Welcome back to The Rate of Change with York Wealth Management.
As advisors to some of the wealthiest families in the country, The Rate of 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 broadcast we're speaking with Russell Pilema,
CEO of Pengana Capital Group.
Russell brings extensive experience from his time as an investment banker at Goldman Sachs
and shares his journey of founding and growing Pengana, which now manages $3.5 billion across
12 strategies ranging from domestic and global equities to domestic and global private credit.
For me, I really enjoy delving into the how of the strategies, in particular, their innovative
approach to listed private credit and trying to solve the problem of having unlisted assets
inside a listed investment company or a trust vehicle trading at a discount to net asset
value due to volatility from market uncertainty.
If you're curious about how or why they've structured it this way, then join us and hear
Russell unpack everything from their bottom-up investment philosophy to their pioneering
work in attempting to smooth the volatility for unlisted private credit in exchange traded
markets for retail clients.
If you're like me, then I trust you'll be eager to see how the industry responds to
this new approach and curious whether it may become the new normal.
So before we get into this podcast, please remember this is intended for entertainment
purposes only and should not be taken as any form of financial advice.
Be sure to listen to the disclaimer at the end of this broadcast and to keep your feedback
coming.
You can reach me at mgatty at ywm.com.au or via York Wealth Management at yorkwealth.com.au.
So with that being said, I hope you find this conversation as enjoyable as much as I did.
So sit back, relax and enjoy it.
Russell Pilamar, welcome to the Rate of Change with York Wealth Management.
Thanks for having me.
Well, great to be here in your offices.
Nice view over the harbor.
Why don't we begin things off as always, Russell?
And why don't you tell everyone a little bit about yourself and how you got into this beautiful
world of financial markets?
Yeah.
So my background is I'm not a fund manager.
So I've never picked stocks before.
So it's a bit unusual for people in my industry to come from outside of actual stock picking.
And my background was that I was an investment banker at Goldman Sachs for many years, both
in Australia and in New York.
And the last several years I spent in New York and I specialized in doing M&A for funds
management companies.
And so I got into this, I got to understand what the best fund management companies looked
like.
Post 9-11, my wife and I decided with three kids already and another one on the way that
we want to do, our kids to be brought up at home in Australia.
And so we came back to Australia and I decided rather than go back into investment banking
over here, I try my hand at funds management.
And based upon what I knew from my clients in the US, I decided I'd build a business
from scratch and that's how Pengana was born.
Yeah, right.
So when you say you build it from scratch, what does that mean?
Does that mean you came in here and you surveyed who are incredibly bright managers, in particular
asset classes, and then you bought a business?
Or did you literally build it from scratch?
So literally from scratch, I started with a clean sheet of paper.
This is how I think a fund management business should be structured.
And really the essence of it was that the services are all centralized and the brand
is centralized, but different funds should be run by expert teams, do nothing but manage
those funds.
And so essentially almost a partnership type structure where we'd go out and find a really
good funds management team, we'd bring them into Pengana and get them to run a specific
strategy and in a sort of partnership type form where we share the economics with them.
They would pick the stocks, build the portfolios and we'd do everything else for them.
So that was the basic construct.
And we put the construct together and then went out and started looking for teams.
Who was the first team?
So the first team and we still have them today is our Australian small cap fund.
It's called the Pengana Emerging Companies Fund.
They've been going for in excess of 20 years now, I think this is the 21st year, annualizing
at about 12% per annum for 20 years, which is a fantastic amount of compound growth.
And a larger part of our success is due to them because they really helped us establish
the brand and the business.
So Steve Black at the time was the small cap fund manager at Goldman Sachs, JB Weir in
Australia and Ed Prenegost was an analyst at Citibank and the two of them were the initial
team.
And as I say, they're still with us today, which is fantastic.
I love a good origin story.
So how is Pengana blooming?
Because I was just, if people are not familiar with Pengana, you have quite a number of strategies
spreading across multiple assets.
So look, there's a lot there.
I'm not too sure if you want to rattle off the list at all.
Yeah, so rather than rattle off the list, you can think of us as covering all our bases
in equities, listed equities, and that's our origins.
Listed equities started with Aussie small caps, went to Aussie multi caps, went to international
equities, international small caps, and a range of different offerings around the marketplace.
It could be impact investing.
We have a really interesting fund which does Israeli technology stocks.
So mainstream equity investing as well as some sort of more niche type spaces.
And we have both unlisted unit trust and listed vehicles.
So that's really very much in the listed equity space as we cover the whole range of mainstream
listed equities as well as some esoteric asset classes.
And then more recently, we've moved into private markets.
And this is really where a lot of the growth from our business has been coming from.
So initially, private equity was our first foray.
And a number of years ago, five years ago, we launched the Pangana Private Equity Listed
Investment Trust called P1.
P1 is the ticker that everybody knows it by.
And that was a successful launch.
And it's been really helpful for investors in their portfolios to be able to access top
tier global private equity.
And doing it in a listed form so everybody can buy into it.
It really democratized private equity for every investor now can get their hands on
private equity.
Whereas prior to P1, it was really only in the domain of wholesale investors or big institutional
type investors.
And we're doing the same at the moment with private credit.
In the market at the moment with a vehicle that's the tickers PCX, it's the Pangana
Private Credit Listed Investment Trust.
And that will once again bring the best of top tier global private credit to Australian
investors and irrespective of your size.
So previously, just the same as with private equity, where it was only the domain of the
large institutional investors and the big family offices.
Now everybody can buy into it.
So we'll unpack private credit because that's an entire topic in itself.
And there's something specific that you've done which I find very, very interesting,
which we should spend a lot of time on.
But before we do, what is the investment with the equities?
What is the investment philosophy?
When your teams are looking at where to allocate capital, what is their process?
How do they think about it?
