Ag investors may need to be more selective in 2013

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Since the start of 2011, investors looking for exposure to the agriculture arena have been better served by holding specific futures contracts rather than taking a 'basket' approach via funds that hold an array of agricultural commodities futures.

Even funds that hold stocks of agri-businesses such as seed giant Monsanto N> and tractor maker Deere & Co have outperformed funds that diversify holdings across agricultural futures.

For 2013, the more focused approach looks set to pay dividends again, as each of the main crop and agriculture product markets are being driven by starkly different fundamental stories that all but guarantees that a group-based approach will lag more selective strategies.

THE USUAL SUSPECTS

As commodity markets emerged as one of the hottest sectors to invest in over the past 5-10 years, a slew of sector-specific investment vehicles cropped up that promised investors superior return or risk diversification potential.

In the agricultural space, the Deutsche Bank PowerShares Agriculture Fund has been one of the most popular options globally, with investors of all stripes finding the fund an attractive and convenient way to gain exposure to the world's most widely traded agriculture commodities. The fund tracks the performance of the Deutsche Bank Agriculture Index, a rules-based index composed of futures contracts in corn, soybeans, wheat, cocoa, cattle and a number of other markets. Total net assets held by the fund peaked at close to $4 billion in March of 2011 as decent returns since its launch in 2007 drew widespread investor interest.

An equally prominent vehicle in the equities arena has been 'MOO', the Market Vectors Agribusiness ETF (Exchange Traded Fund) which provides investors with exposure to the share prices of companies engaged in various aspects of agriculture, such as Monsanto (MON), the Potash Corporation of Saskatchewan, Inc and Deere & Co. Holdings in this fund surpassed $6 billion this time a year ago, and it remains by far the largest agri-related vehicle in terms of overall holdings.

Other well known vehicles designed to offer exposure to the agricultural space include the iPath Exchange Traded Note (JJA), which is another index-based futures fund launched in 2007 that holds seven commodities futures that are rolled forward according to a pre-determined schedule, and DIRT, which was launched in 2011 and tweaks the futures basket approach a little by allowing the fund's managers more flexibility when rolling positions into forward contracts.

Outright holdings in JJA and DIRT are substantially smaller than either MOO or the DB fund, but remain popular benchmarks for investors looking for broad exposure to the agriculture arena.

A popular, more focused vehicle is the Teucrium Corn Fund which is a Commodity Pool that confines its holdings to an array of CBOT corn futures contracts. The total value of the fund topped $130 million in mid-201, and for most of its first year of existence managed to outperform front-month corn futures by a considerable margin.

However, with the exception of equities-based MOO, all of these vehicles have suffered from steep outflows of investor funds in recent months in a sign that investor interest in gaining or maintaining exposure to agricultural commodities could be waning.

PERFORMANCE MATTERS

A graph of the price performance of these popular agri funds versus the price performance of front-month corn futures reveals a potential reason for the recent deflation in interest in the investment vehicles. An investor who put money into each fund as well as into a futures trading account that contained a long corn position would have seen the corn futures account outperform nearly all the other options.

What's more, corn's impressive price performance in 2012 was fully captured by the futures account, but greatly diluted by the more general commodities funds as some agriculture markets fared poorly last year and so dragged down the returns of the basket as a whole.

So far in 2013, even the performance of a straight corn futures position has paled in comparison to the performance of the broader U.S. equities market, which has enjoyed one of the strongest starts to the year since before the financial crisis, and likely accounts for some of the additional capital outflows from commodities funds seen in recent weeks as investors move to re-deploy some of their resources into the equities arena.

At the same time, the prospect of large fresh crops out of South America, as well as a projected rebound in U.S. production in 2013 following last year's drought, has served to weigh on most crop and agricultural product prices so far in 2013, to further mute investor interest in the ags space.

That said, forward-looking investors will still find compelling opportunities within the agricultural realm this year, but in order to reap rewards will likely need to be more selective in their investment approach.

RIDING THE TREND

One of the chief knocks against the basket approach to investing in agricultural futures funds is the 'long-only' stance that those funds tend to take, meaning that investors in those funds can only be long the commodities contained therein. Such an approach works fine during broad-based bull rallies, but can obviously be detrimental to overall performance during bear market periods.

By contrast, investors dabbling directly in the futures markets can opt to be either long or short specific commodities, depending on their market view. This means that a trader or investor can benefit from price advances in commodities that they are long as well as from declines in commodities that they are short.

This flexibility allows futures traders to potentially benefit under any market environment, and even change their view from long to short or vice versa in response to changes in market conditions.

Going forward, investors looking to fully exploit moves in the agricultural marketplace will need to be similarly nimble, as many of the largest price moves could well be to the downside rather than to the upside should 2013 growing conditions prove to be consistently crop-friendly. Alternatively, should crop development conditions prove to be mixed this year, investors will need to be able to gain exposure to the upside of those crops which are suffering while gaining short-sided exposure to those which may be threatened with an oversupply situation come harvest.

At the same time, there are likely to be other crop and product markets that may largely tread water and head sideways for several months at a time in the absence of any clear-cut fundamental developments rather than follow any particular trend higher or lower.

This means that agricultural investors looking for strong returns will need to take a selective multi-pronged approach to market positioning this year, and so should steer clear of a passive long-only basket approach that could well do more harm than good should the contents of that basket feature more losers than winners during the investment period.


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