Welcome back to The Rated Change with York Wealth Management.
As advisors to some of the wealthiest families in the country, The Rated Change is a podcast
designed to help you in the pursuit of building long-term wealth through the insights of some
of the brightest minds in asset management.
I'm your host Murdoch Gaddi and in today's podcast, we're speaking with Bob Sahoda, the
managing director and CIO of Revolution Asset Management.
Revolution provides wholesale investors access to a diversified portfolio of Australian and
New Zealand corporate loans and asset-backed securities.
The fund currently has a total fund size of roughly 1.89 billion.
The underlying fund holds a total of 47 loans as of the 31st of July, 2023, with an average
expected life for the portfolio being 1.3 years.
Revolution seeks to outperform the RBA cash ride by 4 to 5% per annum.
The portfolio current yield is 10.1% with a credit spread of the portfolio above BBSW
of 584 basis points.
The average credit rating of the portfolio and the loans is BB plus as well.
So, Bob gives his insights into that process and lending philosophy.
He also outlines the private lending universe, the overall health of the loans in the portfolios
and he gives his thoughts on the outlook for lending in current markets as well.
In particular, I found the conversation of the state of the Australian economy quite
insightful, especially how corporate company loans are fairing in comparison to commercial
and residential property loans, especially in a post-COVID rising interest rate and lockdown
environment.
So before we get into the podcast, I would also like to encourage you to listen to the
disclaimer at the end of the broadcast and to keep your feedback coming.
You can reach me at mgatty at ywm.com.au.
So with that being said, I hope you enjoy this conversation as much as I did.
So sit back, relax and enjoy it.
Bob Sahoda, welcome to the Rate of Change with York Wharf Management.
Great Madoc, thanks for having me.
Really appreciate the opportunity to come and speak on your famous podcast.
Anytime.
For many of you who may not be familiar with Bob, before co-founding Revolution, Bob was
one of the pioneers in private credit in the Australian markets, been around the traps
for quite some time.
So can you tell our listeners a little bit about yourself and what attracted you to private
credit markets?
So essentially, how did you get into private credit?
Yeah, great question.
So this year marks 30 years in the markets for me.
So quite a long time.
I started off humbly in the banking system.
So I worked for ANZ and NAB, learnt grassroots credit skills from really understanding how
businesses operate and what sort of leverage you can apply to different industries, businesses
and sectors, both in the business bank and institutional banks.
From there, probably the biggest change in my career was when I went from banking to
funds management.
And I would recommend funds management industry to anyone.
I went from National Australia Bank to National Asset Management in the late 1990s.
And we were back then one of the pioneers of putting a loan product into fixed income
portfolios.
Back when the corporate bond market was nowhere near as developed, and some would say not
even developed today, we were putting loans into those portfolios for really three key
reasons.
And we'll go into this throughout the podcast.
But the fact that these loans are floating right, wonderful back in the late 90s, even
better in 2023.
They are secured.
So we're now looking at the real possibility of recession.
The fact that you've got security and you got security over good companies and good
quality loan collateral comes to the fore when tough times hit.
Thirdly, diversification.
So it's very tough if you're confined to public markets to not have a high concentration
of the banking and financials.
So private debt gives you good access to other industries and businesses that you would not
ordinarily find easy to get exposure to.
So a quick whistle stop tour around the rest of my career.
From there, I went to AMP Capital.
Again, one of the only institutions back then, this is early 2000s, of providing loans to
private equity.
When they go out and acquire a company, it was generally a very bank dominated market.
But AMP Capital were one of literally a handful of institutions that were providing that senior
secured debt for large scale acquisition.
So wonderful opportunity to learn all about that.
Completely changed gears after that work to PIMCO, both in the Australian office in Sydney
and also in Newport Beach, California.
That was more liquid traded corporate bonds, both investment grade and high yield.
I guess the most relevant experience to the chat we're having today came in the form of
when I joined Challenger in February of 2005.
Back then, the life insurance company for Challenger was only about $3 billion in size.
And I had carriage initially of a billion dollars out of that $3 billion balance sheet.
Now, if all your listeners are familiar with Challenger, they issue annuities, and they're
very, very certain in terms of the liability stream.
So I took the idea very early, given my passion for private debt, to say, well, why don't
we put a portion of the allocation into private debt that offers you not only the right credit
margin, but also a pretty handsome illiquidity premium for that complexity and for the fact
that not many mandates can do it.
To their credit, initially $200 million out of that billion dollars got allocated to private
debt.
And that was really my first foray into managing portfolios.
So definitely pre-GFC.
Throughout the course of my time at Challenger, I built that business from scratch, obviously
with a real passion for private.
So that became a larger portion over time as the life insurance company grew, but also
honoring the earliest mandates in the country with Australian Super initially in 2009, followed
by HESTA and Commonwealth Super Corporation.
So three of the larger pension funds really embraced private debt quite early in the piece.
So after that, I guess the road for us to keep doing what we're doing started to narrow
because of regulation.
So initially, global banking reform started affecting the banks, and then slowly worked
its way into life insurance and also Challenger.
So the idea was that myself and two of my co-founders would take the same strategy that
had been successfully implemented and run with the test of the global financial crisis,
but put it into an unregulated format.
And so five and a half years ago, we started Revolution Asset Management with a concept
on a whiteboard, a hope, a dream with $50 million seed capital from Australian Catholic
Super who we're forever indebted to.