Do they chase the market?
Do they wait for essentially they have a list of what they like and wait for it to collapse
before buying it on the cheap to see who survives?
What is actually the process of allocation?
Yeah, that's a great question.
So all of our funds are bottom up, which means that our fund managers look for great stocks
and they build portfolios out of great stocks that work together well in unison in a portfolio.
They're not macro directed.
So we don't sit there and say, what are markets going to do?
What's the economy going to do?
We can build our portfolio based upon a prediction of the future.
In fact, we feel that we have absolutely no ability to predict the future.
And so we build our portfolios irrespective of the future.
And how do we do that?
Well, we find stocks that over the long term we think will do well.
They usually are stocks which are quite resilient in various market conditions.
And so you find that our portfolios are populated with the types of stocks that are on a good
solid cash flow generating stocks by and large.
So that's the thesis, if you like, throughout the business.
As I said, each of our different funds are managed by different teams.
So they all have their own peculiarities about how they manage money.
But in general, as I said, the general concept is to build a bottom up resilient portfolios.
So I understand that.
But then, you know, I've had a number of conversations.
And what's interesting as well is I think I saw a chart for the past couple of years
since COVID that if you literally just made a call which way the US 10-year bond rate
was going, you could essentially call the market.
So I understand I'm all for growth through reasonable price, value investing.
But a lot of value investing is quite difficult when a Fed announcement comes out.
All they're looking at is did they raise rates?
Did they hold it?
And what's the outlook?
And then essentially the market behaves.
So I understand that you're looking bottom up.
But surely when do any of the portfolio analysts or portfolio managers look at, you know, depending
on what's happening with a 10-year bond rate, you know, are we going to be tightening or
loosening, you know, at least as a subsector?
Or do they consider, you know, where to allocate money based on that at all?
Or is it purely just bottom up?
Yes.
I think that when you look at things with the benefit of hindsight, it always seems
easy, right?
And you always think, oh, yeah, I should have been able to predict that or I should have
known or some people get it right frequently or infrequently.
It's kind of like going to the casino, right?
Just because you had a good night and you won money time and time again on one particular
night doesn't mean you're going to go back the next night and have success.
So I think the ability to predict markets is probably random.
And so we just don't do that.
We just don't believe there's any value in doing that.
And by the way, if we had expertise in doing that, that's probably all we'd do because
that would be a pretty easy game to play.
So we don't have that ability.
We don't feel that we have that ability or that anybody has that ability.
We don't necessarily like the tags that people put on stocks, you know, are they value stocks,
are they growth stocks, et cetera.
We just look for stocks which are good stocks that will do well over time, that are somewhat
resilient to different market conditions.
And we'll think about market conditions.
We'll think about in terms of how the actual economy is performing.
So that's important to us.
But really, whether equity markets by and large are going to go up or down based upon
moving your predictions of rates or, you know, the latest inflation forecasts, et cetera,
that just there's no value for us in doing that.
So really, and the other thing which we've got to make sure we do is we focus on the
medium or longer term with all of our stocks because it's quite possible that you can buy
a great stock today that you think is going to do really well over the medium to long
term.
But you wake up tomorrow morning and the markets have moved and the stock is down.
And so you've got to have patience and you've got to have the courage of your conviction
to say, you know, I bought the stock.
I still believe in it.
And just because the markets moved against me doesn't mean I'm going to be selling it.
Now there are plenty of people out there.
They trade or film momentum trade, et cetera, and manage money in a different type of way.
That's just not what we do.
We're there to, as I say, build resilient portfolios which can stand the test of time.
Doesn't mean that we're not going to trade in and out of stocks, but we'll trade in and
out of stocks because the underlying conditions for that stock change, for that stock changes,
not because of equity market movements, et cetera.
We'll take global as an example.
When you look at things, you're looking at a thesis of what companies you think sound
the test of time.
Do any of the studies look at, as an example, companies that have a structure which can't
be easily removed from global economies?
Today, I don't know, credit card payments.
The facilitation of if that business was to be removed or a new technology would come
in, it would take five years to essentially remove that particular space.
Does that factor into consideration?
I'm just trying to understand exactly what do you look at?
The other question on that as well is, I know there's a number of strategies, but are they
go anywhere strategies?
If you're saying global or domestic, you can go resources, tech, or infrastructure, does
it matter where they go or is there a fine particular mandate?
Yes.
Let me address both of those topics, which are quite different.
On the first topic about, I guess, the strength of the business model, if you like, a common
term that's used in the markets is looking for companies which have a moat around it.
They protect the top businesses.
Everybody likes those types of businesses.
There's a whole bunch of reasons why businesses might have moats around them.
Some might be technologically driven, others might be brand driven, et cetera, et cetera.
Everybody likes those businesses, and we certainly look for those types of businesses and thinking
about also thinking about it in a different type of way.
Does the brand provide you with your moat?
Do the locations of your stores give you a moat, et cetera?
That's something that we're very keen on, if and when we can find.
We also like businesses, as I said, which can perform well or hold their heads up in
different market conditions, different economic conditions.
If we go into a recession, what business is actually going to do okay out of that recession?
We don't want to be in types of businesses that get smashed in a recession.
We look for resilient businesses.
Then finally, you really want to find businesses that have growth prospects.
That goes back to the notion of, I don't like the tag value.
GARP might be a reasonable type of term, although people have stopped using that more recently.
I think to find businesses that have growth prospects, it's necessary for your portfolio.
I think you just won't get the types of returns if you don't find growth businesses.
There are managers out there who are deep value managers who try and buy cheap and sell
at a better level at a certain point in time, not because the underlying business has necessarily
done well, but just because valuation parameters have changed, et cetera.
That can work.
It's generally not the way that we manage money around here with those deep value type
plays.
The question about, can our portfolios go anywhere and everywhere?
