Returns, Risk and Liquidity

Having spent a week in Europe it is clear that there has been a sea change in the investment world.  The change has probably been there for a while but there is nothing like breathing it to bring the message home.

Investors treasure three things;

• Returns.  Depending on the asset class they are looking for a mix of regular cash flow and capital growth.
• Risk.  This is a mixture of the risk that the original investment will be lost and the returns will be less than forecast.
• Liquidity.  "I have made an investment but how do I get out."

The problem is that the normal rules applying to traditional asset classes have fallen away (the theory is that share markets can be risky but provide good returns and that bonds provide low returns but are safe).

Let's take the share market.  Returns have stagnated - on average an investor has 'enjoyed' a nil return between 2000 and 2010.  And the general issues that have affected the world economy is affecting company profitability and increasing investment risk.  The share market is liquid, but that is only 1 out of the 3 investment requirements.

The bond market (i.e. deposits), a traditional safe haven, is also in trouble.  Yields are very low in the relatively safe markets of Germany and the US - in some cases at or below the rate of inflation.  But where returns are high (Spain, Italy) that's because there is more than a decent chance that there will be loan defaults or write downs.  So the risk versus return matrix doesn't look very good at the moment.  Bonds are relatively liquid but again, that is only 1 out of 3.and can come at a cost.

That leaves real assets - property and commodities.  Even this asset class won't be immune.  But as noted by Warren Buffet, assets like farms produce products that people need.  With increasing food demand from population growth and growing middle classes (albeit not growing quite as quickly),irrespective of the currency, prices will lift in real terms.

We think NZ dairy ticks the box of returns that are very adequate for the risks taken.  Dairy is 80% a tangible investment in land and stock and despite weather variability, fluctuating commodity prices and exchange rates, an investment in a good farm has been rewarded - at least in modern times.

One disadvantage of a farm investment is the lack of liquidity.  It takes time to sell a farm; it takes time to sell shares in a dairy farm business.  However in designing our investment model MyFarm has addressed this issue to the  degree possible.

Firstly, we buy good farms.  Good farms sell readily - with an excellent prospect of getting a good sale result in say 8 out of 10 years (very few farms sold at fair value during 2010).

Secondly, we work hard at share sales.  In the last 12 months we have sold $8 million worth of shares from investors seeking to exit their investments early.  In all cases the sale was transacted within 2% of the asking price.  We don't always get a quick result but we do far better than any other farm investment business in New Zealand.

So what to do?  At MyFarm we are not financial advisers.  And tenets of asset diversification apply.  But dairy still looks a very good bet.