Murdoch Gatti (00:06.291)
Nicholas Chaplin, welcome to the rate of change with York Wealth management.

Nick Chaplin (00:10.691)
Thanks Murdoch, great to be here.

Murdoch Gatti (00:13.823)
Nicholas, why don't we start things like we always do and tell us how you got into the wild world of financial markets.

Nick Chaplin (00:22.382)
Well, it started a long time ago. If I was to say to you that my banking career was 33 years, I started in banking in 1989. And at that point, we were just two years past what was considered to be the biggest equities crash since 1929. Now I wasn't around in 1929, so I can say that fairly safely. But in banking for all those years,

I spent my time at the CBA for a while in Treasury and whilst I was in Treasury, we issued Pearls 1. The work to do that commenced in 99 and went through till 2001 when they issued it. And from that very moment, I became linked to hybrid capital. so whilst I was in Treasury, I was in capital management there working with some very good people.

good treasury there, good CFO, and David Murray was the CEO of CBA at that time. CBA, I believe, created its equity PE in those days, its 10 % premium of its PE by doing off-market buybacks and managing its capital really well. That seems to have gone out of fashion. I won't go off on a tangent, Murdoch, but corporates have forgotten about the shareholder.

Murdoch Gatti (01:46.835)
I love a good tangent. That's what that's why we're here. I love a tangent. That's why we're here. I know we're here to talk about the fund and everything. But you mentioned I'm now just completely fascinated about the CBA pearls. And like when I was at another broken house, I saw the essentially the aftermath of you know, your fine work where every single bank started to list, you know, hybrid notes, A, B, C, D, E, F, G, and just it was just constant.

Nick Chaplin (01:50.678)
Well...

Murdoch Gatti (02:14.579)
But I do recall speaking to an analyst and I would love to hear a little bit more about yourself and probably a lot of people out there potentially own hybrid nodes will pick these up. But if I'm not mistaken, the CBA pearls, how they were structured were amazing. And by the end of it, people thought they're going in to pick up these hybrid nodes and getting what the original CBA pearls were. And by the end of it,

It was essentially like, you know, a knockoff product from China equivalent. Okay. That's really, really harsh, but you know what I mean? Like it just got changed quite a lot. Do you mind giving some color around that?

Nick Chaplin (02:49.325)
No, I think it's a fair...

Yeah, I think it's fair to suggest that the product became generic after a while. I don't think the regulators like you saying or you or I or anyone else saying that they'd like to think that, hang on a second guys, this is highly complex stuff that could mean investors lose all their money if the bank fails. you know, we'll get into this later, but what APRA and ASIC and all the other people involved fail to realize.

is the type of banking industry we have here in Australia is very, different to anything offshore. It's predominantly a mortgage banking industry. you know, sure, Commonwealth Bank could fail tomorrow and then the the pearls issues will get bailed in and the hybrid holders could lose up to 100%. What investors have done since day one is consider the likelihood of Commonwealth Bank failing tomorrow. And they usually come out saying,

I don't think it's going to happen. I can't say it's going to happen with 100 % certainty, but I don't think it is to the extent that I think I'll buy that pearl and have a nice yield. So you end up with that being the decision rather than what the regulators think, which is the investors don't know what they're buying. They just think it's a deposit with CBA. I've never heard any more rubbish in my life having been involved with hybrids for 25 years.

In fact, their entire existence in Australia in the listed market. So going back a little bit to the uniqueness of the issue that you mentioned, it's quite right. They were designed to be halfway between equities and debt. So you end up with bond-like payment options. It's being paid quarterly and the money's designed to come back to you, but it doesn't have to.

Nick Chaplin (04:47.506)
The equity aspects of it is that it's subordinated. It's got discretionary coupons like a dividend. In fact, they are actually known as dividends on hybrids. And that decision needs to be taken by the board of the bank and with the permission of APRA to make those payments. And then when you get to the call date, which is somewhere between five and eight years, originally, by the way, Murdoch, it was up to 10 years that we've seen.

It was quite common for hybrids to have 10-year call dates. Now it's more like five to eight, typically seven, seven and half. And that's because the global rules on how these things are structured have changed over those 25 years. But even so, you still get to a generic idea of the structure. The most recent major change was in 2013, and now you're generically issuing that structure, which are called capital notes now, whereas originally they were called

reset preference shares or perpetual preference shares. There were a variety of different names for them, but they were all subordinated. They all had discretionary coupons and they all had no guarantee that the bank would give it back to you. It was perpetual, but there happened to be a call date at a certain point. So that was quite unique. And then you get this generic aspect of it as all of the banks sort of jumped on board because it was way cheaper.

for them to issue this to satisfy their capital requirements than it was to issue dilutive equity and sort of dilute the shareholders every time at a discount, which is what happens when equity is issued. Now APRA really does need these instruments because if you ultimately only have equity to go to if a bank gets into some sort of trouble,

I'll use this as an example. Bank of Queensland in 2012 lost about $400 million because they had to revalue their commercial properties predominantly on the Gold Coast at that time and did about $400 million. That took them into a loss situation. First time we'd seen an Australian bank in a loss situation for many, many years, probably back to Westpac in 1991.

Nick Chaplin (07:10.245)
Now, what did Bank of Queensland do overnight? They raised $350 to $400 million without blinking. The investors were there to do it for them. In other words, the shareholders in this case didn't think the bank was going to fail.

Murdoch Gatti (07:40.137)
It says you got an incoming call.

Nick Chaplin (07:40.693)
So, yeah, I've deleted that. So you end up with a situation where they raised that 400 million and went on as a bank, but you can't do that forever and ever and ever. If you continually go to the shareholders and when you raise equity, of course, you do it at an attractive level, usually at somewhere between five and 15 % for the big banks.

If you did that three or four times in a year or two, eventually the shareholders say, I've actually done nothing but lose money in this game. I'm not putting in to the fifth time you do this. And that is a disaster for APRA, the prudential regulator, who is trying to say that there's always equity capital there if you need it. It won't be if you keep doing that. That's why this level of hybrid capital is so important for them.

because it gives the banks an alternative and it's vastly cheaper. Right now, roughly, the cost of equity for a bank is somewhere around 12%. The cost of a hybrid is somewhere around seven. The cost of subordinated notes, so the other form of capital that is not equity is subnotes, which are typically like a 10-year maturity with a five-year call. That's going for about 6%. Senior's going for about five.

Covert's going for about four and half, five, and of course term deposits are giving you about four and a half. So there's the range of returns you can get for investments in Commonwealth Bank, just to continue using that issuer as an example. The standard, the same concern of an investor, whether it be in a term deposit,

even though you've got a government guarantee there for a quarter of a million. But let's say you're putting five million in a TD, that government guarantee suddenly becomes worthless. The same concern is, is the bank going to fail? And the investors that are holding the shares of CBA must have the same concern as the guy that's investing in a senior bond. The rate, ranking of you

Nick Chaplin (10:04.412)
getting your money back if the bank fails, of course, is different for each one. But no one wants the bank to fail. And I think if you said to someone, hey, CBA is going to fail next week, but you can still get a really good return in senior bonds, I wouldn't buy the equity but buy the senior bonds. No way would anyone buy the senior bonds. They wouldn't even put their money in a TD. So it's really important to, if I could sit in front of the regulator, which I do do from time to time and say to them,

People invest in hybrids because they believe the bank is going to be there at the time that the money is due. Even though it's perpetual, there's a call date. And they do trust that the payments will be made. There's things called dividend stoppers in these instruments, Murdoch, and they basically say, if you don't pay the dividend on the hybrid, you cannot make the dividend on the equity. And APRA actually allows that dividend stopper to be in there.