All the portfolios have parameters around which they build.
This is really important because investors who are putting money with you want to know
what you're doing.
You can't say you're an Aussie equity manager and then you wake up one day and you decide,
well, actually, I'm going to put half my portfolio into international equities.
My investors expect it to be in Aussie equities.
They put me into the underlying portfolios because I was the Aussie equity exposure.
It's really important to be clear with your investors where you're going and where you
can go and then manage within those parameters.
A fund manager who steps outside of their parameters really risks their whole business
and their relationships with their clients.
Some of our portfolios are quite tight in that regard and some of them are looser.
For instance, here's a good example in our original fund, our emerging companies fund,
the Small Cap Aussie Fund, we don't do resources.
Why don't we do resources?
You don't do resources in Small Cap Emerging.
That is interesting.
You're about to say why, but sorry.
Absolutely.
I find that quite interesting since we're in Australia and whenever I hear Small Cap
Emerging, I'm thinking resources.
Absolutely.
I thought you'd like that one.
Why don't we do resources?
When it comes to resources, you can't predict how that company is going to perform based
upon the underlying dynamics of the company because usually a resources company, the revenues
or the growth, etc., is driven by the underlying commodity.
You might find the best management team, you might find the best assets in, I don't know,
pick a sector gold or coal or something like that and the price of the underlying commodity
changes and it just destroys the business.
It might be the world's best pay.
Some fund managers, especially fund managers who are looking for relative plays, so they're
trying to beat an index, they'll say, well, we don't mind if that sector goes down because
we'll find the best stock within the sector and so our stock will go down less than the
rest of the sector and so we'll play that index game.
We don't play the index game.
We're not about trying to beat indexes in our portfolios.
We're about trying to deliver real returns to our investors.
That's also probably quite a big distinction.
We also, in some of our portfolios, we'll have ethical portfolios where we can't invest
in a certain range of underlying investments that don't pass our ethical screens, things
like that.
Small caps versus large caps.
If you're a small cap manager, you better stick to the small cap space, don't go into
the large space.
If you're a large cap manager, don't go into small companies that are illiquid even though
they might have higher returns when your investors expect you to be in more liquid larger stocks,
et cetera.
So it's really important to stick to what you've told investors you're going to do.
It's just really interesting about the emerging companies fund you mentioned.
It just made me think, you're right about resources.
Resources are essentially like farmers.
You can work so hard, do everything correct, try to cut the deals correctly, but at the
end of the day, that business sector, you're a price taker.
You don't control essentially the price which you can sell for.
So what I'm hearing is essentially you look for businesses which can control the price
which they can essentially sell for, which means potentially more stability with your
funds.
Is that what I'm hearing?
Absolutely.
So really they can take, you want to have as many knowns in the process as possible.
And if you've got a big unknown there, which is the price of the commodity, and they can
rarely move around their profitability hugely, that just doesn't work for us because we want
to allow for investing is variable as it is.
We want to try and reduce that sort of variability.
Yeah.
Look, I know you don't really focus on macro, but I really wanted to bring this up because
when people are looking, one thing, the other reason why I do this podcast is I find managed
funds, I came from a stockbroking background when you get like a list.
When you look at the ASX, you look at international markets, there's a list, there's the scoreboard,
right?
Everything's there nice and transparent, but I'm finding in managed fund land, having access
to the entire scoreboard, looking at performance and understanding why these things occur,
people can find quite challenging.
And as an example, you mentioned the emerging funds is average 12% going back, but for the
past year, it's gone 18%.
I think one of your funds, the high-conditioned equities fund has done like 54% for the year.
I don't think you've had a fund in the past year that hasn't done 10% or greater, with
some of them doing like 30, 40%.
It's been a very, very large movement from November.
And why I want to bring this up, I'm finding some families are in the making a switch from
direct equities to international.
They look at the past 12 months ago, this fund did 30%.
That doesn't guarantee, as we know, past performance doesn't guarantee, but I'm just trying to
... Why essentially has that move happened?
And where does Pangana think the markets are going to from here?
Yeah, so by and large, a lot of the positive performance over the last six months or 12
months has come from just a general upswing in equity markets.
And we're subject to those movements like everybody else is.
So we try not to focus on them too much.
We try to keep our mind on the targets on the middle to medium to long term.
But we absolutely get kicked around in the process like every manager does.
I think it's also then important to think about when you look at the portfolio to what
degree are your returns being driven just by market valuations improving versus your
underlying companies.
So a good way to think about that would be to see are your actual underlying companies
improving or the cash flows of your underlying businesses improving.
And really almost like you put your blinkers on, try not to look at the market, try not
to worry about the market.
You can't impact that.
You can't predict where it's going to go.
So just focus on your companies.
And as I said, if your companies are improving in terms of their cash flows and the growth
of their businesses and their revenues, et cetera, that sounds great.
And that's really the true test.
It's funny you bring up our high conviction fund, which has done fantastically.
I think we're up certainly north of 50%, probably just over just since the beginning of the
year, so the numbers are quite out there.
I think the numbers are quite potentially from March or April.
Yeah, so phenomenal performance.
And that's actually a great example of a fund where these super returns are not being driven
by the markets.
They're actually being driven by the underlying stock.
So a high conviction portfolio, which is investing in stocks that really have great potential
associated with them.
A lot of it is medical technology, some technology, some biotech, et cetera, and really trying
to pick the eyes out of the market out of quite unusual types of stocks.
And the performance has not come from the market at all.
It's really been driven by the fantastic developments or progress that has been made in these underlying
companies.
So that's the type of thing you really want to look for when you're trying to evaluate
the fund managers.
I know your job is to essentially run everything, but now I'm curious if potentially one of
those companies that have been invested, because you can't go anywhere down the street and
not go to a barbecue without hearing someone has taken a Zempik or Transmet.