Today we have $2.5 billion of committed capital in the fund with our flagship strategy approaching
$1.9 billion.
What's the average return?
So the return has been an interesting one.
So as I mentioned to you, we do everything in floating rate.
So we have 47 loans, and those loans generally pay a credit margin above the floating rate
of anywhere through time since inception of about 5.8% to about 6% return.
And so as you know, with 12 successive and rapid interest rate rises, our yield on a
look forward basis is currently 10.2%.
So it's basically the 4.1% base rate plus roughly a 6% margin.
So you end up with 10.2 kind of a gross yield pre-fee.
Yeah, well, I went to an event yesterday and a gentleman up there was discussing that if
you're looking for essentially a return above risk, well, what is essentially the most conservative
asset you can get?
So you'd agree you can go get a government bond these days, what, for 5.5?
I think CBA is paying 7.2%.
So 10.2% for essentially above that in this particular space from an investor listening
can be perceived as quite attractive.
So why don't we actually just touch on what actually is the universe of the private lending?
And why I'm phrasing this way is a lot of our listeners, some of them are highly sophisticated
understand the space.
Some of this may be the first time they're listening to what is this space because they've
just had legacy banks for their entire life.
What actually is the private lending universe?
And then secondly, as a subcategory, what underlying, as an example, commercial property,
I know the answer, but commercial property, companies, what exactly do you like lending
to?
Yeah, great question.
So look, for your listeners, you'd be forgiven to not completely understand what people mean
by private debt or private credit.
And you'd be forgiven because it means very different things to very different people.
So under this broad umbrella of private credit or private debt, you've got low risk, low
return points in the market.
So for instance, lending money to BHP through a loan, that's private debt, rather than
a corporate bond.
But as you know, banks are very happy to lend to a credit quality of BHP.
So the returns that you get on that would be sub 2% margin.
Also infrastructure lending.
So good, stable, transparent cash flows means that you've got very good credit profile,
very, very efficient market to getting cheap long term funding.
At the other end of the spectrum, however, excuse me, you've got very high risk return.
So special situations, distress debt.
And what we don't find attractive for us is lending to property development companies.
Lending to property development companies.
These sorts of opportunities come along through the cycle, but we feel as though anything
of that cyclical nature or ones that rely simply on selling assets to pay back alone
rather than real cash flow lending is what we're all about.
So they belong in a high risk, high return kind of setting.
The other one that we see quite often coming up is lending to smaller companies, SME lending.
You should be getting a high return for those because when the cycle turns, SMEs are the
ones that aren't the most pressure and least able to pass on input price increases to their
end customers.
So you might ask, what are we focused on in our strategy?
Really we have three key subsectors.
First and foremost in real estate is the lower end of what we consider to be the risk returned
in our strategy.
Because we're looking for stabilized property, i.e. built property in industrial commercial
office with good quality tenant cash flow.
Now that cash flow is what allows us to do our credit work to work out whether we can
lend the money and they can pay us back through that cash flow.
And should that not come about for whatever unforeseeable reason, we can then sell the
property to get our money back.
Rather than simply saying, we're going to lend money to a property developer, you've
got the risk of it being completed on time and on budget.
Then you have to sell the particular underlying property or properties to get your money back.
That is in our view, not really credit risk.
That is really taking a forward view on execution and also then the forward valuations of those
particular properties for you to get your money back.
So that's one element.
The second element is leveraged by out lending.
So this is senior secured lending to the very, very familiar and top market share companies
that everyone would be familiar with if you're in Australia.
So we're talking about companies like Arnott's Biscuits, MYOB, HealthScope Hospitals.
So all of these three are Patty's Foods, 4 and 20 Pies and Nana's Apple Pies.
We lend money to the private equity firms that have purchased those businesses, but
then lent the money on a senior secured basis alongside other lenders.
We take security over these wonderful companies that are through the cycle very, very stable
in terms of their cashflow.
They have the ability to pass on input prices to their end consumers and thereby maintain
profitability and be able to pay our debt under all reasonable forward views of the
world.
So what we don't do is lend money to retail, to tourism, to hospitality, to mining.
Any of these sorts of industries are very cyclical businesses.
And if you lever them up, it should come as no surprise that at some points in the cycle,
it gets very difficult for them to service their debt obligations.
So we've shied away from that.
The third element of what we do is asset-backed securities and more so on the private side.
So this is probably less familiar to most people, but everyone might be familiar with
residential mortgage-backed securities or RMBS.
But within the overall umbrella of asset-backed securities, we're talking about anything that
you can securitize.
So be it a pool of mortgages or car loans, auto loans, credit cards or personal loans,
these pools are set up in terms of special purpose vehicles where we back very well established
non-bank lenders like Latitudes, First Mac, Wiser, like Mortgage House, Bluestone Mortgages.
These sorts of groups, they originate loans that go into these special purpose vehicles
that we help fund.
We don't give the money to those particular companies that I just mentioned.
We have exposure to the loan pools that they originate and we take security over these
pools of loans.
And so should there be anything wrong at the company level, we still have very sound security
in the form of these pools of loans.
So we provide that lending alongside banks who do the most risk remote, AAA and AA kind
of lending.
And we provide that mezzanine finance above what these companies put as first loss in
these particular pools.
So across these three different sleeves that I just described, we are aiming for a target
return for our investors of cash plus 4% to 5% through the cycle.
And we've been able to deliver that consistently since the inception of the firm because we
firmly believe that's where the risk starts to really increase much above sort of 500
over 600 over credit margin.
