Agriculture missing from broad sweep of ETFs in local market
• Zeder and Oceana could be part of the mix with food processors and chicken producers
Among investors it is assumed that there is a strong relationship between taking on more risk and earning higher returns. This is because if investments are risky, investors require a higher return to compensate them for taking on the additional risk.
Examples of risky investments include newly formed companies with no track record, or companies that operate in high-risk industries such as agriculture or technology.
However, what investors must keep in mind is that even though a higher return is expected, it is not guaranteed — especially in the short term. Companies can liquidate and entire industries can become obsolete, leaving investors vulnerable to losses.
Based on this economic theory and presuming that investors are saving for retirement, the younger investors are the more risk they should be willing to take on. This is because even if the economy collapses the average investor has a long enough remaining lifespan to recover from the recession and reap superior returns from the additional risk before reaching retirement age.
This implies that purely risky investments are not viable for senior investors or for individuals who rely on a steady income stream from their investments to pay the bills. In these cases, investors are more likely to invest in highly liquid, low-risk investments such as bonds, debentures and equities that have significant market capital positions on regulated exchanges such as the JSE.
Nevertheless, investors can hold risky stocks if they have suitably diversified portfolios. By holding investments in many different industries and markets, investors are less vulnerable to a single-industry catastrophe obliterating their savings.
In terms of equity investments, financial advisers usually recommend choosing a few key industries to invest in and then, based on the individual investor, recommend specific companies within those industries.
One of the many methods of reducing risk exposure is to invest in exchange-traded funds (ETFs) instead of directly in the equities themselves.
This means the investor holds shares in all the companies or investments that make up the index of the ETF, in proportion to the client’s investment into the ETF. The investor then earns the returns of those holdings, less a management fee.
In comparison with mutual funds, ETFs are cheaper, more diversified and offer better trading and arbitrage opportunities. Although these arbitrage opportunities exist, ETFs are mostly used for long-term investing.
They allow investors to invest in a class of asset such as retail, without limiting their exposure to a specific company within retail.
Typically, an index will be formed to meet demand for an explicit investment type, such as the Ashburton Top 40 ETF. This, as indicated by its name, is made up of the 40 companies on the JSE with the most market share. Other ETFs are formed to give investors exposure to overseas markets or to resources or anything else that investors have a high enough demand for.
One of the riskiest asset classes that is not yet represented in the South African ETF market is agriculture. For an industry that is highly susceptible to weather changes, has abnormal income streams and whose prices — especially in the beef market — are relatively unregulated, agriculture can still provide significant returns. This is largely dependent on the GDP growth of the country, as well as import and export tariffs. However, agriculture serves as an anchor industry to many finished consumables and as its demand stems largely from population growth it is highly unlikely that the industry will not be able to provide value in the long run.
The lack of an agricultural ETF in SA could be chiefly due to agriculture not being represented sufficiently on the JSE. Although commodity trading makes up a large portion of daily trades, the equity investments available in the agricultural field are found wanting. Similarly, ETF curators could be concerned about whether there is adequate demand in the market for such an investment.
If an agricultural ETF were to be formed, it would probably contain Zeder and Oceana, which are the largest and most liquid agricultural companies listed on the JSE. If the ETF spanned other platforms, it could potentially include TWK Investments, a company that is focused on timber and grain, which has recently listed on ZAR X, along with Senwes, an agricultural co-operative.
Due to the apparent lack of primary agronomic companies, the ETF could alternatively contain food-processing companies such as Illovo Sugar, AVI and Clover. Similarly, chicken producers such as Country Bird Holdings, Astral Foods and Rainbow Chicken could be considered.
A limiting factor, however, is that most of these companies have very small market positions, which would lead to difficulties when the ETF is rebalanced and could lead to volatile market prices as the shares are thinly traded.
In the meantime, while SA waits for the seed of an agricultural ETF to take root, investors can take advantage of their foreign tax limits by participating in the PowerShares DB Agriculture ETF or The Teucrium Agricultural Fund.
Even though both ETFs have significant exposure to commodities, and to a lesser extent agricultural enterprise, beggars can’t be choosers.
INVESTORS CAN HOLD RISKY STOCKS IF THEY HAVE SUITABLY DIVERSIFIED PORTFOLIOS