Portfolio Diversification Using Farmland Investments

This study examines the impact of farmland investments on the risk-efficiency of mixed asset portfolios. Traditional asset classes considered available for investment include various equity market indices, commercial REITs, corporate bonds of investment- and sub investment grade, government bonds and treasury bills, corporate bonds, ex-U.S. equity indices, short term interest rate indexes, and commodity investments. Unlevered farmland returns were constructed at the state level as the sum of cash rent and capital gains less property taxes as a fraction of asset values. In addition, a unique, high quality data set comprised of the returns to all managed farmland properties in the NCREIF Farmland Index was also considered. A traditional optimal E-V frontier is first identified considering optimal financial-asset only portfolios in the absence of the farmland asset class. Results show that, relative to financial-asset only portfolios, the inclusion of farmland significantly improves the risk-efficiency of the optimal E-V frontier. To address potential aggregation and smoothing biases, farmland returns are systematically penalized through reduced returns and increased variability. While the mix and shares of farmland investments under these restrictions are reduced, the fundamental result remains that farmland investments significantly improve the risk-efficiency of mixed-asset portfolios.