Investors sometimes use what’s known as a Sharpe ratio to compare an investment’s returns to its risk.
Named for the Nobel Prize-winning economist who created it – William F. Sharpe – it’s essentially a reward-to-risk calculation where the biggest ratios are prized because they signal higher risk-adjusted returns.
The figure can be particularly helpful in judging performance over long periods, where the economy has had enough time to experience both boom and bust cycles.
The S&P 500 sets the benchmark and scored 0.4 when looking at Q1 year-over-year returns from 1997-2021, according to a primer on the U.S. farmland sector developed by Green Street Advisors. That’s slightly lower than the 0.6 Sharpe ratio for the U.S. corporate bond index.
Farmland fared much better than both.
Green Street found that U.S. farmland earned a 1.2 mark over the same 25-year period (estimated using the NCREIF Farmland Index, a dataset maintained by the National Council of Real Estate Investment Fiduciaries).
In layman’s terms: farmland has delivered steady long-term returns while exhibiting less volatility than equities.
It’s outperformed other forms of commercial real estate, too. The average for real estate investment trusts (REITs) representing major sectors, such as offices, warehouses, and retail, was a 0.4 over the same time horizon.
And as Green Street notes, farmland returns have proven to be less correlated to other asset classes, including stocks, bonds, and other forms of real estate, which creates a powerful hedge and offers diversification opportunities.
Risk is something we are always closely analyzing when considering acquisitions for our portfolio. For example, different crops carry different risk profiles.
The same report explained that primary row crops like corn, soybeans, wheat, rice, and cotton carry less risk than permanent crops like tree nuts and citrus.
Why? Because row crops are planted every year whereas trees live for 10-25 years, and in some cases even longer. Row crops are also more resilient to weather challenges, historically generate more dependable outputs, and have more stable markets.
But that doesn’t necessarily make them better. Permanent crops are generally more valuable products and have the potential to generate higher returns. Essentially higher risk and higher reward potential.
So where does our portfolio fall?
By value, approximately 70 percent of our farms produce row crops and 30 percent permanent – not coincidentally, the same general makeup of the U.S. agricultural industry.
This mix, we believe, provides an index-like portfolio that mirrors the nation’s unique crop diversification. And that mix enables investors to capitalize on the established strengths of America’s agricultural community while becoming better insulated from possible changes in consumer preference.
That’s pretty Sharpe.