Off-farm investments - are they worthwhile?

Abstract

Many farmers traditionally maintain most of their capital in the farming business. This seems to occur not only when all available capital is required to purchase the farm, but also later in the farming lifecycle when expansion or intensification is considered. From the investment practitioner's point of view this behaviour would appear to be sub-optimal, at least at first glance. Most investors in financial assets do not place all of their wealth in one asset, but choose to spread their wealth across a range of assets in order to limit the impact of a major loss in one of those assets. The potential benefits from this diversification process are noncontrovertible when one is limited to a universe of financial assets. That farmers remain undiversified may in part be rationally explained by the unique characteristics of the farm investment. The most obvious of these is that the farmer is required to accumulate a high level of capital in order to purchase a viable farming unit in the first place. At least for the first few years after the farm has been purchased, it is unlikely that the farmer has any surplus cash available for investment in other assets. Further, it appears that many farmers anticipate expanding their operations once the initial position has been consolidated, and this again forces the farmer to invest all of their available capital in the farm business. Thus, the ability to even contemplate off-farm investment is very dependent on the farmers current level in the faming lifecycle. With these points in mind, it is obviously not possible to clearly demonstrate that offfarm investments are suitable for all farmers. Rather, the intention of this presentation is to provide a framework within which the general features of diversification can be discussed. This is done using some standard paradigms from the world of financial economics, and by imposing the restrictive assumption that an investment in farming can be treated just as any other asset. Such an assumption clearly contradicts the fact that the farm asset will form the cornerstone of the farmers entire investment portfolio, and that that asset is held for reasons that cannot necessarily be quantified in financial terms. The remainder of the paper proceeds as follows. Firstly I will briefly discuss some standard ways of quantifying financial performance. Secondly I will describe the potential benefits from diversification into various other asset classes, and thirdly I will present some simple examples to demonstrate those benefits.