That gives people a fairly strong concept of the payment being made because you won't want, as a board of a bank, you won't want the equity being, the dividends on the equity being stopped because again you start to ruin your relationship with your shareholders.

Murdoch Gatti (11:26.523)
If I'm understanding correctly, what you're saying is this investment class, the hybrid notes is purely tied from an investor's perspective in the belief that the bank won't fail.

Nick Chaplin (11:39.385)
the investor will come in with that view very strong in their mind. Okay.

Murdoch Gatti (11:45.151)
So let's touch on that for a second because I mean, channeling a couple of analysts and some good fire managers who are comparing say CBA to Lloyd's bank, right? And when they did this analysis, the CBA was at say 20 times and Lloyd's was at seven. Practically, if you look at the page and the numbers, it's the same bank except for CBA is company owned and Lloyd's is in a trust vehicle. And I think Lloyd's has 100%. So they learned out 100 % of the money based on

100 % deposit whilst I think the CBA was what 80 20. But the point he was making, which I found quite fascinating is that hypothetically, on a crazy hypothetical evaluation, say the valuation ran to 120, right for CBA, they're underneath the mindset that people will still buy it. And his logic there, which and I have to research the numbers and please fact check me on this.

from what I've read that apparently with passive investing, via the superannuation vehicle, which Australia is, and the super funds out there, something incredible like potentially 10 % of all retail super or just super vehicles is essentially going into the Commonwealth Bank every year. From your knowledge, is that accurate? So based on that there, you technically have this, you know, capital pool on the equity side continuously, you know, potentially over

used to come propping up just using CBA as an example. Is that logic there part of why people think that the bank won't fail? So essentially, theoretically taken a massive step back when COVID came in, if anything, the biggest threats of the banks is people not working losing jobs, and then that passive amount going into it drops off and then it becomes volatile. Is that an accurate theory or

Nick Chaplin (13:14.283)
I think that's accurate. Yeah, I think.

Nick Chaplin (13:36.621)
I think it's an accurate theory, but I wouldn't suggest that that's the prime reason people think the bank won't fail. I think the prime reason people think CBA or Westpac or NAB or anyone won't fail is A, they do have a healthy respect for the regulator, although APRA is starting to, we'll talk about this no doubt, but APRA is trying to destroy its reputation at the moment with these hybrids.

They do go in saying, like the fact that the regulator sits over this bank and the bank has to have X amount of capital behind it. If you were to say, go and buy BHP or if you had the option of buying BHP or buying Commonwealth Bank, there is a fair swag of investors out there that will prefer to buy Commonwealth Bank for the reason that they are being told to hold protective capital to X amount.

They are being told to maintain liquidity ratios of X amount. They are being told how they must run their bank to protect depositors. There is no one out there other than the board of BHP telling BHP how to protect the shareholders. So you've got this very material added element of protection for a financial in Australia versus a corporate. And consequently,

the investors are saying, I like the prudential regulation is there. I like the fact that perhaps there is an element within the investing public that says, I don't think the government will allow CBA to fail. Now that's different from saying, I think the government will bail me out if CBA fails. Okay, they're actually saying I don't think the government will allow CBA to fail. However,

Murdoch Gatti (15:34.643)
Well, if anyone doesn't understand hybrids, I think this has been a very good introduction to what is a hybrid, what's the investment thesis and why they exist and why people look at these from a low risk perspective. Sounds like you've had a fun career, mate.

Nick Chaplin (15:44.638)
Yeah.

Nick Chaplin (15:50.762)
A lot of people would question that. I didn't set out, and I've said this to people, I didn't set out with the idea of becoming a specialist in prudential capital, instruments, hybrids and sub-debt and all the rest of it. It just worked out that way because the market presented itself. I was an originator for many, years, which meant I had to structure the instruments, go out and see the treasuries and say, here's what would be beneficial to you. It satisfies APRA, it satisfies the regulators, blah, blah.

But no way did I start off saying I want to do that. I was at ComSec for a while, was happy in the equity world. I was doing listed investment trusts for a long time, all the way back in the early 2000s. Jumped back on that train a little bit from between 15 and 20, but always originating hybrid or structured equity through that period.

The market has been very, important for all the reasons we've said. Investors are very comfortable with it. And let's face it, this market in Australia is unique. I mean, we have franking credits in Australia. The only other country in the world that has these imputation credits is New Zealand. That's for various reasons attractive to especially super funds. So they like this product because it's franked. They like buying bank equity because it's franked. But

It's just very unique. And I think the way the APRA should be looking at this market is very different. They shouldn't be looking at Credit Suisse in Switzerland that failed and had to be bought by UBS. I look at that and they say, that could happen in Australia. No, it couldn't. Or it could under extraordinarily unlikely scenarios. Credit Suisse is an investment bank that was doing all sorts of things wrong. The banks in Australia are mortgage banks. They take in money from deposits and lend it out for mortgages.

really basic. The only bank in Australia that is somewhat comparable to Credit Suisse might be a piece of Macquarie. That's it. The rest of it's pretty...

Murdoch Gatti (17:51.623)
It's pretty.

Murdoch Gatti (17:59.763)
No, it's pretty interesting. how did Adam Curtis reached out? We've been in good relationship with those guys. A number of the funds that they work with are quite sound and we've been working with them as well, very, very smart people. So how did the relationship with Curtis and the guys at Seeds Fund Management come to be? And what's the new fund, the hybrid income fund?

Cause that's been around for quite some time now, right? It's not just, it's not just, you just went, let's set up a new fund. It's been around for quite some time. And now, you know, you're working with a Seize My Fund. What's happened there?

Nick Chaplin (18:29.383)
Yeah.

Nick Chaplin (18:35.462)
Yeah.

How did that happen? It started actually while I was at NAB back 10 years ago because we were talking to a lot of investors. Sometimes I'd go up and talk to UBS Asset Management. There'd be 60 guys in the room there and I'd be explaining what's going on with the market to them. And then an hour or two later, I might be talking to Mr. and Mrs. Smith from Parramatta about their super and they're a J.B. Ware client and about the same products. And you had to sort of aim your

education correctly to the audience. But that was being done in sort of, I started at NAB in 09, before that I was at Westpac, before that as I mentioned I was at CBA, always involved in these products. Used to head up the desk at NAB in terms of originating these products and other sort of structured stuff. We did a lot of deals over those years but we were always talking to investors.

And the investors were always wanting to know a variety of different things. There was some commonality with the queries, but generally what there was always unique things going on in the market that we had to address. And I said to Steve Lambert, who was running the institutional bank there at NAB at the time and running it very well. I said, look, we should really run a fund because when we're talking to investors and they say this events occurred and prices are down.

