14 May 1999

Managed fund may spread the risk

By Philip Clarke

PROFIT, as any economics student will tell you, is the reward for risk.

But arable farmers may be starting to question the theory. On many UK farms profits have all but vanished, while the risks involved are as big as ever.

One of the greatest threats is price volatility, which makes marketing grain a particular challenge. And it is a problem which is getting worse. "With the arrival of Agenda 2000, farmers are going to become more exposed to world markets and will experience even greater volatility," says Gary Hutchings of agricultural merchant Dalgety Arable.

Dalgety recommends that growers commit at least 50% of their output to some form of risk management strategy, be it a grain pool, a minimum price or buy-back contract, or a merchants managed fund.

"Each farmer has to make the right strategic decision for his business. It is not up to us to tell him what to do, just so long as he does something," says Mr Hutchings.

He is satisfied the Dalgety managed fund has performed well since it was launched in 1997. "The fund was born out of the minimum price contracts we were already offering," he says. "While they gave the farmer security, we wanted to use the market volatility to add value."

To join the fund, a farmer has to commit at least 300t of his wheat, for which he gets a guaranteed price for the period in question.

Farmers signing up pay a 5% premium. It is this money that Dalgety uses to buy options which underwrite the fund. It then trades these positions with the aim of making a gain out of market movements.

Dalgety operates three funds – short (October-December), medium (January-March), and long (April-June). At the end of each period, the farmer gets his base price, which is different for each individual, depending on the day he joined the fund, plus any bonus, which is common to all fund members.

For example, the most recent fund to close (January-March 1999) paid farmers an average base price of £80.07/t, plus a fund bonus of £2.60/t (see table). Over this period the actual market price slipped to £71/t, giving fund members an average market premium of £11.67/t. From this is deducted the 5% premium, leaving farmers about £7.54/t better off.

The managed funds operate on a regional basis and recognise individual quality, paying milling premiums where appropriate. But while they offer flexibility, Dalgety does limit the amount of grain it takes into each fund. &#42

Dalgety managed funds: Average results

1997/98 harvest year 1998/99 harvest year

Short Medium Long Short Medium

Base price 90.42 93.90 96.69 80.39 80.07

Closing market price 73.00 74.00 75.00 76.00 71.00

Price fall 17.42 19.90 21.69 4.39 9.07

Fund bonus 3.46 1.50 2.08 2.68 2.60

Total premium to market 20.88 21.40 23.77 7.17 11.67

Net gain after 5% premium * 17.12 16.58 19.81 2.92 7.54

* 4% in 1997/98 harvest year.