There's all these fascinating businesses emerging that are having very large changes on social
dynamics in the market.
Is that the type of companies they're investing in?
First of all, is that global or is it domestic?
It's actually global.
I mean, we have the ability to do Aussie stocks, but it's a truly global portfolio.
And it's a fantastic...
I don't run the actual portfolio, so I run the business.
And you might want to have a separate podcast with our manager who runs the portfolio.
So basically, you can invest into the larger pharmaceuticals or medical technology companies
that have already established themselves.
And yes, there might be fantastic growth in the market, like in the example of Zempik.
But what we're trying to do in this portfolio is to find the future leaders.
And so we're trying to get really early on into stocks that we think have this potential
to make rapid developments over the coming years.
So it's a real stock picker's heaven, if you like.
And not only are we looking for those stocks and not only are some of them relatively early
on in the process.
Now they're all listed companies and they're not tiny companies, but they're certainly
not household names yet.
And a lot of them are like in relatively early R&D stage, or sorry, I should say actually
R&D stage, relatively late R&D stage, but they might not have actually been producing
the full range of their products just yet, etc.
So it's relatively early on.
So if you can find those types of stocks early on, you can do fantastically well.
And that's what our fund managers in that strategy do.
And I think at the moment, we've got half a dozen of those stocks in our portfolio that
are just driving the portfolio to great lengths.
And the portfolio only has a dozen stocks in it.
So it's a highly concentrated portfolio.
So we find this type of strategy is pretty suitable more to sort of family offices, really
high net worths, who can take some volatility and who can take a bet on stocks, etc.
But once again, if you believe in the abilities of the fund managers and put your head down
and don't worry about where this thing goes on a day to day basis, hopefully over the
long term, you do extraordinarily well out of this.
Yeah, it's very, very interesting how it all works.
But one thing I quite enjoy is speaking to people like yourself that actually run the
business.
I just want to remind before we get into the credit fund discussing, essentially, you're
running a stable, right?
It's a fund of fund stable.
And what's beneficial here is assuming hypothetically, everyone just invested in Pangana, are you
trying to create essentially an avenue of different portfolios or funds that if the
market conditions do one particular thing, you have an option, which will do well, and
then essentially one might trade lower.
And you have the capacity, if that changes, to essentially allocate that particular asset
class and then file with.
Have you tried to create more stability in the portfolios?
Yes.
So it's interesting that you bring that up because I think that will hopefully be the
case in our business going forward with sort of more breadth to our business.
We don't set out to do that.
So that's not our objective.
Our objective is not to buffer our own business.
Our objective is purely to create product that makes sense for our investors and can
fit into our investors' portfolios and can do well for our investors in their portfolio
construction.
So are you quite different to other fund managers?
Most fund managers will go and sit down with a client and our typical client might be a
high net worth investor or a financial advisor or a family office, et cetera.
And they'll go in and they'll say, we manage international equities and, wow, have we got
the best international equity fund to show you in the market?
Now, sometimes it might be top of the charts.
Sometimes it might not be.
Sometimes it might be bottom of the charts.
But they're there to sell the product.
When we walk into that same room, we never say, have we got the best fund to sell you?
We say, tell us about your portfolio.
What do you do?
Where are you making money?
Where are you happy?
Where are you unhappy?
Why don't you have private credit?
Why don't you have private equity?
Why don't you have impact investing?
Why don't you have Aussie small caps, global small caps, et cetera?
And we can help people improve their portfolios through our different solutions.
And so it's a fundamentally different conversation that we can have with our investors.
And I think our investors really like talking to us because we're so multifaceted.
I couldn't agree more.
Finding problems with solutions, finding where a weakness is and then providing a solution
to that problem is substantially more helpful.
Well, that's how I do it anyway.
So very, very similar.
So I should have asked before, how much money is currently Pingana overseeing?
So we've got about $3.5 billion that we manage across the business.
And so I think maybe one of your observations might be that well, if you've got a dozen
different strategies, that's not a huge amount of money per strategy.
But a lot of our strategies are capacity constraints.
So we can't manage huge amounts of money in them.
Good example would be our emerging companies fund, our original fund.
So in small cap land, if you've got too much money, every time you buy and sell a stock,
you move the markets.
So you can't have too much money.
So our fund managers, they cap the amount of money that they want to raise.
We have about $3.25 billion that we manage in that strategy.
And our fund managers don't want much more than that.
They want to outperform.
And the way they outperform is by they keep the funds relatively small.
So a lot of our strategies are in the capacity constraint buckets.
And that's one of the reasons why we don't have a lot more money.
We do have other strategies that have got lots of growth potential.
And hopefully, those will grow over time.
But I'd say the reason why we've got so many strategies and not so much fun is probably
just due to this capping notion.
And I hear that all the time.
You speak to a fund manager, oh, yeah, we can go to this particular amount.
They say, oh, we can do $300 million.
And then they raise a huge amount of money.
And then all of a sudden, that just moves to $600 million.
It moves to a billion dollar.
Then you look at the returns which they've made, the years they got them there are phenomenal.
But then all of a sudden, their return average starts to come off.
Absolutely.
Classic phenomena in this industry.
Is that normal?
Do you see that quite often?
Absolutely.
You see that all over the place.
Now, it doesn't apply to all strategies.
But it certainly applies to those strategies which have that dynamic.
And so small companies could be a typical example of that.
With the larger funds that can take larger caps, what's the cap on those?
Sorry, Mr. Stapp?
The funds that can do larger equities, not the small caps?
What's the cap on?
Oh, so look, if you're doing real large caps or mega caps, you can manage a huge amount
of money, hundreds of billions of dollars of money.
But you're doing a certain thing.
And you're investing in big stocks that are poured over by the market, etc.