I can say, yep, we feel that too because we're managing a fund and this is how we've addressed it. This is what we're doing to address it. He liked the idea, but said, you can go do that, but you'll have to work in asset management. You'll be off the street and you won't be originating. That was not a good outcome. So essentially I started it privately. I knew at the time that you're not taken seriously with a very non-existent history.

Nick Chaplin (20:34.119)
in funds management, can't, as you said, you can't just sort of think, let's start a fund today and all of a sudden, Lonsick's going to rate it and you've got a track record. You can't really run something just off your experiences, even though they might be 30 years long. You've got to have a track record on investing in the product. So I had that in the background going along, got to about 22 and I took it out.

publicly at that point because it had seven years of history. I'd started it in 2015 and it was purely originally investing in just the tier one as APRA calls it hybrid instruments, tier one capital. And they were fine. They were giving good returns. Obviously rates were very low for a lot of that period Murdoch. So, know, comparatively getting four, five, six percent

at the time might not have been very exciting, but people had adjusted their expectations for return. The guys that say, need a minimum of five in 2015, suddenly were accepting three and a half by 2022. But then rates started to rise. And remember, we'll get into this, but this is an important piece of the portfolio. It's not the whole portfolio. It's an important piece that allows you to take more risk elsewhere. If you've got this piece of conservative.

fixed income. But it became apparent as it got up towards sort of 70 million, it was still immaterial, particularly when you compared it to other guys out there that were managing this style of fixed income, but be it an ETF or a fund of just a fund. distribution became key. I'd

been supported by an array of people that I'd known for those decades and they've been thankfully very, very happy with the fund since 2015. But to really make it grow materially, which means that when you've got fixed costs in running a fund, the larger that fund is, the smaller those costs become as a feature of it. So it was important to grow it. And that's where seed came in. I'd worked with them for roughly about nine or 10 years.

Nick Chaplin (22:56.059)
the listed investment trust market. They'd done all lids for people like Griffin and Regal and L1, KKR, really important stuff that they distributed. because I knew them so well, they're a great bunch of people. And so spoke to Will Spragott and Chris Donoghue there and they expressed an interest in distributing the fund.

And subsequent to that happened earlier, much very early this year, was talking to them back in February, we've taken the fund retail. So in other words, we've made it a PDS as opposed to an information memorandum. And we're working on the Lonsec rating, I think, Stu, very, very imminently, hopefully within the next week. And the moving it to retail has been sensational. The connections of seed have been very, very solid. And we're up around 290 million now.

So it's been excellent growth. So we've got effectively a nine year track record. The returns on that, and by the way, in 2022, I also expanded the asset classes for the portfolio Murdoch from just purely hybrid. I added in the capacity to buy subordinated notes, which is the tier two capital and senior notes as well. Really important liquidity additions.

the fund. So when people have come in with what might be a sizeable deposit into the fund or a sizeable investment in the fund, I can utilise the senior straight away, get them a higher return than cash and then trickle down or cascade down from the senior to tier two to tier one depending on when the primary issue occurs or where the value is in secondary markets. So that's been really useful because they're very liquid, the senior and the tier two bonds.

Whereas tier one is not as liquid. And obviously the primary market is fewer and far between compared to those other two products. what I've got now is a very good liquidity mix in the fund. It's yielded about 8.25 over the last 12 months. For a, remember this is specific to this type of asset class. So it might fit really well with a portfolio that

Nick Chaplin (25:20.437)
has property might be some sort of rate or actual physical property. It might have equities in it. It might have all sorts of different asset classes. But I think having a piece of this conservative, if you've got a portfolio without this sort of conservative fixed income piece, there's probably less scope for most investors to do more of the risk.

stuff, the higher yielding stuff. With this piece in there, it enhances your ability to do that high risk. So I think it's got a place in most portfolios.

Murdoch Gatti (25:58.216)
So just with the mechanics, is there a performance fee and what are the management fees?

Nick Chaplin (26:03.913)
Yeah, 55 basis points is the management fee. There's currently about a 10 of administrative sort of costs on top of that. That's fairly typical, 55 plus 10. There's no performance fees. I can't actually justify putting a performance fee in fixed income.

Murdoch Gatti (26:26.015)
It's interesting you say that and what I've realized is a number of my friends that operate in the private credit space have also the exact same thing. the number one reason why they cited that was they said that when you look at where people are fucked up in the past, excuse my French, but that's literally how it is. It's essentially how people are remunerated. And if you have a very conservative product and you're trying to push a conservative product, but then you've got performance fees in it, doesn't that just...

you know, incentivize people to essentially go, no, we're behind this quarter. Let's do it. The worst case scenario, let's do Virgin bonds. You know, and then that's the worst case scenario I could think about, you know, potentially might creep its way in for a 12 % position, but you might find yourself down a rabbit hole pretty quick.

Nick Chaplin (27:02.987)
Yeah, precisely.

Nick Chaplin (27:14.293)
By the way, I'm proud to say that NAB was offered a lead role on that Virgin bond and I took about eight seconds to say no to that, or eight nanoseconds to say no to that. And part of the explanation for saying no was, okay, well, let's think about this. Virgin just announced a loss of 375 million and they've announced to fix that. They're going to shut roots and sack thousand people.

Murdoch Gatti (27:26.034)
Hahaha

Nick Chaplin (27:44.001)
and that will save 75 million. Can you first explain what they're gonna do to get the other 300 million back? And there was ums and ahs on the phone. I said, no, we don't want any part of this. So if you go back and look at the PDS for that instrument, you will not see now on that deal. So we were very choosy about what we did. And I like to put that sort of decision-making process into everything that I buy. So to your point, I'm not gonna rush off.

If I was in a situation where there was a performance fee, which I can't justify having one, the temptation on the 25th of the month to say, if we shut off now, if the market does nothing or goes down now, our yield is pretty ordinary. Let's absolutely go and find something a little bit riskier just to top up the return for the last week in the month.

No, it's just one thing you must do when you're managing a fund is stick to mandate. And this is a, I'm happy to say, I'm proud to say this is a highly conservative portfolio. It's, I'll just quickly tell you the broad parameters of it. I've told you what I invest in, but I can only invest in Australian dollar issues.

I can only invest in issuers from New Zealand or Australia. So if they're Kiwis, they have to be invest issuing in AUD, which is rare. So it's predominantly going to be Australian. That's because ultimately the instruments, because of the instruments I'm buying, they're going to be the issuers that generally potentially regulated. I do not trust any regulator globally other than APRA because I know APRA very, very well. I've worked with them for 30 years over all of the deals that I've done. So

When Banco Popular had a hybrid that was bailed in by the Spanish regulator in 2017, I could sit back and relax saying, well, I don't know that rubbish. And by the way, Banco Popular didn't need to be bailed in because a buyer came about a week later. But the Spanish regulator bailed them in because they wanted to try it out. Let's see how this trigger works. I don't want to deal with a regulator that does that. I think the UK regulator would do that in a heartbeat.

