A Small-Cap Way to Play Agriculture

Abraham Bailin: Playing the ags with equity-based commodity focused ETFs.

I am Abraham Bailin here with Kevin DiSano from IndexIQ, National Sales Manager. You guys just launched CROP, your Small Cap Agribusiness ETF, the 22nd of last month; it's done fairly well, and we wanted to glean a couple insights about the broader space and the small-cap agribusiness space specifically.

So, thanks for being with me.

Kevin DiSano: Well, thank you very much for having me here. It's been an exciting couple of weeks of the initial launch for CROP, so we're happy to be here.

Bailin: Sure, absolutely.

So, to get started here, I really wanted to get more of a bird's eye macro level picture of the space. Can you just touch on, for our viewer's, some of the macro level drivers that we've seen?

DiSano: The global agribusiness space and agricultural commodity space in general is being driven by really I think two key things.

First, you have the significant demographic trends that are happening around the world, right? Projections are that you're going to see upwards of 1 billion people over the next 10 to 15 years just in India and China alone moving into the middle class. Obviously that drives significant demand for different dietary needs and things like that.

You also have a second driver which is the biofuels area. So, both of those two things combined create a significant amount of demand, and then obviously the challenge then is to provide supply to meet that demand, and that's really where this stuff fits perfectly.

Bailin: All right, if you wouldn't mind, for those of our viewers that have dabbled in this space a little bit know that really the two big names here might be MOO and DBA, right, and that becomes a bit of an equity-based versus futures-based paradigm. Can you touch on that?

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DiSano: We've launched a few strategies in the global resources and commodity space. We also have our Global Resources ETF, right? That strategy is an equity-based strategy. CROP fits very nicely into that story. It is an equity-based strategy. So we've a little bit of experience, and what our research has shown is that while you do get some different currents, if you will, that underlie both the equity and the commodity performance, the correlations are actually quite high between the price of the physical commodities and the underlying equities that derive their value primarily from those sources.

You do have some operating leverage that you get in the equities. You obviously avoid the contango and backwardation issues that you have in some of the futures-based strategies, which is potentially an advantage for some. Of course, the equity strategies don't have K1s, so that's a nice feature, too.

I think the operating leverage works well, not only in an up market but also in a down market where companies can cut costs and expenses to maintain margins in tough environments, whereas in the futures-related strategies, generally speaking, where they're long-only, you're moving in one direction, up or down. So, you do have some unique dimensions.

Bailin: So you guys don't see that operational leverage cut in the other way on the downside in the short run at all?

DiSano: No, absolutely. You can definitely see where in the short-term you could have some problems on the equity side as well. I think having both commodities and equities at investors' disposal is a very good thing, and especially the resource and commodity space, because you can see very different dynamics in short-term environments that affect both somewhat differently, which is good for diversification at the end of the day.

Bailin: Sure. Now, CROP obviously is an equity-based offering, and so as I had just mentioned, MOO is really the 800 gorilla in this space, but MOO really hits the largest of the large cap within that agribusiness complex, hitting the Monsantos and the Syngentas and the Potashes of the world. But you guys don't do that. You guys focus solely on small-cap names. So just run us through what your thinking was in that?

DiSano: When we looked at the space, obviously the objective was not to create another MOO-like strategy. MOO does a very nice job of covering the large-cap part of the market. Where we saw a hole, and again this fits with our strategy in looking at white spaces, if you will, in the ETF landscape was underneath that in the small-cap area, which is typically a very under-represented part of most investors' portfolios. We've already talked about the dynamics behind this space, so there's no question that this was a very fast-growing area of the market. So by putting a small-cap offering in for investors to use in conjunction or complement….

Bailin: to just pad that exposure...

DiSano: ... it gives them a more broad-based approach to the global agricultural commodity area.

Bailin: So, let's take a scalpel to that and really boil down into your index. Now, MOO on the one hand, as you've noted in our discussions, is really agri-chem heavy with those fertilizer producers, and you guys aimed to diversify across the broad space. So could you give us an idea of what other types of holdings you include and what some of their specific or unique drivers might be?

DiSano: Touching on the ag-chem area. Our portfolio only owns about 7% of that sector, so again a very good complementary position.

The CROP portfolio has 52 companies across 14 countries; six sectors of the agribusiness marketplace. So, you really have a very diversified, actually it's much more diversified than the large cap, which makes sense because the small-cap part of the market tends to be a little bit more fragmented. So you are going to have more diversification there.

So again, it's quite a bit more diversified than when you market-cap weight in the space, you tend to get fairly concentrated. So our portfolio, I think, the largest sector of the portfolio is generally no more than about 25%, and it's spread out pretty nicely across all six, and the largest country is only 25% of the portfolio, which happens to be the United States, and then 75% is outside the U.S.

Bailin: Then I believe the second-largest geographic allocation was China followed by Japan, both of which have a couple of issues. On the China side you have investors might view that as a little dicey, and then on the Japan's side, we obviously wish them a very speedy recovery and hope they are doing well, but might you be able to speak to some of the pressures there on your index with China and maybe some of the transparency issues, and then Japan on some of the issues that might have arisen out of the recent disaster?

DiSano: Clearly with respect to Japan, it's something that investors are watching and have been watching just across the board. It's not obviously just with this particular part of the market. The fact that it's right around 13%, 14% of our index, clearly when Japan sold off, it was impactful, but when the equity market recovered, performance has been very good.

Bailin: That's where you are leaning on that diversification?

DiSano: And that's where the diversification benefits help. With respect to China, and I think as you start getting into it, the fact that the portfolio is very diversified does tend to limit any one geographic or demographic issue specifically from impacting it negatively, but I think when you look across the portfolio, this is really a long-term growth story. So from an investor transparency…

Bailin: So you're looking at that population growth.

DiSano: We're looking at the population growth, the supply-demand imbalances globally as really the drivers for the space. Again, we provide daily transparency just like any other index, so investors can actually take a look and see what those 52 companies are and what their ranking is every day on our website. So, for investors that want to do a little bit more digging that information is readily available for them.

Bailin: Great. Well Kevin, thanks for being here. I really appreciate you coming out and discussing CROP with us.

DiSano: Thank you. Pleasure to be here.

Bailin: For Morningstar, I am Abraham Bailin.