Above that, we start to feel as though you're more correlated to the overall macro picture.
But we are really in business to provide people a non-correlated defensive income that we
can deliver to them in the form of cash every quarter in distributions at that sort of gross
yield of 10.2% currently, less a flat management fee.
Well, thank you for that very in-depth insight on how it all works.
Can we go into just quickly, the best thing about this entire conversation is digging
into what's the loans, which specific companies, what's the macro outlook, so many interesting
things, but why don't we quickly cover the mechanics first, right?
Is this, do you only have a managed fund, correct?
How many loans are in the fund?
As you said, it's quarterly income.
How long does it take to get money into the fund, out of the fund?
What are the overall mechanics?
Yeah, so let's talk about the main flagship open-ended vehicle that we have is Revolution
Private Debt Fund number two.
It is approaching a size of 1.9 billion and it allows institutions to access that particular
strategy through the Master Fund.
The Master Fund is designed for the larger insides and about three quarters of our funds
under management is actually institutional.
So large clients like QIC, Brighter Super, AMP, these sorts of names.
With that particular Master Fund, it has a one-year lockup and half-yearly redemption
windows, but we've also got a very good vehicle in the form of a wholesale feeder vehicle
that purchases units into the Master Fund for people like high net worths, family officers,
qualified wholesale investors to access the strategy.
For that particular vehicle, it is monthly applications.
So we accept capital at the end of every month.
And then we have quarterly redemption windows with no specified lockup period.
But we would say the underlying investments that we invest in are quite illiquid.
And whilst there's a 1.4-year credit duration, as in the average tenor of the loans now,
it's about one and a half years, we really don't recommend it to be a short-term ATM
machine for anyone, even though we offer quarterly redemption windows.
We would recommend it because we're trying to harvest both the appropriate credit margin
for the loans, but also a pretty handsome and observable illiquidity premium of around
2% to 3% when you compare it to the same rating and what you can get in public markets.
So we always say you can't turn lead into gold.
So what do you give up for that additional return?
The illiquid nature of it means that you get a better return, but you should have a more
patient outlook when it comes to allocating to this type of strategy.
Okay.
So that's the mechanics.
So how many loans?
There's 47 loans in the flagship strategy.
And across the three sleighs, what's the percentage split?
Look, commercial property is one that I would say has been very opportunistic.
So in our five and a half years, we've been in a historically low interest rate environment
where the banks have actually loved the deals that we would have liked even more and done
them at much lower spreads, lower yields than what we would entertain.
So we've only ever done two deals in that space in that time.
But the rest of the two other sleighs are roughly over time 50-50 between senior secured
leverage buyout loans and private asset-backed securities in the portfolio.
What's the largest loan?
What is the largest loan and what's the percentage weighting of that largest loan?
So we have a stated maximum Murdoch of seven and a half percent of the fund, but that's
an upper limit.
These days we're more limiting it to about 5% of the fund.
So it's not a, I mean, 47 loans, it gives you some diversity, but it's not super granular.
The biggest loan would be just north of a hundred million dollars out of that 1.9 billion.
And that's, to give you an example, that's like MYOB.
Yeah, right.
Yeah.
So MYOB, let me, maybe if I can give you listeners a little bit of a background on why we like
MYOB.
That was going to be my next question.
Right.
So look, I think a lot of people have the equity lens.
And when they think of MYOB, they go, oh, it's not a terribly sexy name.
And there's other, maybe disruptive companies coming in that sort of accounting software
arena, like Xero and others.
From a debt point of view though, we really look for companies like this.
They have an unassailable 30 year market leadership history.
The retention of their client base above six employees, so we're talking about slightly
larger than very small companies.
Their attention rate three times has been more than 94%.
We honestly believe that they have transitioned from having desktop versions of their software
to cloud, which has meant their customer base is even stickier.
You think about the mission critical nature of what the service that they provide means
that it's a very high risk strategy to actually pick up all of your accounting and move it
to another company.
If it is actually serving you well, it remains to be a very sticky kind of an investment
that you make in providing that very essential part of doing business.
So for us, this is all the characteristics we like.
It is number one market share for 30 years.
It has got higher barriers to entry.
It's got the ability to pass through any particular increases in the interest rates that they
get charged by people like us.
But also if there's a labor shortage and they've got to pay more for staff, they pass
that through in subscription rates.
We've seen them increasing their subscription rates with very inelastic demand.
And so this is exactly the kind of business that we particularly like because we have
security over that whole business.
Now it's not bricks and mortar being a software business, but you can say that the inherent
ability for that company to generate cash flows, given its position, is very strong
through the cycle.
The subscription businesses are fantastic.
You can afford to look what's coming through.
You see where it's coming through.
But I remember when we were looking at Xero, I could have a couple of friends and clients
going, how the hell do you look at what Xero is going to do?
Because people don't understand the numbers.
What they mean by that is you get no subscriptions for 11 and a half months of the year.
Then everyone panics.
The last two weeks, it does their books and goes, and they log in that last two weeks.
And they get an influx.
And how do they calculate for it?
It's quite interesting.
So that's on the positive side.
So everyone knows that with these investments, loans, et cetera, they're like lobster traps.
Easy to get into, hard to get out of.
That's one way to think about it?
Yeah.
Well, they taste delicious as well, right?
Especially when it tastes delicious, like a couple of lobsters.
