADEMIQUE 2014-2015 This paper provides insights on a relatively new way to address agricultural investments, namely via exchange-traded portfolios. The investment fund industry is large and complex. While BEMO EUROPE - Banque Privée has until now mostly offered various types of open-end mutual funds, this paper explores the field of exchange-traded portfolios. We analyse in more detail the functioning of Exchange Traded Funds (ETFs), how they differ from open-end mutual funds and from Exchange Traded Notes (ETNs). Even though ETNs generally have a smaller tracking error, they bear additional risks in case the issuer defaults. On the contrary, ETFs are collateralized via the underlying assets, leading to less risk for an investor in case the issuer defaults. This strongly secured structure, combined with low administrative costs, is a key positive consideration of ETFs compared to open-end mutual funds. After assessing the advantages and risks of ETFs as a financial product in general, we assess the reputational risk of investing in the agricultural sector by analysing various ethical considerations. We show that there is common ethical ground for investing in agricultural commodities, land and production sites, biofuels, and even in biotechnology. Nevertheless, in many cases, scientific sources provide diverging results, depending on the author's methodologies, hypotheses and convictions. In addition, mass media does not always provide objective statements, especially not during the food crisis of 2007-2008. Statements have often been highly populist, presenting a scapegoat rather than the true root of the problems. As a result, mass media has created a poor public perception for these types of investments. Recent cases of bad publicity for other financial institutions offering investments in agriculture show that reputational risks remain serious factors. The economic outlook on the sector indicates the cyclical nature of this market. Apart from the traditional forces of supply and demand, we observe that the market is strongly shaped by political forces. In a nutshell, we see that efficiency gains across the value chain remain a value creator, as arable land is limited. This effect will be strongest in emerging markets. This is also seen in those countries with the highest overall growth potential, especially in countries where strong population growth, rising incomes, and increasing urbanisation rates is accompanied by stronger protein-based dietary habits. Commodity prices will remain volatile and represent a major calibration tool between supply and demand. Thus, taking a broader view on the sector via investment funds makes sense, as growth will appear across the various parts of the agricultural value chain and not necessarily at a primary production level. The empirical finance literature on agricultural assets in investment portfolios remains fairly limited; many of the studies are based on relatively old data with a strong focus on the US market. Farmland investments are usually represented only via price indices, rather than real market values. Common findings are that agricultural assets generally represent competitive risk-return properties as compared to other assets, while also having a low correlation with traditional asset classes and a positive link with inflation. The part of an investor's wealth invested in agriculture varies not only with risk tolerance, but also over time. While farmland investments play a generally stronger role in low-risk portfolios, agribusiness stocks are increasingly present as risk tolerance increases. The latter stocks also represent stronger correlations with the overall stock market, especially in the lower tails of the returns' distributions. This makes it questionable that such stocks could be used as a proxy for real farmland investments for diversification purposes. The theory further suggests that investments in agricultural commodities should be done via managed futures and not through the use of a passive portfolio management approach. However, the use of ETFs, ETNs or farmland REITs has not previously been elaborated. Our study focuses on modern portfolio theory, developed by Harry Markowitz in 1952, to analyse whether investments in exchange-traded portfolios would be a good choice for private banking clients in the case of BEMO EUROPE - Banque Privée. The results suggest that the considered ETFs had less positive risk-return properties as compared to other funds offered by BEMO. The agri-ETFs showed generally high correlations with the overall stock market and with other equity funds offered by BEMO. Indeed, they generally reflected the properties that previous studies had found for agribusiness stocks and less the properties of farmland. As we set maximum weight constraints in the portfolio construction, we saw that the Powershares DB Agriculture ETF, specialized in agricultural commodities, was a major player for global minimum variance portfolios and low-risk portfolios. The Pictet-Agriculture ETF played a strong role in low- to medium-risk portfolios, while the RobecoSAM Sustainable Agriculture ETF was strongly present in medium- to high-risk portfolios. Overall, we found no evidence that agricultural ETFs have similar diversification properties as farmland and other agricultural assets, as indicated by previous studies. Despite the fact that they regularly enter optimal portfolios, they show traits that are comparable to other equity funds, rather than behaving like a special asset class. As the differentiating characteristics we sought have not been revealed and a reputational risk still persists, we do not advise BEMO EUROPE - Banque Privée to add such an ETF to their short list. Nevertheless, in case a client specifically suggests investing in agriculture, relationship managers should keep the Powershares DB Agriculture ETF, the Pictet-Agriculture ETF and the RobecoSAM Sustainable Agriculture ETF in mind, dependent on the client's level of risk aversion.

Citations

• APA

Schram, P. (2015). Agricultural ETFs : an adequate investment for private banking clients ? The Case of BEMO EUROPE : Banque Privée. https://dial-mem.test.bib.ucl.ac.be/handle/2078.2/15306