Nick Chaplin (30:08.812)
I think the only perhaps the regulator that might not do it is the Canadian one, but I'm still not buying the Canadian banks. only I have a duration and interest rate duration limit of one. That means my portfolio is 98 % floating rate. I will not play duration risk even when it's highly likely rates are going to go down. People have said, well, why wouldn't you do that? I mean, you've just seen the effect of rates rising on fixed rate bonds.

seen the values go in some of the cases from 102, 103 to 80. Why wouldn't you take that 22 % gain back? I said, first of all, rates aren't going back to 0.1. Okay. So don't think Michelle Bullock's going to do that. They might go to 3. something once we've got inflation under control. So consequently, the duration pickup is not going to be anything like the duration loss.

that you've had since 2022. And by the way, we haven't started, I've been told rates are going down for about nearly two years now, almost since it started to go up. They have not moved down. So good luck with that. So whereas floating rate instruments perform in whether it's going up or down, it just when they're going down, you get this little sugar high trading fixed rate bonds. But that's not

That's not the sort of risk I want to take in this portfolio. People want me to be consistently delivering, not ending up with this...

Murdoch Gatti (31:46.079)
So just on that point, just to make it clear for everyone, right? When interest rates were essentially free and bugger all, what were you averaging? And then one phrasing in that way is, hypothetically, some people may have that in their mind. Well, if it goes to bugger all again, you know.

down there as well, is there essentially a return that they'll be getting? Historically, that's essentially a minimum, or are you targeting a number of basis points above the, I can't remember, is it the bank bill swap rate, or is it RBA cash rate?

Nick Chaplin (32:19.01)
Yeah, it's a 90. Officially, it's the three month bank bill rate. So 90 day bank rate currently about 4.4. But of course, back when cash rate was 0.1, it was basically down around that level. The only thing was the credit spreads you were getting on top of that on top of that bank bill rate were a lot higher back then. So you were still getting 400 over for a for a major bank during that during certainly during the nine years.

period I've been running this fund and certainly during the period where interest rates were at 0.1 or slightly higher than that. So you were getting offset by the low base rates by getting a higher credit margin for the issuers. Of course, I buy CBA, buy NAB, I buy Westpac, I buy ANZ, I buy the regionals, I buy anything financial. So Australian Unity, Challenger, AMP. Two years ago, AMP was

dirty word. I was able to buy a tier two subordinated note issued by AMP. Effectively, they issue capital, that money goes to the bank. It wasn't going anywhere else. It was going to the AMP bank, which is regulated by APRA and has been chugging along for 25 years under the surface of all the rubbish that they've been doing really, really well. And yet they issued this tier two capital in

I think it was late 22, might have been early 23, at a margin of 460 over. here we are sitting with rates were around about at that time, rates had already gone up quite a bit. By November, we were in the, I think we were in the threes. So you're up well above, you're in the deep 8 % return for

for a prudentially regulated bond effectively from AMP Bank. I was all over that thing. And then just after that, they issued a senior bond at 300 and I think it was 375 over, which

Murdoch Gatti (34:33.311)
Well, I find it interesting in the past two months you've done was at 8.23 % on average for the past year. I'm just looking at the website, right? I find that number quite interesting. And why I say that for people out there, and please correct me if I'm wrong, from the research that I've looked at, roughly, people are like, what's true inflation? Is it the RBA cash rate? Is it that plus what bank plus what's true inflation?

Nick Chaplin (34:39.34)
Yeah, that's right.

Murdoch Gatti (35:01.871)
I live in Lane Cove and if you look at the cost of food, houses, et cetera, there was definitely an argument to be made that true inflation is probably property inflation. And property inflation is what, about 7.5%, 8.5 % over the past 20 years, if you really want to look at it. just to be essentially standing still and not losing capital, you kind of need to be doing eights or greater, even on the conservative side, right? Is that an accurate analysis of the situation we're currently in?

Nick Chaplin (35:31.014)
I think most people would probably put property inflation to the side because most of the people that seeing that property inflation is in a home that they're living in as opposed to an investment property. But they would apply the actual inflation rate without question as a base. So you're already talking about at least three and a quarter. I know that's materially lower but

using it as an example, most people if they bought an inflation protected bond of some kind, they're looking to offset that three and a quarter official inflation rate. So eight and a quarter maybe gets you down towards high fours five.

Murdoch Gatti (36:10.879)
talking about potentially. Yeah, okay. So I'm mainly looking at say, from a cost of living. So maybe the houses and dwellings and you know, people are comfortable that I'm moving but in this whole ATC thing with what was calls, you know, just using example and you have to have your free market, etc. But the cost has come back from Japan, right? I could buy Wagyu, Saki, you know, the standard things, you know, good fruit, vegetables, rice feed the family for two days and have a great time for what 100,000, maybe 120,000. It's ridiculous.

Nick Chaplin (36:35.63)
Wagyu and Saki are the standard things. I love that, madam.

Murdoch Gatti (36:40.529)
That is ridiculous. Like, you know, because the sushi just as a supermarket, it was, it was insane. And then you just have a great time. I came back here to Lankova, I did essentially the exact same shot and it cost me like 250 bucks. Like I understand the cost of living, what you earn and everything's down, but I'm just, what I'm trying to discuss is, know, it's an interesting vehicle which you have that can tickle on and give conservative numbers. But I suppose what people are thinking in their minds where to potentially place, you know,

Nick Chaplin (36:52.109)
Yeah.

Murdoch Gatti (37:09.149)
strategy like this is, will this also have the capacity to ensure that, you know, they're keeping up with from they say true inflation, which might be, you know, the cost of the palm, the cost of living from a perspective. And the reason I'm phrasing that way is as you've gone to retail product, not just on the institutional side, like, you know, when someone's thinking about this particular strategy, does this and then the numbers, you know, which I'm looking at, just just wherever I'm looking at. the

Nick Chaplin (37:20.137)
Yeah, I hear you. I hear you. I think,

Nick Chaplin (37:27.881)
Yeah.

Murdoch Gatti (37:38.143)
The five year analyze return from your website is 5.13%. But at that time, the RBI cash rate was 1.84, which is fair. And right now for the past 12 months, it's been 8.23 % when the RBI cash rate average has been 4.41%. So that's just kind of how I'm trying to, I suppose, frame how maybe people are thinking. What do you think about that?

Nick Chaplin (37:52.715)
Yeah, that's right.

Yeah, I think that's a good way to look at it. Yep, it is a good way to look at it. They will overlay though, and it's really important that investors consider what you've said, but they will naturally also overlay their own risk spectrum. And that's why it was really important, I think, for people to understand this fund is a piece of the pie. It's not necessarily the whole pie.

Now for some people, it is the whole pie. I've met people who have said to me, my entire superannuation is hybrids. And I'd say, okay, that's an interesting thing. Why do you do that? said, because I just cannot stand risk. It gives me what I need. So, okay, for that person, it was suitable, but it's not going to be suitable for many people to have everything in the same, all the eggs in the one basket.

