Farmland Investor. Contents. Hancock Agricultural Investment Group

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1 Hancock Agricultural Investment Group Farmland Investor Volume 17, Number 1 Spring 2009 U.S. Farmland Continues Strong Performance Amid Bear Market for Stocks, Bonds, Demonstrating Benefit of Negative Correlation with Financial Assets; Cranberries Generate Top Performance F or the sixth straight year, the Hancock Agricultural Investment Group (HAIG) farmland portfolio in 2008 produced double digit total returns. Once again, permanent crops were the main portfolio income driver, while both permanent and row cropland appreciation contributed to the portfolio s 8.5 percent appreciation for the year. This newsletter analyzes the factors driving overall farmland performance with a focus on the recent strength of the U.S. cranberry industry and HAIG s cranberry investments. Over the past ten years, HAIG farmland1 has produced a 13.4% annualized total return, generating even stronger annualized performance over three-, five- and seven-year periods as shown in Figure 1 on page 2. Returns during the most 1 recent five-year period have been particularly strong, as relatively high income combined with significant property value increases produced a total return of 22.2% for the five-year period ending December 31, These returns contrast dramatically with returns for major U.S. stock indices, such as the S&P 500, which fell 37.0% in 2008, resulting in negative total returns for the S&P 500 Index (-1.4%) over the most recent 10-year annualized period. HAIG farmland also surpassed U.S. All references to HAIG farmland refer to Hancock Agricultural Investment Group U.S. directly-held, investment grade properties only. The portfolio is valued at $842.3 million as of December 31, All returns are calculated at the property level after deducting investment management fees. Since all return components are calculated separately, the sum of income and appreciation may not equal total return, due to rounding. Past performance is no guarantee of future results. Potential for profit as well as loss exists. Please see Fee Addendum on last page for more information on fees and performance. corporate bond returns as reflected by the Citigroup Long-term High-grade Corporate Bond Index which Continued on page 2 Contents U.S. Farmland Continues Strong Performance California Drought Update

2 U.S. Farmland Continues Strong Performance... Continued from page 1 generated 8.8% total return in 2008 and 6.5% annualized total return over the 10-year period. HAIG Farmland also outperformed the Goldman Sachs Commodity Index (GSCI) Spot Gold Index which returned 5.5% in 2008 and 11.8% over the 10-year period. However, the Gold Index slightly outperformed HAIG Farmland over the most recent three-year period. HAIG s performance relative to these other asset classes reflects the fact that farmland performance tends to be negatively correlated with that of financial assets, but positively correlated with the performance of other commodities such as gold. Double digit total returns As Figure 2 illustrates, total returns have declined from the peak of 37.4% reached in However, the past three years total returns remain in double digits. HAIG farmland generated strong overall income of 8.0% in 2008, about the same level as in Row crop income of 3.4% (See Figure 3.) and permanent crop income of 11.3% (See Figure 4.) also came in very close to 2007 levels. Appreciation positive in 2008 Appreciation continued to play a significant role in HAIG farmland returns in 2008, increasing from 5.0% in 2007 to 8.6% in Strong row crop commodity prices continued the upward trend begun in 2007 as the remainder of that year s crop was marketed during the first part of 2008.According to the USDA, the value of 2008 U.S. crop production, at $181 billion, exceeds the previous record set in 2007 by $30 billion a 20% increase. However, by year end, as world economies weakened, commodity prices had begun to decline and farm expenses had begun to increase. Despite the recent price declines, prices of major crops such as corn, soybeans and wheat remain at historically high levels. 2 These levels continued to be capitalized into row crop property values during the year as row crop appreciation reached 9.5% for the year, up from 8.2% in (See Figure 3.) Permanent crop income, appreciation keep pace Permanent crop income remained strong but flat compared with 2007, while appreciation increased to 7.9% in 2008, up from 3.0% in (See Figure 4.) The appreciation increase is due primarily to a 35.8% increase in cranberry property values along with moderate increases in walnut, apple Figure 1: HAIG Farmland Annualized Total Returns vs. Total Returns for Other Asset Classes for Periods Ending December 31, 2008 Figure 2: HAIG Farmland Annual Returns by Component for Periods Ending December 31 and pistachio property values as 10 out of 11 cranberry properties generated doubledigit appreciation in The strong cranberry appreciation was tempered by depreciation of 0.7% in the almond portfolio, which represents about 23% of the market value of the HAIG U.S. permanent crop portfolio.while the income returns may have been similar to those of 2007, different crop types drove permanent crop income in 2008 vs Cranberry income surged from 18.3% in 2007 to 30.8% in 2008, reflecting a growing cranberry product line, 2 Agricultural Income and Finance Outlook/AIS-86/ December 2008 ERS USDA 2