But the reason why I phrased it that way is when you're looking at these loans, obviously
you don't want any to go bad on you.
So you have a particular criteria that they must reach in order to even consider it.
What is that criteria?
And then secondly, if a company which you lend to, macroeconomic thematics change, a
competitor comes in and takes them out or cut each their lunch, how do you deal with
that relationship?
And do you support them or do you just go, right, sorry, boys, can't help anymore?
What's your process?
Yeah, great question.
So look, despite doing all the analysis, there are things that sometimes happen outside of
everyone's control.
And therefore, the ability to work with a particular sponsor or company becomes very
paramount.
So having the restructuring and workout experience that I've had over a very long period really
comes to the fore.
But our modus operandi is not to end up in that situation at all costs avoided.
So that lobster trap, you want it to be absolutely wonderful for all parties, including the lobster.
So the other analogy I use is you can walk down George Street with a wheelbarrow full
of cash and give it away.
The hard part is getting it back in terms of people paying you back.
So what do we do?
So we get really under the hood on understanding how the historical businesses operated.
What are the key drivers?
What are the reasons why they're around?
How their ability to generate cash and are they able to sustain the margins that they've
historically had in periods of high cyclical times and low cyclical times?
And what is the key drivers for us to understand the historicals?
Then we generally from private equity get these wonderful hockey stick projections in
terms of the future outlook because clearly they're more worried about the upside.
Think about we take the same inputs to that, but then we look at what can go wrong because
we have absolutely no care about the upside.
The best thing we can do is get our interest payments as and when due and our money back
at the end of the line.
So we start to sensitize what happens to this company.
Should there be a competitor come in?
Should there be a macroeconomic downturn and recession?
What happens if they need to pay more for input prices?
How long is the lag?
Or specific things like when we lent money to Ingham's.
What happens if a whole group of chickens in one of their biggest farms need to be destroyed
because of disease?
What happens to the cash flow and are they able to still service our debt under those
downside scenarios?
And really that informs us on how resilient it is.
So we promise our investors that we are trying to do everything in our power to have capital
preservation being the ethos of our business.
So for us to be true to that label, we're looking at what can go wrong.
What happens if there's a recession?
What happens if there's double digit unemployment rates at the same time as we have house price
declines of 30 to 40%?
Way worse than what APRA stress tests the banks on.
If and only if we get to a point where we're comfortable under those ridiculously hardship
scenarios, does this company actually start to falter or this group of loans start to
falter?
Do we then include it into the portfolio?
And then once we're in a deal, we are monitoring those deals very closely.
So we have a very strong relationship and a private side information.
Unlike public markets where there's a reporting period, we're getting much more regular and
timely information on how these businesses are performing.
So if there is a period where there's deteriorating performance, we can actually address that
with the company and sponsor and to see what we can do about working through it.
And in the worst, worst case is enforce our security and get our money back before we
lose our money.
Any specific companies that you've had to deal with that?
Well look, we've got and look, we try to be honest and upfront with all of our potential
investors and our current investors.
I'll give you a real life example of a deal that hasn't gone so well.
We were involved in a company called Genesis Care.
And in fact, I've been lending to this company when KKR first purchased it back in 2012.
This was a wonderful success, Australian success story.
It started with the roll up of radiation oncology businesses that started in Queensland.
It really became the number one, it still is the number one provider of cancer radiation
oncology in Australia.
They successfully expanded into the UK and into Spain and have got market leading businesses
there.
And then I would say they embarked on what we would say is a very, very big, big acquisition,
which really was a big change for that organization.
Right before COVID, they decided to buy a company called 21 Century Oncology in the
US to the tune of 1.4 billion US dollars.
So a very large scale acquisition.
And look, COVID didn't help the company, but also I would say KKR and the management team
did a very poor job of actually integrating that business into the existing very successful
business.
And pretty soon the earnings in the US started to dwindle.
And as a result, because it was debt funded acquisition, the leverage spiked to in excess
of 30 times debt to EBITDA.
So what happens in that case?
Look, we campaigned with KKR and China Resources who were the owners.
We actually formed a consortium of other Australian lenders to be able to campaign our best interests.
We ended up getting involved in the debtor in possession financing under the Chapter
11 proceedings in the US.
And we've gotten, I would say, an outcome where we've written that asset down to what
we believe the recovery rate is.
And we have some ability to recover that should the company continue to trade on and be able
to basically sell the US business and then the value returns back to the blue chip assets
of Australia and Europe.
But it's one where I would say the thesis of why we went into that deal still remains.
We like the fact that they were number one in the world in cancer radiation oncology.
The fact that this is very non-cyclical, high barriers to entry.
We're talking about cancer, sadly.
The incidence of cancer is only on the rises.
The developed world ages.
And so that's the fundamental thesis behind it.
It's actually time critical treatment as well.
So you need to get treated very quickly if you're sadly diagnosed with the cancer.
But I would say the execution of that foreign acquisition, not the first company to go overseas
and not do so well, but it won't be the last.
So I guess that's something we've learned going forward.
If there's a large scale acquisition of an already successful business, then we would
really pause to see whether we are going to continue to support such a bold venture.
It's interesting you say that because it doesn't matter what thematic you're investing in,
sorry, what asset class, right?
Is that you might be even be worrying some of this thematic, but at the end of the day,
there's always a cycle within the cycle.
It's either central bank related, inflationary, monetary policy related, or it's a cycle within
the cycle that's specific asset class.