It's a hard gig to try and outperform the market in mega caps.
What do you know that somebody else doesn't know about Netflix?
Wow, that's going to be a hard thing.
But what do you know that somebody else doesn't know about a small little small cap stock
based in Western Australia?
Well, you could really know things.
And so that's the difference between the two.
And I think it doesn't necessarily mean that investors can't do well investing in mega
cap stocks and large cap stocks.
But it's probably a, you know, it's a tougher game.
And outperformance is tougher.
But there's still ways of managing money that can do really well for investors, which is
what we try and do in those spaces.
Yeah.
And have you ever noticed that it's more of a case of not what they're picking, but what
they didn't pick.
And then a portfolio manager has a reason not for picking that.
But those are the seven companies, mixers of seven.
I can't buy it because the value is not there.
But if you're not in them, and essentially you're running behind the pack.
Yeah, I would actually think that's substantially more difficult, like, you know, from a behavioral
standpoint, would you agree?
Like, you have your mind, no, no, this is how it's going to go.
This is how we're doing things.
And one thing starts going.
It's like, well, I've missed it.
What do I do?
Yeah.
So I think it's really all what you promised investors.
And if you're promising your investors that you're going to outperform the equity index,
then that's a tough.
That's a tough call.
And to do that on a consistent basis now over the long term, you might very possibly be
able to do that.
And you should be able to do it with some smarts because the index should be somewhat
inefficient.
But if you somehow have given the impression to your investors that you're going to beat
the markets and you might not be in those stocks for very valid reasons, you're going
to fall short from time to time.
And so I think it's all about the communication piece and about what you're promising your
investors so they understand where you're at.
So if you go out, for instance, and say, look, we don't like investing in those magnificent
seven stocks because we think they are overvalued, we think it's too risky.
And so we're out of that.
We don't do that type of investing.
And people understand that that's what you do.
And if those stocks run, they understand that you're going to underperform.
But that shouldn't matter to them because everything's easy in hindsight.
But we're setting up portfolios for the future where we're worrying about not only returns,
but we're also worrying about volatility and about risk of loss, et cetera.
So yes, those stocks, after the fact, might have run really hard.
But the reverse could have happened as well with highly valued high growth stocks.
So I think it's all about the communication piece and providing people know what you're
doing and you stick to what you're doing.
Hopefully, they're happy with that over time.
I'm going to agree more.
So since we're talking about communication, you communicated before about the second fund
in private credit.
This is very interesting.
So before I bring up something in particular, do you want to give everyone a bit of understanding
what the new fund is and how it works?
So private credit is a really interesting space.
So this is global private credit.
It's probably the hottest space in the market at the moment.
Private credit can generally be defined as anything which is non-bank lending.
So it's a really, really big space, anything outside of bank lending.
What we focus on and what we like specifically is what we call bilateral loans, which means
one-on-one lending.
So like a bank lends on a bilateral basis, bilateral loan to mid-market companies.
Like companies we define as companies with pre-tax earnings of 50 to 250 million US dollars.
So by and large, think of them as billion-dollar type companies.
So we like this space a lot.
And the reason why we like this space a lot is because you can get fantastic risk-return
dynamics in this market.
So I'll wind back, indulge me for a second, just the history of this and why this opportunity
exists.
So post the GFC, the banking regulators offshore decided they were really worried about the
banks running liquidity mismatches in their businesses.
So basically, corporate lending, you lend out to a corporate for five or seven years.
On the other side of the ledger, you've got investors or you've got depositors who can
come into the bank on any given day and withdraw their money.
And so that's a really dangerous dynamic, we call it a liquidity mismatch.
So the regulators said, look, if you want to, to the banks, if you want to lend to corporates,
you have to hold extra amounts of equity.
So you've got more liquidity in your book.
That meant that lending to corporates became an unprofitable, less profitable activity
for return on equity because you have to hold more equity, went down.
And so the bank stopped, basically, by not stop lending to the corporates.
We have a situation today, 85% of lending that goes to corporates comes from private
credit providers, not from banks because of that dynamic.
And so what that meant is as the bank sucked all their capital out of the market, they
stopped lending to corporates, corporates didn't have anywhere to go.
The really smart people on Wall Street saw this opportunity, and then they went and put
these private credit funds together, that really you can think of them as the new age
banks, they lend to the corporates, just like the banks used to lend to the corporates.
But whereas a bank might lend to a nice big billion dollar corporate that is a good business
model and a moat, etc. around them, while the banks might lend to that type of business
at say 200 basis points spread to 200 basis points over the base rate, the private credit
provider lends at 550 or 600 basis points over.
So if you think where rates are today, a private credit provider is getting a double digit
return from lending to a billion dollar corporate in a really safe and secure market.
That is fantastic, right?
Especially when you think about the risk, and we think about risk in two forms.
The first way we think about risk is what is the risk that that loan is going to fall
over?
Well, the answer to that is if you're a good private credit firm, and you've been doing
this for a lot of years, and you know how to structure your loans, the risk of a billion
dollar corporate, and that's nice and safe and secure, of them falling over, provided
you don't gear them up too much, is tiny.
Because billion dollar companies don't fall over.
They're too big to fall over, unless something untoward happens.
So maybe COVID hits and they're in the entertainment industry, yes, they can fall over.
Or maybe there's a fraud or something.
But by and large, it's highly, highly unusual for these companies to go bust.
So that's why the risk of loss is really small.
And then what's the other way to measure risk is volatility.
So what's the volatility of the underlying asset?
Well, when you're doing one on one lending, so this isn't buying and selling tradable
securities, this is just lending like a bank lends.
You lend out $100, that stays in your books of the private credit fund manager at $100
and you're clipping your 10 or 12% interest rate every year.
But it stays in the book at $100.