3 U.S. Farmland Continues Strong Performance... Continued from page 2 Figure 3: HAIG Annual Row Crop Income and Appreciation Returns for Periods Ending December 31 Figure 4: HAIG Permanent Crop Annual Income and Appreciation Returns for Periods Ending December 31 marketed to an expanding global customer base. In contrast, after years of global demand growth amid larger and larger harvests, almond performance declined in After six consecutive years of income ranging from 11.1% to 55.6%, almond income moderated to 5.6% in 2008 as the global recession reduced potential buyers just as another record crop was harvested. Apples once again produced strong double digit income returns at 32.6%, up from 23.4% in 2007, and walnut and pistachio income remained strong. The consistent income generated by the portfolio despite the decline in almond performance demonstrates the benefits of broad diversification within a permanent crop portfolio. Row and permanent cropland diversify portfolio Despite the strength of the recent appreciation of its U.S. farmland portfolio, HAIG s investment strategy remains focused on delivering strong income returns by combining higher risk/return directlyoperated permanent cropland with lower risk, stable return row cropland in a diversified portfolio. Over the long-term, as shown in Figure 5 on the next page, HAIG farmland income remains an important component of portfolio performance, providing on average 11.4% income over the most recent five-year period and 9.1% income over the most recent 10-year period. The long-term interplay of row and permanent crop income on overall HAIG income performance is illustrated over an 18-year period in Figure 6 on the next page. Permanent crop income is a significant performance driver for HAIG farmland investments.with an average of 59% of the HAIG portfolio in permanent cropland and 41% in row cropland over the 18-year period shown, HAIG s income returns follow the trend of its directly-operated permanent crop income. More stable row cropland income has moderated the highs and lows of permanent crop income performance over time. Cranberry Performance Sweetens 2008 Returns As noted previously, 2008 was a particularly strong year for HAIG s U.S. cranberry properties, all of which are located in the state of Wisconsin, the leading cranberry producing state in the country. HAIG s 11 cranberry properties, valued at $47.2 million at year end, produced an aggregate total return of 76.9%, comprised of 30.8% income and 35.8% appreciation. 3

4 U.S. Farmland Continues Strong Performance... Continued from page 3 This is the highest return year for HAIG cranberries. (See Figure 7.) Since inception, despite the volatility shown in Figure 7, HAIG s cranberry properties on average have returned 9.1% income. As Figure 7 shows, both income and appreciation performance has improved dramatically since HAIG purchased its first cranberry property in At that low prices. In early 2009, HAIG purchased its first Canadian cranberry property, a 300-acre property in Quebec.As values have risen in the U.S. market, HAIG now sees a buying opportunity in Canadian cranberry properties that tend to be larger, which increases operating efficiency, and are less influenced by developmental pressures. Figure 5: HAIG Farmland Annualized Income and Appreciation Returns for periods Ending December 31, 2008 We are very optimistic about the future of the cranberry industry. Over the past several years, the strong performance of the Ocean Spray brand, both domestically and internationally, and the dramatic success of the Craisins and other products has propelled the industry into a situation where it needs additional fruit production from farmers to meet current and future demand. time, the cranberry industry was depressed, crop prices were at a cyclical low, and property values were falling. Some cranberry growers went out of business as the cranberry market hit depression-like lows. However, HAIG saw exceptional value in the properties available for purchase and was able to acquire them at historically Paul Stajduhar Vice President, Ocean Spray Cranberries, Inc. Demand for new products increases cranberry prices, land values As reported in the Fall 2008 edition of Farmland Investor, cranberry products are currently enjoying a resurgence in popularity among consumers, due to their refreshing taste and the health benefits they provide. The Ocean Spray cranberry Figure 6: HAIG Farmland Annual Income Returns for Periods Ending December 31 Figure 7: HAIG Annual Cranberry Returns for Periods Ending December 31 4