It reminds me of a quote which we discussed off air by G. Michael Humpf in his book, A
Pocalyptic Novel, right?
Where he says, hard times create strong men, strong men create good times, good times create
weak men and weak men create hard times, right?
And the reason why I'm bringing that up right now is it's very, what you just described
was very reminiscent of QBE's current problems, right?
When all you see miners, when essentially everyone gets excited, the party's happening,
people are popping champagne, you've got cash up here, you're writing a success of the current
people, and then these companies proceed to look at mergers and acquisitions at evaluation,
which they shouldn't because they don't believe that the party's ever going to stop, right?
And then again, like, you know, these easy times become, you know, poor times type routine.
But then if you look at the other side of this, so many people out there as well waiting
for those hard times, you know, like we're currently seeing it right now, there's a consolidation
play across the globe in the online gambling space, right?
Completely.
And what's happening is the strong will survive and whoever survives will essentially swallow
up everyone else and then those hard men that are doing the odds at the bottom may see essentially
come up the other side and create the good times.
So it's just very interesting what you're saying.
So why don't we pivot based on that?
Just on that Murdoch, I wholeheartedly agree.
So we've had a period where rates have been historically low for a long time.
And then we also had unprecedented fiscal policy stimulus as well in the form of COVID.
At those periods of time, you know, it was most important to be disciplined.
And this is the times where, you know, it was very easy to make money, very easy to
lend money.
And a lot of younger people have never seen a default cycle.
You know, there's never been one, you know, for many of them because they don't have a
long career.
However, there was reason to understand today because you don't have a chance to trade out
of these private debt deals that we do.
And none of our peers do either.
That our report cards are all going to be collectively marked over the next 12 months
on how you've constructed your portfolios in terms of coming into this period of macroeconomic
stress where the hard times will come and it will be only those that are strongest will
survive.
And this is where experience comes to the fore.
And the other thing is we don't offer a retail product.
We don't think we should be investing in illiquid assets and offering daily or monthly liquidity
to mums and dads.
Why is that?
Because the weaker hands when it comes to redemptions, we're seeing this in property
already.
Redemption gates are coming down.
People are unable to get their money out when they were previously promised monthly liquidity.
This is foolhardy in my view.
So this is a...
I was just discussing on there like an article written by David Rowe on the AFR.
He quotes this.
He says, the global office property crisis has finally hit Australia.
More than eight months after the property fund managers by Blackstone shocked investors
worldwide by limiting investor redemptions.
Charter halls unlisted direct PFA fund, which owns 2.45 billion portfolio of office properties,
most which are located in Australia's maybe CBDs, has also told investors that essentially
they've limited redemptions.
So with things like this coming in the press, but the reason I'm phrasing this way is you
walk down the street and you see artificial intelligence and the Nasdaq running.
But then you go to an event like I went to yesterday for two hours and heard a particular
fund manager speak and then what they're saying, they're all saying that the interest rate
cycle on the way up is not finished yet.
They're saying that the reason why people's mortgages, yes, you went from 2% to paying
6% is 200% increase from a bottom.
These people leverage themselves to their heel, but like why aren't they defaulting?
But I think someone showed a chart regarding that bank default rates if it's from a bank,
a lower than it was from the private lending side because of the unregulated private lending
markets.
And the main reason for that was they argued that since people were just home for so long,
they'd build up like a buffer, so to speak.
So I'm speaking to clients now, like I spoke to a client today, a very lovely family, very
wealthy family, and we're discussing how do we play from today going forward because it's
in this weird state of flux.
And I would argue that it's somewhat in this, we discussed the cycle before with hard times
creating good men, right?
The decisions we make now will essentially derive which way the cycle goes.
So what's your opinion on what's happening with that?
We see this in asset-backed securities portfolio.
We get a good take on what the consumer's feeling throughout those pools, be they mortgages,
auto loans, personal loans, credit cards.
What we found is the impact of the monetary policy tightening is coming in the bigger
lag, a longer lag this time around because of those fiscal stimulus payments and people
building up bigger reserves.
But fear not, as sure as night follows day, the two-speed economy is going to come whereby
the people who are stretched will run out of those savings and they will be forced to
liquidate assets.
And this is the time where if you've got patient capital, as I mentioned, we don't offer liquidity.
We want to be buying not distressed assets, but we want to be buying off distressed sellers
of the best and brightest assets, be that in real estate, be that in leveraged buyout
loans or be that in asset-backed securities.
And my career, some of the best money and the best deals I made for our clients was
in the aftermath of the global financial crisis when we had capital, when everybody was heading
for the exit gates.
Just like when Buffett bailed out Amex, the dealer of last resort, the best deal he ever
did right at the bottom.
There are some wonderful opportunities when that market is so dislocated and everything
starts with a liquidity crunch and people need liquidity and need it pronto.
People that offer daily liquidity, people suddenly go from greed to fear.
They want their money back and they want it to put in the mattress when fear really takes
hold.
So what does it force fund managers or banks to do is to sell their best assets.
And you want to be there to collect them at your level rather than where they're currently
trading.
So this is a very interesting time coming up in my opinion.
So you don't take a macroeconomic view, you know, it's like it's an all weather style
lend, right, but surely you must take a macroeconomic view in the essence of what project or company
you will lend it to right now.
And what I mean by this is say something's at the top of the cycle because clearly you
don't want to be in that same scenario with that cancer clinic company, right?
