The philosophy ‘Invest in what you know’, advocated by Warren Buffett, has been a popular guide for investors. The premise is that having specialized knowledge in the field should mean an investor can pinpoint strengths and weaknesses of the business, evaluate the industries climate and know when to make a move. But is this really an ideal strategy to follow for those in agriculture or is it placing all your eggs in one basket?
- Why Invest Off Farm
The main objective of investing off farm is to increase diversification of your broader wealth and ultimately reduce risk. Other reasons are:
- To smooth out the volatility of your farming returns;
- To provide an income stream during retirement;
- To help with succession planning;
- To provide an alternative source of funding during periods of lower agricultural returns;
- To reduce reliance on debt funding.
- Considerations prior to investing off farm
When investing off farm it is important this is considered in conjunction with your farming enterprise to maximise the diversification benefits. In essence this means your off farm investment portfolio should have a low correlation to your farming enterprise.
- You need to be clear with the reason for investing off farm and the time frame for the investment, as this will impact the type of investments you access and your return expectations.
- It is important to ensure you seek the appropriate advice with regards to investing in the correct entity for tax efficiency purposes.
- Focus on asset allocation and risk management
Asset allocation is the foundation of every investment portfolio. Studies have shown that 90% of returns are generated from utilising a diverse and suitable asset allocation strategy. It is difficult to predict what the future holds i.e. commodity prices, property values, interest rates etc, but having a tailored asset allocation and risk management framework helps to reduce risk and volatility of returns and therefore provide more predictable and consistent outcomes.
Everyone will have a unique set of objectives encompassing investment horizon, income requirements, capital growth requirements, risk appetite etc. It may be of benefit to seek specialist assistance to develop an asset allocation capable of reaching these individual long term objectives, whilst also maintaining the flexibility to react to changes in market conditions.
- Portfolio Construction – focus on growing cash flows
The key to building an investment portfolio is to build a portfolio of sustainable and growing cash flows and once this is achieved everything else will take care of itself. The below chart illustrates this point. Active management of your investments is important to minimise exposure to companies that cut their dividends as can be seen in 2016.
The above graph highlights that it is not the starting yield that is important, however, it is the growth in the income stream over the long term that will provide much better outcomes for investors.
For those in the agriculture industry, holding stocks in companies like Graincorp, Murray Goulburn and Costa is a common choice. But when it comes to managing risk in investment decisions through diversification, farm assets must be considered as part of your portfolio. This means, that to diversify and reduce risk, it’s important to look for companies away from your field and spread those eggs.
A guest blog with Wiliam Richardson, Evans and Partners