So I've always said that this fund should be a piece of a portfolio, but not the whole portfolio. And that's generally been the case for, I try to have as close a relationship to every investor that comes into this fund as I can. It's difficult with the platforms to do that. That's actually one of the frustrating things about platform investment is that you don't get to meet the guys that are coming in and you can't talk to them. Because I like to also say, if you're coming into this fund,

where when the volatility hits the market, and it will, generally there's some material volatility on average every three years. There'll be some less material volatility kind of constantly. But when the US equity market is sold down, when it eventually happens, by five to 10,000 points, because I don't know, the Middle East is blown up or,

Nick Chaplin (39:53.899)
there's an event, somehow a geopolitical event that causes that or just people have got to the end of their tethers with the equity bull run. And therefore, the Australian equity market drops by a similar percentage and that affects the hybrid market by a lesser percentage, but it still affects it. I would prefer the investors in this fund ring me and say,

You're buying, aren't you? You're not selling. And I'd say to them, you're absolutely right, I'm buying, because I know this market will settle down. And the instruments I'm buying are pull to par instruments, meaning that their call dates will ultimately occur. And that's when the hundred dollars is given back to you. So I'm buying at 80, if I can get it. You shouldn't be doing for some reason, investors in Australia, maybe it's an equity mentality, but they sell at the wrong time.

they're selling when the market is giving them an opportunity to buy. And that's something I like to talk to people about and I can't do that when they're through the platforms. So I try to do that in my monthly reports.

Murdoch Gatti (41:07.315)
Well, gives bigger the platform's a bit of credit because essentially it's created like, know, essentially a Google Play Store on your phone, which gives everyone access to things. And I like to say that platforms, the best thing about a platform, in my opinion, is some of these fund managers have minimums, half a million dollars, a million bucks. just don't have that capacity. We're giving up a portfolio, but to give the ability to be essentially a remora fish underneath the belly of a great white shark.

Nick Chaplin (41:17.354)
Yeah.

Murdoch Gatti (41:34.503)
and stick in 10 grand, as long as the minimum is met from an institutional level, I think is fantastic. But Nick, you'd also say as well, this is the benefit of working with an advisor for an investor. You're having this conversation with myself and then as a byproduct, I'm communicating that message, essentially with the hundred clients which I have, and then you extrapolate that across all the advisors in our space.

Nick Chaplin (41:39.631)
yeah.

Murdoch Gatti (41:59.871)
So there is a scalable means of communicating the same message which essentially saves you time. So there is a benefit.

Nick Chaplin (42:04.541)
absolutely. yeah, no, no, no, I should say that's, that's what I shouldn't have started talking about platforms with the only negative, which is I can't talk to the investors. So I'm glad you said that. I am delighted. I am really delighted with the way the platforms can assist a fund and can assist those those investors in the fund. And so we work with numerous platforms. And we're actually going to bring on

at least three more as we get the rating for Lonsec. And I couldn't be more positive about that experience. There are ways you can arrange with the platform to get your reports out to those individuals. It's an extra step, that's all. whereas I I welcome phone calls from investors and they might say, hey, APRA has got this paper out saying they're going to

take out or phase out hybrids over the next eight years, what do you think of that? And I can talk to these people directly and say, this is what I think of it. But then I'll write about it anyway. I try to write about this stuff publicly, whether it be live wire or, for example, in this sort of an interview or in the paper, certainly in my monthly reports, and try to discuss what the upshot will be. the platforms are coming back to it. The platforms have been

an immensely efficient way of allowing investors to participate in a fund like this.

Murdoch Gatti (43:40.911)
It's it's very very interesting. one just on a macro The reason why I'm asking you because you can see things from a particular lens that other people may not be able to see the one thing I noticed when I was in Japan was essentially the well, obviously everyone's saying the crashing ants everyone's now going to Japan right so much so they're putting in restrictions You can't drink on the street in Shibuya anymore, right? but where I'm going with this is since fear what how many decades the

the Japanese have essentially pegged their central banking to essentially the US and we're seeing the essentially money lending through, sorry, money smuggling, I'd like to say, you know, obviously fact check that, know, through Ukraine and, know, et cetera, et cetera. But the money printing has just been huge. You know, it's like, no, the USD dollars fine, but they're just diluting, diluting, diluting, draw a line on the sand, more debt. And it just keeps going on and on and on and on and on.

Hopefully there's a change, maybe it's the Trump government or whatever it is that puts a line in the sand and turns that around. Is that heavy dilution in this space impacting the hyperinflation in the Australian market or is essentially is it segmented? Are we essentially in a Western belt where essentially if they, as they say, the US needs is we catch a cold, but I'm just trying to

As you said, you only invest in the Australian side that are Aussie dollar based, but Houndoo huge geopolitical changes on a central banking level, you know, over in the States since like the COVID times essentially impacting our markets. I'm just very curious.

Nick Chaplin (45:24.256)
you'll always get the impacts and you'll you just got to deal with them when they occur. There is a level of uniqueness though about this market. I think from an inflationary point of view that that is true too. think inflation affects us all of the jurisdictions in a very similar way. a blunt. You've only got it depends on how you're dealing with it. The blunt instrument of interest rate movements is the only thing you use. And that seems to be the way that Australia did it. Because if you think about it,

We've got inflation coming down, but we've held and we didn't probably go hard enough on interest rates. Getting up to 4.35 cash rate was probably underdoing it. That's very subjective murder, but I'd say we should have gone to five and we would have been probably in a similar cycle too.

Murdoch Gatti (46:07.251)
Well, you said you're saying that but now everyone's saying they're cutting now which makes even a little bit more concern.

Nick Chaplin (46:12.086)
Well, you probably would have started the cut earlier. You know what I mean? I think if we, mean, this,

Murdoch Gatti (46:16.767)
If you ramped it up, put a lid on it earlier, then you started cutting. Yeah, I can see your point.

Nick Chaplin (46:19.746)
Yeah, yeah, yeah. So I think ignoring Phil Lowe's comments that, know, nothing until 2024, which was amazing that he actually said that, but we won't go into that as well covered. But I think the fact that we started raising rates in May of 2022. So let's forget the fact that we could have raised them earlier, which we well could have. What we should have done is not stopped raising them when we did. I think if we'd raised

We kept doing 25 cent increments. don't know why they didn't get rid of by the way. Just the finickiness of the way I think sometimes. Get rid of that little 0.15 difference and push it up to 4.5 honestly. Why didn't they do that? But we should have maybe gone to 5. I know that the RBA would have concerns about what was going on in the mortgage belt.

for Australians. But remember during COVID or prior to COVID occurring actually, we had a situation where the average mortgage in Australia was two years ahead of its payments. The average, not saying everyone, the average. That put Australia in a unique situation to actually set up for this inflation because as COVID then hit, there was enough reserves to sort of

survive for two years but subsequent to COVID sort of being dealt with here in Australia as opposed to I mean I think it's probably similar but in a much smaller way to the US inflationary situation the spending just kept kept going. I mean even in 2024 we've seen massive wage increases to offset the inflation but all that's done is kept us in a spiral of inflation and some of that stuff hasn't even been baked in yet.

So some of the large public wage increases in this country are yet to be fully felt in the quarterly inflationary numbers. but putting that aside, generally the trend is down and so rates could start coming down. I think it would be silly to start moving rates down, just putting myself in the governor of the RBA's position for a minute. It'd be silly.

Murdoch Gatti (48:44.447)
Should I add his name to the podcast when I put this out and say, hey, man, you're interested in your comments?