You know, something's running up.
So if you had your time again, you're looking at that.
Someone's coming to you, shouldn't you, when you be thinking yourself, right, it's top
of the market for this particular sector.
We definitely potentially could do the line.
Are you sure you really want to do it?
Do you have these conversations?
No.
So Murdoch, what we do is exactly what you're describing is not what we do because if it's
at the top of the cycle, we don't want to touch it, but we don't really want to touch
it when it's at the bottom of the cycle.
As in we just want companies that just produce cashflow.
Yeah, right.
So we don't take a macro view on is the next, is a good time is going to roll for another
two years or three years or five years.
Just look at the cashflow.
Just look at what can go wrong because in the end we don't get rewarded for the upside,
right?
So even that Genesis Care example, cancer hasn't gone away.
This business in Australia is still very valuable.
It's just that they had a misstep on that integration of that big acquisition.
But again, this is mission critical, time critical cancer treatment they're providing.
This is exactly what we're looking for.
We also back the number two provider of cancer radiation oncology called ICON in Australia.
And it's performed beautifully because, you know, again, sadly, people are getting cancer
in a higher prevalence.
Yes, it's just so interesting.
The entire like where we are today, it's in this weird state of flux can go either direction.
You know, people are looking at it and just going, you know, it could go north, could
go to north in the short term, could go south in the long term.
You know, what are people doing with the money?
But I'm hearing more and more and more that people are quite comfortable to sit in cash
to, you know, potentially lose the user fund like yourself or, you know, use a competitor
where you do get a cash flow component is defensive.
You're getting essentially more than a government bank bond.
Sit there, relax, let essentially the markets play out however the way they play out.
Like I just potentially don't want to play, you know, with all my money in that particular
game and they just wait for events to unfold and then look at us as when they're cheap.
Yep.
I hear it everywhere.
But the biggest thing, I suppose, and as you say, I really like the fact that you guys
focus mainly on companies look for things with cash flow.
So the really part I'd like to hear your opinion on is commercial property because I'm hearing
this everywhere.
And I don't think a lot of Australians out there really can comprehend the potential
impact of some of these managed funds, you know, owning these commercial real estate
as like we're sitting in Sydney right now, you know, near the Sheraton on Hyde Park,
walking around half of these major offices are empty.
Right?
Like, this is unprecedented.
Everyone's ever seen this before.
Yeah.
So can you speak to your thoughts on that?
Yeah.
So commercial property has been a source of a lot of wealth for a lot of people for decades
and cycles.
But I would say if you look back at history, the State Bank of Victoria almost went under
because of its commercial property development risk they had on board.
Over a weekend, they had to do a shotgun wedding with State Bank of Victoria being acquired
by Cobblet Bank.
We know that through the cycle, you can make a lot of money, but what happens when we see
a confluence of factors is what we've witnessed over the last 12 months that all coordinate
to affect property.
Let's look at the factors.
Interest rates have gone up dramatically.
The supply costs of every raw material and everything that goes into a construction deal,
all those prices of raw materials have gone up.
Work costs, labor firstly scarce if you can find it, but when you do, it costs you sometimes
multiples of what it used to.
Also, that all affects time.
And the biggest enemy in any development is time.
There's no cash flow whilst you go and complete that particular property build.
So if you've got the compounding effect of higher rates for a longer period of time,
it will affect your development margins initially, so what the developer and what the builder
gets.
And generally, these are not well-capitalized businesses.
They have multiple projects across multiple locations with all small amounts of equity.
That gets swallowed up pretty quickly.
If you're a lender that you lent on a notional on completion valuation of 60% loan to value,
and you see a lot of people sprouting off on the loan to value ratio of this is 60%.
My question to them is, what is the V in loan to value if you don't finish it?
If it's partially complete, the builder and developer goes under.
In some cases, it's over 100%.
So there's a real way that you can lose money on a senior secured loan.
Isn't that just musical chairs at the highest level?
Absolutely.
And why do you think we've never ever entertained doing these sorts of loans for our investors?
It's not what we feel is always proper credit.
It's playing a game of chicken with the cycle.
You can make a lot of money.
Yeah.
When we first established Revolution Asset Management five and a half years ago, we had
a period where there was no recession in 26 years.
People were saying, Bob, we're not going to lock up our money for what you call a medium
term horizon for 5% or 6% when rates were zero.
We can lend it to these property developer guys, get 8%, 10%, or 12% plus in 12 months.
Isn't that good?
Because it's backed by bricks and mortar.
A lot of those people are coming back these days and saying, you know what?
We prefer your strategy over that because some of them have had pretty poor experience
already.
And I think there's more of that to come, sadly.
Yeah.
So that's the commercial side.
But then you're looking at just normal moms and dads, people taking their kids to school,
people that just want a house.
So if you look at basic economics, what do they say?
That essentially the main reason why an Australian will sell their home is what?
They lose their job.
So let's speak to something that's exactly in your wheelhouse, which is what are the
circumstances that some of these companies that you're seeing that are ASX listed, unlisted,
in what event of macroeconomic stress with fiscal and monetary policy, which we're currently
experiencing, do you think may potentially impact these businesses?
And we're already starting to see companies start to cut.
I think Microsoft just cut 200 jobs yesterday or something in Australia.
So what potential scenarios and how is the, I suppose, the overall health in the larger
businesses of Australia's economy right now?
Yeah, look, we observe that people are in fairly good position.