It doesn't matter, Russia invades the Ukraine, it doesn't matter to that loan.
It's not going to go up or down that $100 stays at $100.
If you were in tradable securities, they might collapse.
So the volatility, which as I said is the other way of measuring risk, is really low
on these assets as well.
So you get this double digit return, which we know is an equity like return with extremely
low volatility and extremely low risk of loss.
And that's why it's such a good asset class.
And that's why it's so keenly sought after by investors.
So if you look at the big institutional investors in the US market, the sovereign wealth funds,
the pension funds, the big family offices, they're investing a lot of money in this
space.
It's probably the favorite space for them to be investing in at the moment.
And so that's where we play.
This is very different to Australia.
So this opportunity does not exist in Australia.
And why not?
Well, the US regulators really worried about the US banking sector because there's 5,000
banks there, right?
And they worried about a bank falling over and then there being a contagion effect, right?
Like we saw last year with Silicon Valley Bank, they fell over and then the next bank
looks like it's going to fall over, et cetera.
It can have that real domino effect.
In Australia, our regulators don't have those concerns.
Why?
You've got four banks or five banks, if you include Maury.
There's no contagion effect here.
They were well capitalized, et cetera, et cetera.
Our banks have no problems lending to BDN and dollar corporates.
And in fact, that's probably bread and butter for them.
So if you want to get these big spreads in the Australian marketplace, can you do lending
to the mid-market?
No, because the banks are there and they're probably lending at, I don't know, 150 or
200 or 250 over for various corporates.
So the opportunity in mid-market lending to earn these widespread is not there.
So where do Australian private credit providers go to get the high margins?
Well, they go to places where the banks don't like to go.
Number one is property.
Whether it's highly geared property, property development risks, the banks don't like that
and they don't like it because of the underlying risk.
But also because of the consolidated nature of that risk.
Property markets are correlated to each other.
So you don't want to do a lot of that stuff because if one of them falls over, there's
a chance that the whole market might fall over, et cetera.
So they don't like those risks of banks.
And so the non-bank lenders or the private credit providers are very much in that space.
And that's where they can earn those high yields.
The other place that they can earn them is small situations.
So they can go and lend to a $50 million company and you can get a nice high spread because
the banks don't like the risk of smaller companies.
But the mid-market, bilateral loan markets where we make so much money off shore doesn't
exist in the Australian marketplace.
Very different.
Now that's not to say that what we've got here is bad and I think people have done really
well out of it and we've got really good fund managers in the property space and the small
ticket lending space, et cetera.
But this risk return that we see in the US markets and in Western Europe, I'd say it's
an anomaly where you're just getting overcompensated for being in this marketplace.
And that's purely driven by the regulator coming in and playing around in the market.
So regulators have created an inefficient market and we're able to take advantage of
that inefficiency.
Yeah, I was just digesting what you're saying because we're very, very familiar with the
money that can be made in property lending.
Like you can't walk down the street without someone going, hey, I've got a property lender
for you, you can make good money.
You make anywhere from 10 to 15%.
It's fantastic.
Clients are very happy with it.
But it's interesting in discussing and as you mentioned as well, there's a number of
other fund managers, very great people, great operators.
They do, as you said, participate in that 10 to $60 million bracket.
But yes, the risk increases.
Are there any other players or any other funds available?
What's the competition for what you're doing in Australia?
Like I spoke to a fund manager the other day that's in Southeast Asia.
They're doing exactly the same thing, exactly the same thing, but they have the capacity
to do venture debt.
So they attach a warrant to it to participate in the equity upside with the land.
And they said there was only three other players like that currently in Australia.
As you mentioned, for the exact same reason, if you're dealing with upper echelon businesses
and something happens to the business, you only need to sell like 3% or 5% of the business
to essentially call back your capital.
So the risk substantially drops off.
So I think they're really interesting niche spaces and we do cover some of these niche
spaces in our portfolio.
So we're not just totally doing stock standard lending.
We've got a small piece of our portfolio, which also does some interesting things like
we've got a little bit of an exposure to venture debt.
So you do venture debt in this as well?
It's tiny in our portfolio.
What percentage of the portfolio?
It's probably about 2% of our portfolio.
Would you potentially look to increase that if it goes well?
No, I think that's enough.
We've got 10% of our portfolio is earmarked for more innovative type of things like venture
debt and we've also got some distress debt in there.
These strategies can be fantastic.
We've given our investors in PCX just a little taste of that.
But our portfolio on PCX, so what we've actually got, I should have actually mentioned this,
is we decided on pursuing a fund to fund strategy.
So fund to fund strategy, usually people say fund to funds isn't a good idea because you're
just giving money out to other people, et cetera.
But fund to fund strategy is necessary in this space and why?
Well twofold.
Firstly, I spoke about these great returns with these really low risks, but not everybody
gets them.
Only the better fund managers get that.
So you want to put your money with the best of the best.
And these are quite big, powerful businesses.
Remember, we talk about companies who are lending to the mid-market.
Average corporate that they're lending to is a billion-dollar corporate.
Average loan size is probably a 35% LVR.
So you're lending $300, $400 million a piece.
So these are big lenders.
That's where you want to be.
Big lenders, big teams, lots of experience, been doing this for many, many years.
And as I said, they're the ones who've got the great track records in this mid-market
lending space.
They know what they're doing.
So we want to give them our money to manage.
So that's really important to us.
The next thing about private credit is that you want to have diversification.
Diversification is absolutely your friend.
So if you're doing equity investing, you might not want diversification because you, the
equity holder, you're going to get all the upside.
When you say if something really does well, the equity holder makes money off that.
If you're in private credit and you're lending to companies, if that company does extraordinarily
well or modestly, it doesn't matter to you.
You're only worried about the downside.
