Over the years, possibilities for investors to engage in alternative and obscure bets on businesses and commodities have only become more plentiful. These opportunities are not only limited to professional investors, like Hedge- and Private Equity Funds, but also presented themselves to private investors. Bets on inflation, wind power, and cargo containers have given institutions and private investors more diversification alike. Another wide field that massively broadened its spectrum in the last years is ESG investing. Focusing a portfolio on not only gaining financial returns but also having a positive impact on the environment, society and political stability is more appealing today than ever before to investors everywhere. This investment style goes from just being conscious about avoiding specific industries going against ESG principles to investments strictly focused on providing an improvement to our planet. Exemplarily, this could be investments giving education to the poorest, fair compensation over market rates, or reforestation for endangered forests.
A new, emerging kind of investment on the interface of both developments are cocoa farms. Investment companies offering these engagements are advertising, on the one hand, the low-risk nature of exposure to an essential good – cocoa – as well as a complete independence from other return sources, like stocks or bonds. On the other hand, cocoa farms are promising green and ethical returns. Providers commit themselves to pay fair wages above market rates while growing produce only with ecological methods and careful cultivation practices.
In the following article, we want to check those claims by providing an overview of the investments themselves but also the market conditions for cocoa surrounding them.
We will begin by shortly analyzing the business models on which the investments are based and continue by examining the legal and financial risks. Furthermore, we provide a summary of the cocoa market structure as it currently stands and conclude by weighing the involved risks with opportunities for such an investment.
A new, emerging kind of investment on the interface of both developments are cocoa farms. Investment companies offering these engagements are advertising, on the one hand, the low-risk nature of exposure to an essential good – cocoa – as well as a complete independence from other return sources, like stocks or bonds. On the other hand, cocoa farms are promising green and ethical returns. Providers commit themselves to pay fair wages above market rates while growing produce only with ecological methods and careful cultivation practices.
In the following article, we want to check those claims by providing an overview of the investments themselves but also the market conditions for cocoa surrounding them.
We will begin by shortly analyzing the business models on which the investments are based and continue by examining the legal and financial risks. Furthermore, we provide a summary of the cocoa market structure as it currently stands and conclude by weighing the involved risks with opportunities for such an investment.
For our assessment, we analyzed three cocoa investment opportunities for institutional and private investors. The first provider, ForestFinance from Germany, allows individual investors to enter into a land lease and a service contract in Panama. The initial investment of 3000€ per hectare is then used to cover all the costs of both contracts and material costs. After placing the funds, investors must wait around four years for the first harvest to be sold and produce excessive cash flows to be paid out to them. In the following two years, the tree still grows so that any subsequent harvest should bear more fruit and cashflows grow over time. In year six not only the harvest will be sold but also the trees themselves, allowing for most of the predicted returns to be achieved. Similarly, Luxembourg registered 55 Amegreen Fund I uses investors funds to build two completely new facilities in Brazil and generate cashflows from harvests while providing an exit strategy after 6 to 8 years. To achieve that, 55 AmegreenCap allows investors to invest in a Luxembourg registered Alternative Investment Fund, which is managed by the investment firm. The last, and only example outside of South America, CacaoGrow from the Philippines, works in principle like Forest Finance in that investors lease land from private owners, which is then serviced by the already existing farm. CacaoGrow mainly differentiates itself from the other two opportunities by not providing an exit after a couple of years but instead offering a service contract over 20 years. This could, in theory, give the investors steady cashflows over many years. We explicitly say ‘in theory’ here, since the investments are subject to many legal and financial risks. On the business side, investors are not only exposed to price fluctuations on the market – which we will later address in more detail – but also to the risk of natural hazards. This could be fires breaking, extended dry periods in the farming areas, diseases and so on. ForestFinance addresses these risks directly on its website and names several countermeasures to limiting those risks in every stage of the investment’s cycle. The other two providers do not address the associated risk to such an extent even though they both advertise the great experience their staff has in carrying out farming projects of this extent. Next up, also legal risks of such an investment should be considered. For the Alternative Investment Fund the risk is quite clear; investors can lose all of the capital invested in the fund. In case the investment manager goes bankrupt, the investors have to look for an alternative one. With the two providers, the risk situation displays itself as slightly more delicate. In case of a direct investment – so in case of direct ownership of the asset by the investor – private person having funded the financing can be made liable for any charges arising from the servicing after the provider goes bankrupt. This is a risk Investors should bear in mind. It not only means that all the invested capital can be lost, but also further charges for the servicing and sale of the trees can arise.