I mean, we've got an unemployment rate of three and a half percent.
So that's historical lows.
So whilst you've got a job and you've got cash flow coming in, you've got options.
You may not be able to afford the new repayment, but generally a bank or a lender will work
with you to maybe extend the tenor of the loan to accommodate you making some payments.
It's only when you really get to a desperate situation where you lose your job for a long
period of time, you can't get another one, where you see real stress in the residential
property market.
Now, this time around, you might see more stress because your listeners may remember
in COVID, there was a term financing facility, TFF, that was offered to the banks at a 0.1%
interest rate.
And what that led to was the banks offering very low rate honeymoon periods in fixed rate
loans that then converted to variable loans, which are all about to go variable right about
now and in the next six to eight months, which is quite often coined the mortgage cliff.
But look, that's a problem mainly for the banks because they got this really cheap funding.
But with the banks, we don't see a wholesale enforcement action of people getting tipped
out of their house.
The banks will be in a position where if these people maintain employment, they will be able
to find a way through the next little period without the real pain of having large scale
foreclosures around the residential property markets.
Having said that, the people that have extended themselves in the last two years especially,
we're starting to see unseasonably high sales for people that have owned their property
less than two years, according to CoreLogic.
So that's a little bit of an early indicator that people who probably think, oh, you know,
this is getting way too big on me.
I need to get out.
I'll sell the property, pay off the bank and maybe move back into rental accommodation
before they get foreclosed on.
Do those CoreLogic numbers say whether or not that's closest to the city or rural or
does it say specifically?
I'm not exactly sure whether you can make a general observation.
I would say these are probably more fringe areas of the metropolitan areas where you
typically get first time buyers and that sort of cohort that have got lower amounts of equity
in their homes and have probably stretched themselves to balance the budget to make the
payments on their mortgage payments but then potentially get more squeezed on a cost of
living basis as we've seen all goods and services increase in price.
Yeah, it's definitely an interesting one out there.
And look, again, for our listeners out there, we're just discussing the good old fashioned
risk versus reward of what's out there and why we're looking at particular assets.
But I suppose the reason why we're having this conversation now is, yes, there is a
lot of private lenders out there in different asset classes.
So we're just looking at essentially one asset class benefit to another.
So back on the company, so there's 45 companies, right?
47 lines.
47 lines, which you are currently doing.
With the current economy as it is, if someone came to you, I'll phrase it a bit differently,
in your opinion, what are you seeing in some of the best cash flow style businesses?
Now is it fast moving consumer goods, is it mid-tier infrastructure?
What's your ideal loan?
And I wouldn't mind getting back into some of the loans you've discussed like one or
two, but a couple of the loans are very interesting.
Absolutely.
So early this year, we helped finance the acquisition of Patty's Foods by PAG.
Patty's Foods?
You mean Patty's Markets, Patty's Foods?
No, no, Patty's P-A-T-T-I-E-S.
Oh, Patty's, the pies.
Patty's Pies.
As Aussie is 4 and 20 pies and that is apple pies.
I don't know, maybe that used to be the CFO.
As soon as CFO, he used to work for the CFO about 12 years ago.
He loved it there.
Right.
So what do we love about that particular business?
In some ways, it really does represent the earnest biscuits of the frozen food aisle.
So when people get hit in the hip pocket, they have less money to spend, they will probably
move from fresh to frozen.
And these ready to eat meals, they also bought Vesco as part of the acquisition, which are
ready to eat meals, plus these frozen food type of products that have been around for
a long time.
We like the resilience of it.
And you think about through the cycle, we saw Patty's trading in periods where things
are a bit tougher, their cash flows actually sustain.
They have large scale Australian manufacturing, which they're rationalizing to a couple of
large centers.
Taking out cost synergies, but then also being able to supply coals and woolies.
Like Arnott's, you've got very good market position to be able to push through input
price shocks.
As every business has been affected, their ability to move up prices in relation to all
of their input prices, be it raw materials, freight, interest costs, labor costs, energy
costs, you name it.
They just move that right through to the consumer and increase their prices, thereby sustaining
their gross margin.
In that way, this is the kind of company we really like.
I can guarantee you if you're a coals or woolies and you've got a supplier of one or two products
and your prices go up, you're going to have to swallow some of that pain with the coals
and woolies breathing down your neck.
Otherwise they can do without your product.
They just go, well, you know what, we'll just go with someone else.
That illustrates the negotiating power of these large companies when you occupy a dominant
market share is very, very powerful and what we look for whenever we lend money to these
sorts of companies.
Yeah.
What's the minimum size loan parcel you would look at?
These days, we have a $1.9 billion fund.
We're likely not to look at deals that are below $50 million in terms of our allocation
and then on the size of a particular company.
We don't do smaller companies.
That generally means in Australia, we don't really look at opportunities that are below
a $30 million EBITDA scale and that or above.
That gives you a sense that they've got to be decent sized businesses with good governance
and good controls.
This is the fun part.
When you're looking through those financials, ideally what type of profit margins are you
looking at?
Well, this is interesting because we were looking at one the other day where essentially
one particular industry said to make it work, it needs to be 14.5%.
Then you go speak to other colleagues or if in our business, I want to go to those numbers,
but say someone else's business, they won't touch a business unless it's like 30% as a
bare minimum.
Yeah.
But you get some other businesses where 6% is huge because it's just so tight.
So what type of profit margins, as you said, is cashflow orientated?
