With prices on the increase, some see this as a good time to invest in the food industry. It can be a volatile sector, however, and there are ethical issues too

A COMBINATION of rising demand from emerging countries, drought in the US, and the growth in the production of new forms of energy is pushing food prices to new highs. If you would like to offset the hit your wallet takes, you could hedge your bets by buying food-related investments. You could make a good return, but investing in commodities is not for the faint-hearted and there are ethical considerations to keep in mind.

Food prices have faced upward pressures for some time now, thanks to increased demand from the emerging middle classes in countries such as India and China, and the use of food, such as corn, in the production of biofuels – almost half of US corn production is now used in this context.

The situation was exacerbated this summer by a drought in the US, the worst to hit the midwest in 56 years. This alone pushed up the price of corn by more than 20 per cent in July, and investment banks, such as Goldman Sachs, are forecasting further hikes in the short term. Producers of consumer foodstuffs, including Nestlé and Kraft, have already warned that they will likely pass on the increasing costs to consumers.

In the long term, there is serious potential for the sector. Investors such as Jeremy Grantham, of the $100 billion Grantham Mayo fund, recommends a 30 per cent allocation to resource-related investments such as farms and fertilisers, while Warren Buffet has expressed a preference for the sector. Earlier this year, he said “productive assets” such as farmland will far outperform non-productive assets such as gold or currencies in the years to come.

“A century from now, the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton and other crops – and will continue to produce that valuable bounty, whatever the currency may be,” he said.

So if you are convinced of the merits behind the arguments, what are the options for Irish retail investors?

There are a number of ways of getting exposure to the food sector, including purchasing stocks outright, but the main option is to invest in commodities through an exchange-traded fund (ETF) or an index fund that is linked to commodities futures.

The advantage of having an allocation to commodities in your portfolio is that they tend to behave counter to traditional asset classes, such as equities. So, while stock markets have been treading water for the past number of years, commodities have been roaring ahead. This can bring risks, with some analysts warning of a potential bubble in the sector.

Commodities can protect against inflation, as their value tends to rise in line with prices, which could be useful if inflation takes off.

Remember that when investing in commodities, you incur a currency risk in the underlying asset, as most commodities are denominated in US dollars. Also, they can be extremely volatile investments, so a cautious allocation is usually warranted.

As Liam Igoe, an analyst with Goodbody Stockbrokers says, we are heading into the third peak in food prices over the past five years. “Every time prices go up, commentators say it’s a permanent change, but they’re volatile,” he says, adding that when it comes to commodities, you’re pretty much taking a straight gamble on prices going up or down, which can heighten the risk.

“You’d want to be keeping your finger on the pulse. Even if you buy at the right time, you have to know when to sell.”

If you still have an appetite, one of the easiest and cheapest ways of investing is to do so through an exchange-traded fund (ETF).

Irish investors can buy such products through a stockbroker, paying a broker transaction charge and a low annual management fee, typically about 0.5 per cent.

IShares, which is run by Blackrock, the world’s largest asset manager, offers the iShares SP Commodity Producers Agribusiness ETF, which aims to track the performance of the SP Commodity Producers Agribusiness index. This index invests in publicly-traded companies involved in the agriculture business worldwide, with major holdings including seed producer Monsanto and agricultural equipment maker Deere Co. The annual fee is 0.55 per cent.

Another option is the PowerShares DB Agriculture Fund, managed by Deutsche Bank, which tracks changes in the DBIQ Diversified Agriculture Index Excess Return. It has a 12.5 per cent allocation to corn, soybeans and sugar, and has fallen by 12 per cent in the year to June 30th. It has a management fee of 0.85 per cent.

If you are looking for a unit-linked fund structure, there are a couple of options on the Irish market, which track an underlying index, usually through an ETF. These typically attract higher charges than purchasing the underlying ETF outright however. Irish Life’s Indexed Commodities Fund tracks the Goldman Sachs Light Energy total return index. This has an exposure of 36 per cent to agriculture and 10 per cent to livestock, and is up by 9.2 per cent in the year to July 31st.

Zurich Life also offers an index-linked fund, the Global Commodities Fund, which tracks the Goldman Sachs Commodities Index – Total Return (GSCI). This fund covers all the major commodities, including agriculture and livestock. It is down 7.3 per cent in the year to June 30th.

If you are prepared to pay extra for management charges, you could opt for an actively managed fund. Bear in mind that just because you pay more in fees doesn’t mean the fund will outperform the index.

Rabodirect offers funds from Swiss investment group Sustainable Asset Management, which specialises in sustainable investing. Its Agribusiness equity fund invests at least two-thirds of its total assets in global agricultural stocks or in stocks that profit from developments in the agricultural sector.

Its largest holding is Titan International, which produces tyres for farming equipment, while it also has significant allocations to chemical firm DuPont and fertiliser manufacturer Agrium. The fund is up almost 15 per cent in the year to August 21st, but this will be offset somewhat by entry and exit fees of 0.75 per cent, as well as an annual management fee of 1.5 per cent.

Another option is to find a play on food prices through investing in food companies. Picking a stock will depend, however, on whether the company is a seller or user of commodities. In this regard, though it has weathered the storm of rising food prices well to date, Kerry Group is at risk of an upward trend in commodities, while other stocks, such as Origin Enterprises, will benefit from them.

If you decide to take a punt on food prices rising, bear in mind that the world’s poorest are hit hardest by rising costs. Some argue that money pouring into investments in the sector and speculation are fuelling price hikes.

Earlier this month, Germany’s Commerzbank removed agricultural products from a commodity index fund after such accusations, while Deutsche Bank has indicated it will not release any new investment products based on agricultural commodities until it is sure of the impact on food prices.