And so when you're worried about downside, you want to diversify as much as possible
because if you have an accident in the portfolio, you do not want that to impact the whole portfolio
in any meaningful way.
So what we have done, we have invested in 20 different managers.
And if you look through all of our managers to the underlying loans that we provide out
in the marketplace, or our managers do, there is more than 2,000 loans.
So by buying one unit in PCX, your one unit is split essentially 2,000 times amongst 2,000
different loans to billion-dollar type companies.
So huge amount of diversification.
So we think that that really helps control the risk, as you can imagine, and get that
general dynamic where we're getting these high returns with these really low loss of
loss rates.
There might be a couple of companies that fall over because, as I said, for any sort
of specific reasons, but a couple of out of 2,000 isn't going to impact our portfolio.
Let's really, really, really dig into this because this is quite interesting.
Basically in, what was it, 2020, we had three lenders hit the market.
And I think they're fantastic fund managers.
They came on, unfortunately COVID happened.
And then one of them, in particular, as an example, went from $2 down to like 90 cents
and has taken a while to recover.
But then you look at their unlisted managed funds, they barely even got hit because, again,
exactly the same reasons which you're mentioning, the product is good.
It's just, I don't know if it's the Australian mindset or Australian investors don't understand
exchange, trade or listed investment trusts that do illiquid assets, so to speak.
But apparently you were telling me the other day that you found a solution to this problem
to kind of deal potentially with the liquidity and the level of volatility so Australians
can get access to this level of asset class without that whip, to put it nicely.
Yeah, absolutely.
So I think there are a couple of other listed vehicles in the marketplace and some of them
have delisted or in the process of delisting.
By and large, they don't do what we do.
So what we do is, as I said, bilateral lending to mid-market companies, no volatility in
the underlying Nassau returns.
Some of the other vehicles actually invest quite a meaningful amount of their portfolios
into traded credit.
And so what you find in traded credit markets, when things go badly, the spreads widen and
the traded value of these assets can plummet.
And so that can be highly volatile.
So I think some of those vehicles were overexposed to traded credit.
The markets hit a wall and you had some write downs in the portfolio.
So there was one issue.
Now it's easy to build traded credit portfolios.
If you gave me half a billion dollars today and you said, can I invest in traded credit?
I'll do that portfolio tonight or this afternoon.
I'd hand it over to you.
In bilateral lending, it's going to take a long time because these are one-on-one loans.
So that's why a lot of fund managers go to the traded side because it's easy to do.
We've taken the hard path going on the bilateral lending side.
So that's sort of the underlying assets in our portfolio.
I think that's an important distinction.
But the other thing which we've noticed, and I think this applies to everyone, is that
whilst listed vehicles are fantastic for investors from a ease of functionality, so it's listed,
which means you can buy it and sell it on the market any single day.
If you need cash, go and sell it.
If you want to rebalance your portfolio, buy some, sell some, et cetera.
So really easy to use and there's a daily price for that.
The problem with listed vehicles is that they can trade at a discount to their net asset
values and that can happen from time to time.
Sometimes you get into a bit of a rut where it trades down and people aren't going to
buy it higher than the traded down price because they don't believe it will go back up to the
net asset value.
So it has been a problematic part of the market.
Maybe it might be cyclical and we might be, well, the lows were several months ago when
these things were trading at very large discounts, the market as a whole.
It's probably narrowed now and less so of an issue, but there's still some issues in
general with regards to discounts across the listed markets.
So we sought to correct this problem or put in place a mechanism to ensure that our vehicle
won't trade at a discount to net asset value.
And what we've done is we've given investors an option to liquidate, not just through the
market, and obviously they can go and sell their shares on any given day because PCX
is a listed vehicle.
But if you do not like the return that you're getting on market, then you have an ability
to actually put your units or sell your units back to the fund at the net asset value.
So you can essentially get redeemed right at the net asset.
We really need to shine a light on this.
Like as an example, what's the current, is it trading right now?
It's only listing in two weeks time.
And what's the listing price?
So it's $2.
$2.
Okay.
So technically world collapses, fingers crossed it doesn't.
And then this hits $1.60.
But the net asset value of the fund is $2, which is a 20% discount.
There is actually an arbitrage there to potentially as a trader to go in and buy a $1.60 and then
go straight back to you and sell it to the house.
Yes.
Now you have to sell it back on a quarterly basis.
So you'd have to wait at least three and a half months to get your money back because
you only do this on a quarterly basis and you get your money back straight away.
But if you think about it, like using round terms, say this was doing to pick a round
number, say the portfolio is doing 10% per annum and so two and a half cents a quarter.
So when I put in my redemption notice, I get the net asset value at the time or at the
beginning of the period plus the two and a half cents for the quarter.
That's how I get out.
So I'm getting out at net asset value plus the growth for the quarter.
If I'm desperate to sell and so I need my cash, I can't wait to get it out at net asset
value, I might go and sell it on market at say $1.99, but I'll use $1 just easier with
the maths.
So if I sold that $0.99, somebody else comes in and buys it from me at $0.99 and they arbitrage
the price, which what they mean is they buy it at $0.99, they put in the redemption notice.
What's their return for the quarter?
Well, they'll get the two and a half cents plus they'll also get the one cent discount
that they bought it at.
So they'll earn three and a half cents for the quarter.
And your last three and a half cents for the quarter, 14% per annum.
We'll all do that trade any single day.
So should a trade less than $0.99 in the dollar, we would hope not.
So we think that this will really keep the discount very narrow.
We have said that the total amount that we will be looking to buy back in any one quarter
is 5% of the total stock that's out in the marketplace.
So it's possible that if there's a real rush for the exits, you won't be able to get out
in one quarter, you might need to get out in two or three quarters.
But nevertheless, you will still be able to get out at the net asset value plus the returns
for the period.
And we think that the 5% is sufficient in any event.