5 U.S. Farmland Continues Strong Performance... Continued from page 4 grower cooperative, comprised of 600 member growers in Massachusetts, Wisconsin, New Jersey, Oregon,Washington, British Columbia and other parts of Canada, is the leading producer of canned and bottled juice drinks in North America. In addition to cranberry juice and Craisins Sweetened Dried Cranberries, Ocean Spray has recently developed a number of new products that meet consumer demand for healthy alternatives to soft drinks and traditional juice products. Demand for cranberries to produce these new products along with other traditional cranberry products has trended upward in recent years. HAIG and other cranberry producers have benefited through higher prices received for their fruit and through accompanying land value appreciation over the past few years. Market remains healthy Overall, the North American cranberry market appears very healthy, with favorable demand trends for an expanding number of cranberry products. As Paul Stajduhar,Vice President, Ocean Spray Cranberries, Inc. notes, We are very optimistic about the future of the cranberry industry. Over the past several years, the strong performance of the Ocean Spray brand, both domestically and internationally, and the dramatic success of the Craisins and other products has propelled the industry into a situation where it needs additional fruit production from farmers to meet current and future demand. 5

6 California Drought Update C alifornia and water issues are inextricably linked. Agricultural production, the state s growing population and environmental issues all come into conflict over this scarce resource. With much of the state, including the agricultural Central Valley, naturally dry, water travels long distances in California from source to use. The Central Valley relies on annual snowpack in the Sierra Nevada mountain range to provide the majority of its water. Southern California relies primarily on water sourced from the Colorado River and the far reaches of the Sierras, while coastal California is almost entirely dependent on water from rainfall. A complex network of canals and aqueducts, regulated by state and federal water districts, transports water to both residential and agricultural customers throughout California. Governor mandates conservation According to the California Department of Water Resources (DWR), is the third consecutive dry year for the State, with below average precipitation and runoff beginning in the fall of Snowpack, precipitation and reservoir storage are several indicators commonly used to evaluate California water conditions. In 2009, the first two seasonal snow surveys indicated snowpack below normal, and on February 27th, Governor Arnold Schwarzenegger declared a state of emergency, asking all residents to curtail urban water use by 20% and all agricultural users to continue to implement and continue to seek additional methods of conservation. 1 He also charged the DWR with monitoring and implementing a number of longer-term conservation and drought mitigation efforts. In addition, to help facilitate the exchange of water throughout the state, the DWR has established a 2009 Drought Water Bank.The Water Bank will purchase water from willing sellers, and the water will be transferred to water suppliers that are at risk of experiencing water shortages in 2009 due to drought conditions and that require supplemental water supplies to meet anticipated demands. 2 Despite wet February, drought continues Following a wetter-than average February, the statewide snowpack level reached 90% in early March, in line with longer-term averages. Despite this improvement, Sacramento and San Joaquin Valley regional water supply indices remain at critical or dry levels and key reservoir storage remain below average capacity. 3 Although recent storms have added to the snowpack, California remains in a serious drought, said DWR Director Lester Snow. This year s precipitation levels are still below average. On the heels of two critically dry years it is unlikely we will make up the deficit and be able to refill our