Nick Chaplin (48:48.763)
Yeah, yeah, I'm happy to comment as the potential governor of the RBA. I wouldn't drop rates at all in 2024. Never. No, it's not going to happen and shouldn't happen. Sometime in 25, yes, if inflation drops to below 3 % and consistently, not just once, but consistently. So let's see, let's see a quarter of monthly CPI numbers under three and let's see at least two

I'd like to see two quarterly numbers under three before we started dropping rates. So that's harsh. That's harsh. But that's how you manage an economy. The government would hate that. They've got an election to happen probably sometime in between March and May. And I'm sure that, you know, they're in talking to the governor of the RBA and the governor of the RBA needs to tell them to go away.

Murdoch Gatti (49:43.711)
Well, if you get it, if you actually get in and you find yourself in that position, can you actually, I'd love to actually know the true formula, which goes into the calculation of that, CPI numbers. Cause I've seen a lot of jokes around where essentially they just pick a dot and there's, then essentially if you look, and then if you actually do a bit of digging, like they intentionally to manipulate numbers, you know, many people, not saying they specifically do, you know, what actually goes into the calculation, you know, of that CPI.

Nick Chaplin (49:58.395)
you

Nick Chaplin (50:11.513)
Yeah, what's in the basket?

Murdoch Gatti (50:12.189)
because you know, people are, yeah, what's in the basket? Like, please open that up and tell us what's actually in the basket. Cause I can tell you what my most recent shop this weekend, you know, did not feel like those numbers were accurate.

Nick Chaplin (50:23.545)
It doesn't by the way, I'm probably in the same stores as you because I shop at Lankov. So

Murdoch Gatti (50:29.183)
How good is Harris Farm? I'll everyone a at Harris Farm. My God, that place is amazing. When these days, unfortunately, 95 % of Woolworths and Coles isn't real food. If you're hearing about what's happening in the States with the Senate inquiry into make food healthy again, it's kind of scary. Anyway, I won't get there right now, but back to the topic of how they work out CPI.

Nick Chaplin (50:37.349)
They good.

Nick Chaplin (50:46.207)
Yeah, it is,

Some of the investors in this farm shop at Harris Farm Lane Cove. I can tell you that now.

Murdoch Gatti (51:01.037)
It's a great part of the world.

Nick Chaplin (51:03.353)
So look, think we will get some sanity from the RBA and they will do things properly. It might be disappointing for some people who are desperately hanging on to their mortgage payments to hear that it might be not this year. the banks actually can do what they want.

Murdoch Gatti (51:24.863)
Actually on, sorry go on, go on apologies.

Nick Chaplin (51:31.413)
the RBA sets the cash rate target doesn't mean the banks must change their deposit rates or their mortgage rates. And so you've actually seen some of the banks adjust their mortgage rates outside of a movement in the RBA cash rate. And most recently, you've seen quite a number of banks in Australia materially reduce their term deposit rates, some of them by 0.8.

Murdoch Gatti (51:58.397)
did say that they cut the term to buzzes before like, you in coming into this.

Nick Chaplin (52:02.794)
Yeah. So, you you can you can wait for the RBA to make a decision on interest rates, but the banks can do some things before that. And if there was some real competitive pressure in Australia for mortgages, might see, you know, shop around for your mortgage rate, just going out and changing your mortgage from one bank to the other might actually put you in a better position than you are now.

Murdoch Gatti (52:27.423)
Do you mind if I ask you about mortgages? Maybe this is a topic you completely understand, but I just don't understand to a full extent what happened with COVID, because yes, the rates dropped down and then people could cover. And that essentially, you know, just led to a frenzy of fear of out. know, people just launched into the property market, you know, which is great for, know, business looking to exit. They borrowed to the absolute hilt.

Nick Chaplin (52:51.414)
Yeah.

Murdoch Gatti (52:56.863)
based on what they could afford at the time at those rates. But what doesn't make sense in my mind is this three year maximum borrowing capacity term whilst over in the States, even when rates were all the way down, they still had the capacity to take a 30 year fixed mortgage. I'm talking about, know, for fixed rate, locking in the rate. They had the store, the capacity of locking that thing in for 30 years.

Nick Chaplin (53:18.432)
For fixed rate, yeah.

Murdoch Gatti (53:26.321)
And then, you know, as you mentioned, Phil Lauer saying that won't change rates till 2024. It practically just blatantly lied. A whole lot of people just locked in their livelihoods. Now, you know, good old Australians refuse to sell property. They're probably eating baked beans, you know, to essentially ensure that covering all their mortgages. But there's a lot of, mortgage pressure and people, people are supposed to about online or they're just human beings like Australia. They don't mention the war and just try to survive.

Nick Chaplin (53:53.833)
Yeah.

Murdoch Gatti (53:54.633)
but it's put a lot of people in a very, very tight spot. Why, in your opinion, was that 30-year fixed not offered? And it's not, you know, when I compare to the states.

Nick Chaplin (54:03.636)
It's typically not often in Australia on the basis of the way that the system works here. You've got a very, very different scenario for borrowing for a mortgage in the US. The easy story to tell is that if you get in a situation when you can't pay, you just go and hand the key back in. In Australia, you're locked

Murdoch Gatti (54:31.827)
Yeah, right?

Nick Chaplin (54:32.04)
You're locked in. You've got a legal requirement to pay it. Now, if the value of your property goes down, that debt between the value you bought out and the value you've sold out, you still have to return that debt. That's problematic too for the banks in planning their liabilities and asset management.

over a 30-year period, if you get a wave of 30-year fixed rate mortgages and interest rates then materially move over let's say interest rates drop. Let's say, I mean 4.35 cash rate is actually historically it's not that high. It's you know the median between 1994 and 2024, that 30 years is probably quite a bit higher than that or 1990 or 89 to

to 2024, so 35 years, the median would be quite a bit higher than that. So, I mean, you go back to 91 and mortgage rates were at 13, 14. We're sitting, what, around six, seven, six, maybe? We are nowhere near what they were at that point. But they weren't there for very long. The problem would be if it stayed for long. So if you've got a bank that's lent a ton of money at 30 year fixed rate at,

let's say a very low rate around 3 or 4 % and then rates are moving up towards the numbers that I've just mentioned. You've got a problem for the banks trying to manage their asset and liabilities. So those two factors combined

Murdoch Gatti (56:10.335)
That's one way to think about it. But the other way of thinking about it is it's kind like when a client says to me, hey, I want to buy, I don't know, shares in video, right? You know, I don't want to buy it because you know, the share price is too expensive. I can't buy enough shares. And I have to explain to them, ask them a question and they go, are you buying, are you going to have the ability to buy enough to buy 5 % of the company because you want a board seat? They're like, no. And the number of shares doesn't matter. Essentially, it's the percentage.

Nick Chaplin (56:13.127)
Yep.

Murdoch Gatti (56:39.839)
Percentage which you're buying because you're looking at the percentage move and one framing of that way is Yes, I keep hearing I've always heard you know it wasn't it was worse than my day you know 18 % you know but then you look at the fact the average people were borrowing was 70 grand right you know my family family my wife's side lived at Cherry Brook way you know $110,000 house 70 grand you know essentially that's a their average income

Nick Chaplin (56:51.489)
Hahaha.