So this is, you're talking about the psychology of investing.
This kind of is solidifying the notion that this thing should trade at the NAV.
And why would I sell out at anything less than NAV if I can redeem at NAV?
And so therefore, it should trade at the NAV.
So maybe a premium, but I'd be happy for trades at the NAV.
It's such a, hats off to you.
It's such a clever little system because you're essentially using the behavior of the markets
to be able to deal with everything.
You're essentially using other people and other traders there to essentially, it's like
doing a buyback.
You're essentially offering people, smart enough people that can see the opportunity
to essentially buy back, buy it up and create essentially the volume, which as a byproduct
gives you the stability.
And you don't have to do anything except for providing the mechanism available for it to
occur and then it takes care of itself.
Correct.
And I'm not sure that people actually land up putting in there.
Is this the first one of this in its kind in Australia?
Is this happening in Australia?
Did you nick the idea from someone else like university?
Best advice we've got for universities, look left, look right.
If someone's got an idea, realize someone else has had that idea originally, steal it.
Build a product and then buy it.
So unfortunately, I think other people will be stealing it from us going forward.
That's right.
So where we got it from is this quarterly redemption structure is a structure that's
very, very common in markets, but they're unlisted structures.
So to give liquidity to investors, it's very common in the US.
They call them interval funds.
So to give a liquidity mechanism to investors, they say, look, every quarter we'll buy back
people who want to sell, we will buy back their stock at the net asset value subject
to maximum amount.
And so that mechanism, this is very, very common in markets.
And people by and large are happy with that.
Oh, I can get in and out at the NAV.
And all we've done is we've taken that mechanism and we've just overlaid it onto the listed
structure.
So essentially, have the benefits of that unlisted vehicle where you can get in and
out at NAV, as well as the benefits of a listed structure where you trade on a daily basis
and you've got a daily price.
So in hindsight, I don't think it's rocket science.
I think it's kind of-
No, it's like anything simple that makes sense.
When you explain it after it's been done, it's like, how the hell didn't you think
about that before?
It just makes so much sense.
But I'll be remiss to ask, with the numbers, is it fun to find this fees coming out of
fees, which is fine for this ability, and plus the access to retail makes sense.
But what would someone be expecting to return?
I think you mentioned it before.
What's the targeted return for this strategy?
So we have not set out a target return because I think about with the general rule and what
ASIC likes you to do with new vehicles is not to tell investors what the target return
is.
We don't have an actual target return in our PDS.
We do have a minimum yield of 7%.
We have a performance fee hurdle that we've put into the vehicle, which says we will only
get paid a performance fee in the event that returns are 6% above the RBA cash rate.
So 60% above RBA cash rate.
So we will only get paid a performance fee if we generate-
Is there any administration fees?
10.35%.
Everything's net of fees.
Is there any administration fees?
The fees built into the vehicle and into the structure.
But when I talk about returns, these are net of all fees.
We only ever talk net of fees.
So RBA cash rate plus 6.
Plus 6 is where we get paid a performance fee.
So we would obviously hope to generate performance fees.
The only way to control the company is to control how people get remunerated.
So that's how we have set it up.
And we've also set a minimum 7% yield, which we pay on a monthly basis.
So I think if we perform better than that, then the 7%, then maybe we top the yield up
somewhat.
And we've said as a minimum, there's a 7% yield.
It's set on a monthly basis and that will begin from month one of the trust being listed.
We offer closes on the 6th of this month, 6th of June.
And we'll start trading towards the end of the month.
And so from July, from 1 July, we'll be fully invested across the portfolio.
Because amongst our 20 different managers, we've got space to allocate everything out.
And so in the month of August, 1 12th of 7% will be paid to our investors in our first
yield payment.
If anyone wants to learn more about this, because this is quite interesting, how can
they get more information?
Yes.
So our website is pretty full.
It's pengona.com.
It's got a lot of information about PCX.
I think otherwise, if you probably Google PCX, Pengona PCX, etc., you'll get all the
information.
There's lots of videos and I think we've got great materials out there for investors to
get familiar with it.
There's also a lot of brokers out in the marketplace who are representing us in the raising.
We have Taylor Collins and Morgan's, Shores and Canaccord.
So there's brokers who people can speak to and also a lot of financial advisors know
the product and we've spoken to them.
It's in a lot of portfolios, going to a lot of portfolios.
So speak to your financial advisor, get the information, read the documentation, obviously
read the offer document.
If your financial advisor is not aware of the product, maybe you can encourage them
to go and make themselves familiar with the product and hopefully we can get you invested.
Last question, there's probably a lot of youth listening to this, a couple of six-year-old
hopefully that want to get into this space.
Since you've been here, started at Runnit and very happy doing what you're doing, is
there any wisdom you want to impart on potentially young listeners looking to get into other
run a stable or become a fund manager?
Yeah, so funds management is a great industry to be in and there's a lot of people who want
to get into the industry.
If you're a really young person, I'll tell you one thing, just work really hard, get
good results.
If you're going to get hired into this industry and as I say, it's hard to get hired into
this industry.
The first thing people will look at is how have you done in your university, have you
showed yourself, have you showed that you can apply yourself?
Have you showed that you've got the smarts?
So focus on your studies and also read, read a lot.
Read the good books from the great investors, read about what's going on in the market,
read articles.
You really immerse yourself in this type of thing.
So what do we like to see if we are interviewing somebody, somebody who's done really well
so we can tell that they're smart?
They've obviously got really good presentable type people, so make sure you've got confidence
and you can talk to what you do.
But we also want people who are well read and who understand things and have shown initiative
and have got a passion for markets.
So do all that and hopefully you can find your way into the industry.
Russell, it's been a pleasure having you on.
Thanks.
Great to chat.
All right.
Speak to you soon.
Thanks.
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