However, for the risks taken over by investors, the providers promise returns contingent on the natural factors influencing the cocoa farm. In the best-case scenario, ForestFinance promises returns of 33% over the whole investment period. CocoaGrow in contrast forecasts returns between 11% and 16% p.a. – without accounting for possible currency fluctuations. 55 AmegreenCap does not state any direct forecasts of returns but highlights the big market opportunities for cocoa beans in the upcoming years.
The overall market situation for cocoa producers remains volatile overall. Recently the demand side has been mostly driven by the expansion of consumption in many developing countries, tied to the increase in middle-income families. According to the ICCO, the International Cocoa Association, consumption mainly takes place in three areas, Cocoa Butter, Liquid and Powder, which are transformed into three main product categories, namely Cocoa Confectionary products, Food and Beverage, as well as Cosmetics. But, in terms of sourcing cocoa from producers, there is no difference between those categories since all of those are based on the same cocoa beans and only differentiated by the overall cocoa quality used in production.
The demand side of the market is also strongly tied to global disposable income and therefore, is impacted by the overall economic climate. The effect of a decrease in total economic power seems to be ambiguous. Some studies point towards lower overall income, making households allocate more income to “smaller” luxuries like chocolate. Other studies indicate that lower incomes only lead to a decrease in chocolate consumption. On the supply side, however, as we will see, Cocoa is mostly characterized by the conditions under which the atomistic farms operate. Production is geographically limited to a handful of developing countries in South America, Africa, and Asia where it takes place on small, privately owned farms that are either operated by their owners or are run on land acquired through rights of “first cultivation.” The processes on these farms are - for the most part - not comparable to agricultural production in developed nations. This is mainly due to the fact that cocoa producers are able to capture only a small fraction of the overall value generation. For example, it is estimated that cocoa-producing households in Ghana and on the Ivory Coast earn around $2700 per year. Low incomes, as well as little organization among farmers, give almost no leeway for investments in advanced farming technology.
Furthermore, since the initial investment is large, relative to low household incomes, farmers tend to stay with cocoa production, regardless of changes in output prices – as changing the type of crop poses a financial risk too high for many households. This results in a relatively high price-elasticity in cocoa beans supply on the market and hence, to a strong dependency on the household incomes on overseas demand and world market prices. Apart from low technological standards and high dependence on demand, the atomistic nature of the supply side has another drawback. Even after several efforts, no real coordination among farmers takes place. This means that no coordinated efforts to manipulate world prices by suppliers should be expected in the upcoming years – as other big commodity producers/organizations do. The biggest influence on the supply side are environmental factors like droughts, storms, heavy rainfall. Most predictions of supply shortages are based on these risk factors becoming a more significant influence on the low-tech farmers through ongoing changes in the climate and more extreme weather conditions. In the face of this risk, more investment in farms and overall more sophisticated methods should be employed and already used procedures like agroforests used by ForestFinance and many other growers around the can already help to mitigate some of those risks. With this practice, farmers are cultivating more diverse farming grounds with plants of different heights and characteristics, providing support for one another, providing for an overall sturdier plantation without high additional costs. The big question is whether these practices can help overcome the limitations which might be set by environmental challenges in the upcoming years and whether these challenges will occur for all locations evenly or whether some locations like say Africa are less affected by climate change.
After considering all those factors, I want to come to a short conclusion. What is striking about those investments is their low correlation to classic stock and bond investments. Investors can get returns independent from the capital market conditions, but also provide a stable livelihood for people in emerging countries. At first sight, the promised returns do look attractive, especially since they can occur regularly under somewhat normal market conditions. Nevertheless, every investor, be it an institutional or a private one, should keep an eye on the huge risks associated with those investments. Not only will the plausible case of an upcoming economic deceleration have ambiguous effects, but also changes in the global climate are not easy to predict in their influence on farming in different parts of the world. However, as this field of investment develops further, it could evolve into a new building block to a successful investment portfolio, not only in terms of money but also for an ethical return.