7 California Drought Update Continued from page 6 reservoirs before winter s end. It s very important that Californians continue to save water at home and in their businesses. 4 Impact for HAIG clients So what does this mean for HAIG and its clients investment in California? The state overall is experiencing a drought, and the impact of reduced water deliveries on the agriculture in certain water districts is significant. However, the situations profiled in the media do not specifically reflect the quality and availability of water on HAIG California investments. HAIG due diligence identifies and mitigates water risk HAIG has always been aware of California s fragile water balance and the state s drought potential. HAIG s due diligence during the acquisition process seeks to identify for purchase only properties with access to adequate water under a variety of weather conditions. HAIG s acquisition professionals work with local water experts to perform numerous water tests on existing wells, which are the primary source of water. Both the quality of the water and the quantity of the water are tested in the due diligence process. If the tests do not meet HAIG s stringent specifications, HAIG may drill new wells to provide the necessary water allotment that will allow the nut or fruit trees or vines on the property to grow and produce a crop. State and federal water sources are only considered as supplemental water sources in HAIG investments. HAIG has never purchased agricultural land in the Westlands Federal Water District, which has no water allocation for Recent media reports about current drought conditions in California have focused on the agricultural impact on this particular district. In this and other water districts now facing similar water shortfall and use restrictions, some row crops are being left fallow, while irrigation of nut and fruit trees has turned to survival mode: save the tree if not the crop. 5 However, reduced crop size does have the potential to increase prices and thus benefit those growers with any harvestable crop. HAIG avoids at-risk districts According to Carl Evers, Jr., Vice President of HAIG s property manager, Farmland Management Services (FMS), which is headquartered in the San Joaquin Valley, We have intentionally avoided purchasing property in those water districts dependent on the California Aqueduct because of previous restrictions and lawsuits regarding the Sacramento River Delta pumping and export.when evaluating a property located in other water districts, prior to acquisition, we will confirm that there is adequate well water quantity and quality through independent testing during our due diligence process. HAIG typically invests in California tree nut and fruit crops which require significantly less water than row crops such as alfalfa, cotton and rice. For seasoned portfolio properties, HAIG continually monitors water quality and availability with FMS. Conservation key to long-term water security While weather and drought are difficult to forecast and Although recent storms have added to the snowpack, California remains in a serious drought. This year s precipitation levels are still below average. On the heels of two critically dry years it is unlikely we will make up the deficit and be able to refill our reservoirs before winter s end. It s very important that Californians continue to save water at home and in their businesses. 4 Lester Snow Director, California Department of Water Resources

8 California Drought Update Continued from page 7 cannot be controlled, water use and conservation are within the control of agricultural investors and operators. Water conservation has always been a top priority at HAIG, and HAIG s experience and dedication to conservation are evident in its due diligence on potential acquisitions as well as in its continuing assessment of current properties in its client s portfolios. While most HAIG properties in California benefit from highquality well water, the health of the underlying aquifer is also a consideration in determining how much water can be pumped. Drip irrigation supports conservation efforts For mature California assets currently in its portfolio, HAIG implements a drip irrigation system.the idea behind the drip irrigation system is to provide the tree with the necessary amount of water needed to produce an economically viable crop, while not wasting water by irrigating land between the rows of trees where it will evaporate into the air. Water will always be a key element in California agriculture. However, HAIG attempts to mitigate water supply and drought risk for our clients by being proactive in water sourcing, allotment and conservation for all of our California assets. As the drought persists, California looks to conservation, as well as potentially building additional reservoirs and developing voluntary water markets as possible solutions to secure its future water supply for the benefit of both agricultural and residential use. HAIG and FMS will continue to seek the most efficient, cost-effective solutions to providing adequate water for all client properties. Sources: Sources for all charts are HAIG unless otherwise noted. Other sources are footnoted. Fee and Performance Addendum Performance figures are net of fees charged to customers. For each strategy shown, the performance has been reduced by the amount of the highest fee charged to any HAIG customer employing that particular strategy during the period under consideration. Actual fees may vary depending on, among other things, the applicable fee schedule and portfolio size. HAIG s fees are available upon request and also may be found in Part II of the Hancock Natural Resource Group Form ADV.... Hancock Natural Resource Group 99 High Street 26th Floor Boston, MA First Class Mail U.S. Postage PAID Boston, MA Permit No. 11 Hancock Agricultural Investment Group is a division of Hancock Natural Resource Group, Inc., a registered investment adviser and wholly-owned subsidiary of Manulife Financial Corp. Farmland Investor is published by Hancock Natural Resource Group, Inc., Boston, MA, for the institutional investment community. It is distributed with the understanding that Hancock Natural Resource Group, Inc. is not rendering legal, accounting or other professional services. For further information on any of the topics covered in Farmland Investor, contact Jeffrey A. Conrad, CFA, HAIG President at (617) or visit our web site at