Why farmers make good investors

We have a lot of clients from farming backgrounds, either past or present.

They’re great people, and many have spent decades overcoming a plethora of challenges to build very successful businesses.

When the time comes to think beyond the farm, investing in a portfolio dominated by shares, listed property, private equity and fixed income doesn’t always come naturally.

Having less control and influence is a mental hurdle for some, while diversifying far and wide can also be a new concept.

However, farmers that can get their head around these differences often become very astute investors.

As we gear up for Fieldays this year, let me share six reasons why farmers can make good investors.

They appreciate that risk can come from anywhere

Farmers can be cautious, slightly cynical at times, and even a little grumpy. You’d never hold that against them, and that thoughtfulness often serves them well.

Farmers have an awful lot of risks to consider, many of which are outside their control.

Commodity prices, interest rates and the currency are obvious ones, and these are often driven by global factors that are difficult to predict.

Government policy changes are an ongoing risk, most obviously here at home but also offshore. If incentives or regulations change in other countries, that can impact the cost structure or supply response of other regions.

Then there’s the weather. Even if you get everything right, a bout of bad weather can torpedo an entire season.

Share investors have an equally long list of things to worry about, and many of these are just as hard to predict.

Like farming, investing success is as much about risk management, as it is about picking the right stocks or forecasting where markets are headed.

They know the long-term is more important than the short-term

Keeping your eye on the long game can be difficult, especially when you’re in the thick of a bout of short-term market turmoil, but it’s non-negotiable for any good investor.

The return from US shares since 1945 has been 11.3 per cent per annum (including dividends), with positive returns coming in any 12-month period on 78 per cent of occasions.

However, over short-term holding periods the variation can be huge. The best 12-month period was a 60 per cent gain, and during the worst US shares fell 41 per cent (that was in the GFC).

It’s not dissimilar with farming. Anything can happen over the short-term and bad years are simply par for the course.

Like a great piece of land, a good quality share portfolio will just about always do well over the long-term, which is what most of us are investing for.

The hard bit is keeping your cool when the short-term is looking more difficult.

They understand that fundamentals always trump fads

Fashion and fads will always come and go. Along the way, prices and valuations can get out of whack, while markets can become overly pessimistic or exuberant.

However, the value of an asset is ultimately a function of the cash flows and returns it can generate, even if those are some time away in the future.

Investing in quality assets (be it land or businesses) that are difficult to replicate, generate solid returns, and which are exposed to long term structural trends will always trump jumping on the latest bandwagon.

They have a history of innovation

New Zealand is blessed with a climate that lends itself to successful agriculture, but our farmers have also been very innovative over the years.

In part, this was forced upon many after farm subsidies were removed in the 1980s, during a period where other parts of the world benefitted from more generous government support.

This need for constant improvement, innovation and reflection will resonate with investors. If we look at the world’s most dominant companies from 30-40 years ago, few of these would find themselves on the same list today.

The farming landscape will continue to evolve, as will the economy, while sharemarkets and companies require constant scrutiny.

Those who embrace change and appreciate that nothing is set in stone are best placed for continued success.

They understand leverage can be a double-edged sword

The financial term for using other people’s money to invest is leverage. When asset prices are rising, leverage can make you very wealthy, supercharging your returns.

However, in a flat or falling market high debt levels can do the opposite, by magnifying your losses.

Many farmers have lived through an era of much higher interest rates, and some will have seen their peers get into trouble by overpaying and overleveraging.

When it comes to analysing companies, balance sheet strength and an ability to ride out a potential downturn is a key attribute investors should look for.

They recognise the need for growth assets

Many farmers will remember the 1970s and 1980s, when inflation was running at an annual rate of more than ten per cent.

Even at just three per cent, inflation is still the enemy of investors and those looking to maintain their spending power.

Over 10 years inflation of this level will reduce the true value of your capital by more than a quarter.

Land has always been a great asset for those looking to insulate themselves from the scourge that is inflation.

Growth assets like listed property, shares and interests in private companies can help continue this after the farm has been sold.

In the last 50 years, New Zealand shares have returned 9.6 per cent per annum (including dividends).

Over the same period, the average inflation rate has been 5.5 per cent (inflation was very high in the 1970s and 1980s, before slowing markedly from 1990 onward).

That means the local sharemarket has provided a real return (which is the annual return in excess of the inflation rate) of 4.1 per cent per annum.

Shares provide returns from capital growth, as well as dividend payments. Capital growth comes from a rising share price, while dividends are an income stream that is paid by the company to shareholders out of profits.

Great companies endeavour to steadily increase earnings and dividends over time, which provides investors with another element of inflation protection.

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