Tobias Schmidt
However, for the risks taken over by investors, the providers promise returns contingent on the natural factors influencing the cocoa farm. In the best-case scenario, ForestFinance promises returns of 33% over the whole investment period. CocoaGrow in contrast forecasts returns between 11% and 16% p.a. – without accounting for possible currency fluctuations. 55 AmegreenCap does not state any direct forecasts of returns but highlights the big market opportunities for cocoa beans in the upcoming years.
The overall market situation for cocoa producers remains volatile overall. Recently the demand side has been mostly driven by the expansion of consumption in many developing countries, tied to the increase in middle-income families. According to the ICCO, the International Cocoa Association, consumption mainly takes place in three areas, Cocoa Butter, Liquid and Powder, which are transformed into three main product categories, namely Cocoa Confectionary products, Food and Beverage, as well as Cosmetics. But, in terms of sourcing cocoa from producers, there is no difference between those categories since all of those are based on the same cocoa beans and only differentiated by the overall cocoa quality used in production.
The demand side of the market is also strongly tied to global disposable income and therefore, is impacted by the overall economic climate. The effect of a decrease in total economic power seems to be ambiguous. Some studies point towards lower overall income, making households allocate more income to “smaller” luxuries like chocolate. Other studies indicate that lower incomes only lead to a decrease in chocolate consumption. On the supply side, however, as we will see, Cocoa is mostly characterized by the conditions under which the atomistic farms operate. Production is geographically limited to a handful of developing countries in South America, Africa, and Asia where it takes place on small, privately owned farms that are either operated by their owners or are run on land acquired through rights of “first cultivation.” The processes on these farms are - for the most part - not comparable to agricultural production in developed nations. This is mainly due to the fact that cocoa producers are able to capture only a small fraction of the overall value generation. For example, it is estimated that cocoa-producing households in Ghana and on the Ivory Coast earn around $2700 per year. Low incomes, as well as little organization among farmers, give almost no leeway for investments in advanced farming technology.
Furthermore, since the initial investment is large, relative to low household incomes, farmers tend to stay with cocoa production, regardless of changes in output prices – as changing the type of crop poses a financial risk too high for many households. This results in a relatively high price-elasticity in cocoa beans supply on the market and hence, to a strong dependency on the household incomes on overseas demand and world market prices. Apart from low technological standards and high dependence on demand, the atomistic nature of the supply side has another drawback. Even after several efforts, no real coordination among farmers takes place. This means that no coordinated efforts to manipulate world prices by suppliers should be expected in the upcoming years – as other big commodity producers/organizations do. The biggest influence on the supply side are environmental factors like droughts, storms, heavy rainfall. Most predictions of supply shortages are based on these risk factors becoming a more significant influence on the low-tech farmers through ongoing changes in the climate and more extreme weather conditions. In the face of this risk, more investment in farms and overall more sophisticated methods should be employed and already used procedures like agroforests used by ForestFinance and many other growers around the can already help to mitigate some of those risks. With this practice, farmers are cultivating more diverse farming grounds with plants of different heights and characteristics, providing support for one another, providing for an overall sturdier plantation without high additional costs. The big question is whether these practices can help overcome the limitations which might be set by environmental challenges in the upcoming years and whether these challenges will occur for all locations evenly or whether some locations like say Africa are less affected by climate change.
After considering all those factors, I want to come to a short conclusion. What is striking about those investments is their low correlation to classic stock and bond investments. Investors can get returns independent from the capital market conditions, but also provide a stable livelihood for people in emerging countries. At first sight, the promised returns do look attractive, especially since they can occur regularly under somewhat normal market conditions. Nevertheless, every investor, be it an institutional or a private one, should keep an eye on the huge risks associated with those investments. Not only will the plausible case of an upcoming economic deceleration have ambiguous effects, but also changes in the global climate are not easy to predict in their influence on farming in different parts of the world. However, as this field of investment develops further, it could evolve into a new building block to a successful investment portfolio, not only in terms of money but also for an ethical return.
Tobias Schmidt