ESG Frontiers: The investor risks and opportunities in the global agriculture sector

The UN Food and Agricultural Organization said five years ago there were only have 60 good harvests left.

Last month, a report surfaced in Australia in which the government was urged to find A$1bn (€622m) to help the agricultural industry manage its continuing environmental degradation.

It was one of 22 proposed reforms intended to protect both agricultural development and the environment. It called for “careful risk-based management” to protect “the future of Australia’s valuable environmental assets and important agriculture industry”.

The report is the latest in a growing number of warning signs that the agricultural industry is in the sights of lawmakers, civil society and investors for its poor sustainability performance.

The IPBES report earlier this year called for an overhaul of agricultural practices, warning that rapidly deteriorating biodiversity would have grave consequences for much of the world population. The latest technical report on the EU green taxonomy, which identifies key activities for climate change mitigation and adaptation efforts, laid out how farms can qualify as sustainable under the new definitions – stipulating that they either demonstrate a bundle of prescribed farming practices, or show specific outcomes with regards to carbon emissions reductions and sequestered carbon.

This intensifying political interest means firms are increasingly finding themselves exposed to regulatory risk. One example of this is the growing social and political pressure to limit the use of agrochemicals, as the European Commission and others actively consider limits or bans on substances like glyphosate. It’s not just real assets investors that this is relevant to. Every major index has exposure to consumer goods companies and food retailers – in the S&P500 it’s 7%; in the FTSE100 it’s 16%.

According to Andrew Voysey, Senior Associate at farm management company Soil Capital, many conventional suppliers to food brands and supermarkets are dependent on herbicides, insecticides and fungicides for productivity. Voysey says this is a transition that brands need to be thinking about: “It’s not possible to change overnight – so brands will need an orderly transition of their supply base.”

The food system has been estimated to contribute up to 30% of global GHG emissions, with agriculture representing a particularly significant part of that, and it’s also exceptionally water intensive. FAIRR and Ceres have been heading up a collective engagement project asking fast food chains to improve governance and disclosure of climate and water footprints, all along their supply chains.

Piet Klop, Senior Advisor Responsible Investment at PGGM, one of the investors involved in the engagement, said they were working with companies in a way that is consistent with the Task Force on Climate-related Financial Disclosures (TCFD). “We’re looking for well governed and well thought through scenarios in a carbon and water constrained world. What happens when companies have a high dependency on things that are going to be increasingly scarce, whether that’s water, land or the right to emit carbon?”

But agriculture isn’t just a driver of climate change and biodiversity loss – it is also particularly vulnerable to the effects. James Hulse, Advisor to the Natural Capital Finance Alliance, says there are huge risks around stranded assets, citing swathes of agricultural land ravaged by extreme weather in Australia.“With climate change we know things that have never happened before are going to happen, but we don’t know when,” he says. “If you have a big drought somewhere, there’s a price impact and it’s not huge. If you have big drought in two places, then you see a big spike – and that hurts for six months or a year. What we haven’t seen yet is multi-year droughts in places like Australia and the Mid-West, causing companies to go bust. At that point it’s going to get really ugly.”

Hulse says biodiversity loss poses potentially systemic threats too. Pollination collapse would put up to $600bn crops annually at risk, potentially leading to sector-wise losses for agriculture and food companies. “Understanding whether these risks are priced into the market is something investors should be looking much harder at.”

Tools and frameworks are cropping up to map these potential risks through a ‘natural capital’ lens – in other words to begin to assess dependencies and impacts on the natural world that have until now been undervalued at best, and at worst economically invisible.

The Natural Capital Finance Alliance’s ENCORE (Exploring Natural Capital Opportunities, Risks and Exposure) allows users to map every sector and sub-sector to their natural capital dependencies, country-by-country. Mark Campanale and Nick Robins’ forthcoming Planet Tracker initiative is on a mission to translate ecological collapse into material risks that can be factored into valuation models used by investors and analysts.

PGGM’s Klop says the future of responsible investment, not only in agriculture but across numerous high-footprint sectors, will be brought about by technology allowing extensive mapping of assets. “We are going to have to get better at geo-locating the risks as well as the beneficiaries of particular solutions,” he says. “If you can combine the locations of where the impact is – whether it’s positive or negative – with the ownership of the land or who’s delivering the solution, then I think we really have a big break in the next evolution of responsible investment.”

But there are also opportunities that investors are looking to tap. ‘Responsible nutrition’ is a sub-theme in AXA IM’s ‘Clean Economy’ fund, which portfolio manager Amanda O’Toole launched in December in a bid to play the listed equity space to harness the potential of clean technologies. For O’Toole, companies working to improve resource optimisation and water scarcity management are just one example of compelling investment opportunities all along the supply chain which she says are often going missed.

“The fund is addressing the reality that there is a huge amount of waste in the entire supply chain. We look at companies that are adopting sensor technologies, camera technologies and fairly basic A.I., and using them to improve efficiency.” She says it’s a win-win for farmers, investors and the environment. “These companies represent a long-term structural growth opportunity for our investors because they have the strength of distribution in a very large market where penetration is very low. They’re great for the farmers because they save money very quickly, and they obviously have a really significant impact on water use and chemical applications.”

PGGM, meanwhile, invests in “food security” – meaning investing in solutions for food shortages, such as efficient food production and food quality – as part of their broad Investing in Solutions program, with the bulk in public equities. The investments within this include Hexagon, which helps farmers minimise water and fertilizer use, and Trimble Navigation, which sells navigation and positioning systems and information management solutions that enable farmers to cultivate their land more efficiently.

AXA IM’s O’Toole says her strategy is underpinned by the idea that there is a fixed supply of many valuable natural assets that the market has so far been mispricing. “Whether it’s our water supply, land availability or rare minerals, there’s increasing demand on our resources which is only going to continue,” she says. “That’s concentrating
minds on the way that we should use and price these assets. I think we’re right at the start of that transition in practice.”

Others, meanwhile, look for opportunities where 95% of the world’s food is grown – in the soil. Soil Capital’s Voysey, whose firm works with investors, farmers and business to scale “regenerative agriculture”, meaning farming practices that put life back into – rather than take it out of – farmland.

According to Soil Capital, modern industrial agriculture is fundamentally killing the soil and its capacity to continue to feed the growing global population – and merely improving efficiencies of the current system is missing the point. “In the last 40 years we’ve lost a third of our arable land globally,” Voysey says.“The UN Food and Agricultural Organization said five years ago that if we continue on this course globally then we only have 60 good harvests left. That’s a grim context for food brands to be working in.”

Voysey says there’s a good news story on the flipside, though. “If you farm in a way that brings life back into your soils, you start to deliver some outcomes which are really commercially interesting to the buyers.”

Voysey says it’s a common misconception that adopting better farming practices costs more. In fact, the opposite can be true, if managed correctly. “We’ve learnt that if you design the transition of a farm to be more gradual rather than abrupt and aggressive , and you adopt a financial and business mindset to identifying upfront savings, you can actually transition farms and improve their profitability from Year 1.”

Companies themselves are starting to recognise the commercial and financial significance of healthy soils. Danone has set procurement targets for 100% of their sourcing in France to be from regenerative farming by 2025, a starting point for a planned later global roll out. General Mills is starting with the public commitment to regenerate a million acres of crop land.

Voysey says we’re right at the start of the investor base being educated about this. “These companies are starting to identify strategic value drivers, so shareholders should be educating themselves, engaging with investee companies, and ultimately reallocating capital to make sure they’re on the right side of that shift.”