Murdoch Gatti (57:09.311)
You know, it's essentially three to one or maybe it was 300,000, right? And the average income was a hundred grand and the rates were a lot higher. That's three to one. People now are borrowing at 11 to one, 12 to one or yeah, 10 between 10 to 12 to one income to debt ratio. And then when they're locked in and they'll say, I don't know, hypothetically three, and then their rates go to six, that is it. That's double.

Nick Chaplin (57:16.185)
Yeah. Yeah.

Murdoch Gatti (57:37.343)
and their debt on a $3 million mortgage in Lane Cove just exploded on them. Like from a relative perspective. And that's what I think people, when you're having these conversations, that's the thing that either people discuss or that's what they're feeling and that's where they're feeling the pinch. So they always crack the shits a little bit when people go, but rates were a little higher, but I think it's relative, wouldn't you agree?

Nick Chaplin (57:42.361)
Yeah, and that's.

Nick Chaplin (57:55.513)
Well, you could.

Nick Chaplin (58:02.54)
Yeah, I think it would be cruel to say and wrong to say that it's 100 % greed that happened in the COVID years. But it looked like that. I think in reality, yeah, well, it was from the government perspective. investors, and by the way, the spike in fixed rate mortgages during those two years was amazing, as people were trying to make use of what they saw as the

Murdoch Gatti (58:14.143)
looked like 100 % money printing.

Nick Chaplin (58:30.557)
dwindling time frame for very, very low interest rates. If you'd had a 30-year fixed rate mortgage in Australia, everyone would have gone to it. Everyone would have done it. You wouldn't have had one floating rate mortgage. It just wouldn't have worked from a bank perspective in Australia. you have to say that there was some irresponsible borrowing during that run-up in property values in 2021.

Murdoch Gatti (59:00.127)
Or Phil Lowe told everyone they weren't changed until 2024, so everyone thought they had a window.

Nick Chaplin (59:03.873)
Yeah, guess too many people believed it and there weren't enough people out there saying, that's an opinion from one person that is one person of numeral people on a board of the RBA. Do you stake your financial future on a statement made

Murdoch Gatti (59:07.549)
And people believed it.

Nick Chaplin (59:30.603)
by the RBA governor or do you be sensible and say what can I actually pay off if rates went from here to here over the next 10 years? And most people...

Murdoch Gatti (59:39.839)
Well, that's interesting to say, but yes, with people like yourself and myself's education, we can make that observation. But you think about a little Joe Blow that's running a business that does quite well by their side. And they've been taught to believe what the government tells them, or essentially tell them to do. And they do as they're told. And now they're finding themselves in a spot. It's tough.

Nick Chaplin (01:00:01.726)
It is tough. mean, also to your point, if you go back to those early 90s days, the proportion of disposable income that was going into the mortgage was a lot lower. And it has got to outrageous numbers now that people are just putting in. And that's maybe just the lack of properties available in Sydney, for example. But it's starting to happen in even Brisbane, which has tons of land, quite frankly. If you invested in Brisbane,

Murdoch Gatti (01:00:15.999)
Hmm.

Nick Chaplin (01:00:32.113)
in the 1980s, it would have taken 10 years probably to get the thing to move values because depending where you're bought, the amount of land in Brisbane compared to, you know, they've tried to open up the southwest of Sydney and it's probably going to continue because it's the only direction they can really go in and it's being snapped up, it's being snapped up, still the higher proportion of the

people who come to Australia are ending up in Sydney. So to some extent the ability to afford a property within a certain circle around Sydney has just got, it's obvious statement to make, but it's just got to the point where you can't do it if you're just immigrating to Australia. You won't be able to buy in Lake Cove, I'll tell you that. So we'll see what happens.

Murdoch Gatti (01:01:27.284)
Hmm.

Nick Chaplin (01:01:30.346)
I reckon we actually need a couple of new Canberras. Canberra was a man-made city. I think we could do with one at Wagga and one at Orange. And I can hear the people at Wagga and Orange screaming now, but we actually need it. If you can do it for Canberra, you can do it again now. And we really need it. Create two more cities of Canberra's ilk in those rough two areas, or maybe one of them is in Victoria.

In fact, yeah, okay, forget Wagga, stick it in, I don't know, somewhere in Victoria, another Canberra, and you definitely need one around Orange. And that will help people start moving into those places instead of Western Sydney. There you go, if I ran the country, Murdoch.

Murdoch Gatti (01:02:19.443)
I know these questions aren't specifically on what yeah, I know these questions are specifically on, you know, the product. was just considering you're so close to the coal face, you know, and I'm back in our front currency. When I'm a mentor has told me one thing he goes, always follow the money first. Whatever the money's doing is essentially the path is the beginning of the pattern. So I was just curious on, your thoughts.

Nick Chaplin (01:02:37.673)
care. If I was to tell you just to get back to a point you made earlier about the fund which is thinking about the inflationary impact and what the post inflation return is. This fund delivers for those people and there's a lot of them out there because I've spoken to them for 30 years that are very very concerned with risk. They're at yes you've got

person on the street that will buy Nvidia shares now. They should have bought them five years ago. that you'll you've got that person one in a hundred that will listen to the taxi driver telling them that this is the next big thing. You've got a ninety for every one of those people. You literally have 99 that say I just wanna have

this sort of an income and most of the people in this fund have a regular income coming. pay a monthly distribution and we have a daily unit price. know, liquidity of getting in and out is very efficient. But they just want to, right, I'm putting this in, I'm comfortable with the instruments you're buying because you're managing it for me. I'm comfortable with instruments anyway because I trust the Australian banking industry.

By way, we buy insurers and non-bank financials like Australian Unity as well. So I'm comfortable with that concept. I'm going to give you cash that I've got. I've just had a term deposit come up. It's a sizable amount, but I'd like you to put it in. This is now going to be my fixed income piece of what was a heavily cash portfolio. Can you now manage that for me? And I could say to them, why don't you just go buy shares?

And I'll say, I've got shares. I've got my share portfolio. I'm comfortable with that. I have too much cash. I'm wanting to move some of my cash into this. And this is where someone like a regulator like ASIC would stand up and say, you have to be telling them that the risks in your fund is nothing like cash. And I'd say, of course I do that. Of course I do that. And by the way, the investor knows that. But I will absolutely say that. And our PDS says that.

Nick Chaplin (01:05:04.783)
But what they've decided is they're not making the decision that an investment in prudential capital instruments and senior bonds is the same risk as cash. They've done their work and decided that the actual likelihood of failure is the same as cash. So they're comfortable coming in and saying, or the likelihood is sufficient for them to, on a practical level,

compare it to cash. I will move my cash into this fund because I don't think you're going to lose it for me.

Murdoch Gatti (01:05:41.983)
Does apperance sit there as well and say they should also inform these clients that there's only a certain amount of money sitting in cash at a bank that's actually insured? What's the amount again? Is it 250 grand?

Nick Chaplin (01:05:55.62)
Well, 250,000 is the government guarantee. So if you invest 5 million, yeah.