So when you're looking in this business to lend, is there enough room?
I think it's very difficult to generalize because as you correctly point out, industries
and businesses within those industries have very different profit margins depending on
their positions and what is a more mature market with a lot of players, generally lower
profit margins, but is it sustainable is what we look for.
So whatever that particular gross margin is and whatever cash flows it is, how sustainable
is that through the cycle is what we're looking for.
What sort of capex requirements?
Is it maintenance capex?
Is it absolutely mandatory capex or voluntary capex?
What are the things I need to think about in terms of if labor costs go up or the input
price go up, what happens to their gross margin?
What happens to the profitability in that sort of scenario?
What has happened in the past when these things have happened?
Have they been able to sustain?
What is the trend?
What is their total addressable market?
What is their market share in that?
What is their net promoter scores?
What do the customers think of them?
Is this the right leverage for this type of business?
Is that sustainable?
These are things that come with experience.
And so I can tell you a cyclical business, even though we don't look at them, they can
obviously not sustain a high level of leverage compared to private hospitals with huge barriers
like Brookfield owns HealthScope.
They can maintain a higher leverage of north of five times debt to EBITDA.
That's considered to be high leverage.
But because of your market position being number two behind Ramsey in private health,
you can sustain that sort of leverage with a very strong sponsor in Brookfield with a
very sizable equity check that sits as a shock absorber for any loss that we may incur in
the future.
So interesting, we can sit here all day and go in through these things.
I might sort of leave you with a couple of thoughts about what keeps you up at night
and essentially what do you get up in the morning?
Yeah, cool.
So what keeps me up at night?
I think look, the kind of macroeconomic backdrop that we sort of run in our scenarios, if that
were to come true, then we would we're in a world of pain the whole economy, right?
We're talking about huge unemployment, we're talking about big declines in property prices,
we're talking about the big four Australian banks, potentially, they're levered institutions
by their very nature.
So these are the kind of things that I worry about.
But I think, look, the RBA is able to navigate their way through this well without letting
inflation get out of control.
We hope that it moderates so we don't get a very deep and heavy recession.
But that's sort of the sort of left to our risk I worry about sometimes.
On a day to day basis, we're very comfortable with the portfolio as it currently stands.
And we're very proud of the deals we've done, even more proud of the deals we've said no
to that have been financed by others.
And I guess what gets me up in the morning is we really care about looking after our
client money, we take that responsibility very seriously.
Being able to deliver what we promise is what we stand for.
And we've got very strong governance in what we do.
So some of the things that set us apart from some of our peers, we in all of these deals,
a lot of them we get upfront fees.
So we not only get the appropriate credit margin for a loan, we quite often get upfront
fees.
Some of our peers take a more cavalier approach on those and take those fees to the management
company.
We have a philosophy of passing all those fees to the fund in their entirety.
The second thing we point to is we have a philosophy that says we don't charge performance
fees.
Why is that?
That comes foreign to many people.
Think about we the best we can do is get our money back, right?
We're a capital stable product.
If we have an incentive to charge performance fees, we will take on more risk, it's human
nature because we get the upside out of that.
So we don't want to have that misalignment of interest.
And then thirdly, we have a very good governance with every single loan being reviewed every
month by a third party valuation agent called Lidenhall who report back to our responsible
entity.
So if you think about going into private debt today, yeah, you've got wonderful attributes.
You've got floating rate, security, as I mentioned, diversity.
But how do you know you're not walking into a ticking time bomb where there's a whole
bunch of defaults waiting to happen?
We have the ability to tell our clients and our prospective clients these loans are being
reviewed every month according to our original base case for all of these loans.
And only if and only if they're performing will we value these assets of par.
And out of the 47 loans, with the exception of Genesis, 46 of them are at par today and
are performing at our original base case of where we went into the loans.
So we really look forward to having us deliver on our promise to our clients through the
cycle and really navigate these sort of uncertain times that we expect coming in the next 12
months.
But also being there with patient capital, we're experiencing some of the larger inflows
we've ever had in the firm's history, because this yield is now looking very attractive
to many.
When you think about what do you think the equity market is going to return over the
next 12 months, we can deliver you a net return delivered quarterly in income that's going
to be well into the mid nines.
And that for a lot of people is pretty compelling when you look at the long term return for
many asset classes.
Stability is very, very compelling, especially in these times of volatility.
Indeed.
Look, if listeners want to learn more about Revolution Asset Management yourself, how
do they get a hold of you?
Is there a team or how does that work?
So we are very fortunate to have Channel Capital as our investment servicing partner.
So they look after all of the institutional grade, back and middle office, risk and compliance,
finance, IT, distribution and marketing for on behalf of Revolution Asset Management and
other good fund managers out there.
So if anybody wants more information, you can go to revolutionam.com.au or Channel Capital.
They've got their own website.
But there's a team of great distribution people that they can get in touch.
We can provide you with all the information you like.
And happy to, on an individual basis, if people are looking for maybe a bit more of an insight,
happy to make myself or some of the team available for chats to people for their consideration.
Well, Bob, it has been a pleasure having you on.
I really, really enjoyed your thoughts and your insights and looking forward to having
you back in maybe 12 months to see how everything's going.
Great Murdoch.
And thanks to yourself and York for making this possible.
Appreciate the opportunity.
Fantastic.
Have a great day.
Yep, you too.
Thanks.
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and other sole personal opinions of the speaker.
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any action you should seek proper advice from your financial professional.
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