Murdoch Gatti (01:05:59.709)
Yeah, so everything over 250 grand essentially in the bank files you screwed

Nick Chaplin (01:06:04.214)
If that bank absolutely goes under and the government doesn't bail everyone out, even if it was forced to merge with someone else, there's going to be a level of loss. And 250,000 will not cut it for the amount of deposits that's in banks now.

Murdoch Gatti (01:06:21.151)
So how can the RBO sit there and essentially say, you know, the deposit is safe with the bank? and the other side, yeah. Sure.

Nick Chaplin (01:06:25.644)
Well, they also, can I just address that point? Because it's a really important question you've asked. The RBA has also made the generic assumption that the failure is unlikely. Okay, so, I think doesn't want to hear anyone say that, but it's absolutely true. The RBA also doesn't think or the RBA and APRA together.

feel that the Australian banking industry is sufficiently protected by the rules of prudential regulation and everything else that goes into managing a bank and the rules that sit over a board or a treasury are more than sufficient now to ensure the ongoing survival of that bank in the current way that it is. So that's why Australia has four of the top seven credit rated banks in the world.

at double A minus. APRA, we should probably get addressed this, APRA has come out recently and said we're going to phase out AT1 because of what happened to Credit Suisse and we don't like retail investors holding these instruments. By the way, they think that half of the hybrids in Australia are held by retail simply by the value of the trading amount.

If it's under 500,000, that in their mind automatically means that the holder is retail. I don't qualify as retail. I qualify as a wholesale investor based on the rules that are in place for that qualification. I frequently trade at amounts sometimes less than $20,000, but I'm not a retail investor. So their logic is wrong.

I would, if I had to make an educated guess Murdoch, would say that 85 % of people invested in hybrids have wholesale qualification and the other 15 are advised. So, Apera's jumping at shadows here. It's probably not their world to play here. They think that if retail hold that substantial share of hybrids, the government will come in and bail them out if a bank does fail.

Nick Chaplin (01:08:48.841)
They're ignoring the industry differences we talked about earlier, Australia versus offshore. Why look at a failed regime to work your template for how Australia should work? Switzerland and Credit Suisse. Why not look in the mirror and say for 25 years you've managed the Australian banking industry exceptionally well. Just keep doing it guys. As soon as they do this, Standard and Poor's have already said they will downgrade.

tier two instruments by a notch. And by the way, tier two subordinated note instruments is exactly what Apparatus said you will replace the hybrid with, which means that the banks are going to gear up, put pressure on their credit ratings. If their credit ratings move by that notch, you've already got costs for capital management increasing materially anyway for the banks. And you've taken a layer of support out that is there for depositors. So

Apri is doing the precise opposite of what it is there to do, protect depositors. It's insane. So as you can imagine, I'm putting in a submission to tell them exactly what I think of what they're doing. But anyway, I just thought that was worth mentioning.

Murdoch Gatti (01:09:59.771)
Hahaha

Murdoch Gatti (01:10:06.751)
Well, you touched, no, no, it's definitely worth mentioning. but from, suppose my perspective, speaking with families, I'm hearing a lot now of, you know, you know, families that have, have assets, right? They just don't want to go backwards. And I suppose, the cost of living is most important. So the conversation, like a strategy, why this is interesting, you know, for people at a particular level, when, it's income producing, a lot of families out there just want to cover their cost of living. So they're comfortable.

And then they have the cash being spit out and then they're growing greater than true inflation. But then they've got the income to essentially enjoy their lives, which means they have a stable life. But the reason why I think this is interesting and same like private credit and the number of your colleagues is unfortunately the good old fashioned 60-40 portfolio from 15-20 years ago doesn't work anymore. But the rise of what the banks, the sector's done pushing out.

Nick Chaplin (01:10:45.511)
That's what I'm here for. That's what it's for.

Murdoch Gatti (01:11:04.832)
growth based lending and things like this does make these very interesting to explore.

Nick Chaplin (01:11:09.829)
Yeah, you've hit on another good point. I think this is this is a product that ultimately, I hope it can be one that more and more people can utilize. It's really hard for people at the moment with with mortgage rates where they are compared to and look, they have come in trying to get into the property market where it doesn't matter what city it is, it's all the same proportionally, whether you're in Adelaide, Perth or Sydney.

It's hard at the moment. The proportion of your income that has to go into mortgage payments has never been higher. And so consequently, ability to invest to provide a nest egg or a saving. And remember, you can't touch your super. This fund is designed for super, but it's designed also for non-super investment for those that want to use it for regular income. There's a lot of retirees that are ex-super now beyond 65 that are using this fund.

they're using this fund for regular income. I want to make this fund available to people such that they can create a, they can have their super in it. So fine, by the time they're 65 that nest egg's there and then they can even continue to use it for regular income. But I'd like it to be more and more available to more and more people for regular income while they are paying off a mortgage. So well before they claim their super.

So if I can continue to return seven, eight, I think the eights are gonna get harder because hybrid margins have come in materially since APRA have made that announcement. By the way, it's gonna be eight years since they can't phase it out until 2032. And insurance tier one is still gonna be there and non-bank tier one is still gonna be there. That's if they proceed, which they shouldn't proceed. But...

the instruments themselves. So even at 7%, if I came back to you in a year and said, well, you know, the last 12 months, we're at seven and a quarter, not eight and a quarter rates have gone down now. But people are still in the same boat with their mortgage, they're still, I don't think the proportion of, of free income or free cash available to a to a family is necessarily going to go down in terms of the proportion of mortgage payments that they're paying, even when rates start to go down. I think

Nick Chaplin (01:13:34.486)
you've constantly got this rising property base in particularly in cities in Australia, such that I think if you looked at the history over the last 20 years of interest rate movements versus the proportion of income going towards a mortgage, one is fluctuating, the other one's constantly going up. So this fund does have an altruistic aim of providing an option for people

if it's possible in their situation now to start even a small investment that allows them to get some regular income that assists them with their lifestyle, we want to achieve that for them. I know that that's a fairly generic statement Murdoch and everyone would want to do that in running a fund, but this one particularly.

Murdoch Gatti (01:14:31.455)
No, no, I'm comfortable with that. And the other thing which I just realized, which we haven't addressed, which we discussed, know, before we started recording, which I experienced firsthand is when firms say, you picked up all these, say hypothetical, if you picked up every single hybrid note, which we issued, your return will be X. As you and I both know, being in the box for a long time, when there's a good deal, you can't get

your allocation, you might not even be able to get it at all, or you get scaled back, you stick in for an amount and you find yourself with only about 25%. Then unfortunately you end up with a full whack and then they're offering you essentially, know, you know, we couldn't feel it. Would you like some more on the ones that you potentially don't want? Right. So, so strategies like this, and this is the reason why I enjoy using fund managers, provide essentially access to a pool.

Nick Chaplin (01:15:18.519)
Yes.

Murdoch Gatti (01:15:27.699)
of a particular asset class to essentially achieve a goal, but you've got better buying power and connections and essentially, you know, Joe blow and North Rock stars. And, and I've experienced that at a stockbroking forum before. And I wouldn't mind if you just address how that works. Because a lot of people look, the conversation is going to be, I'll tell you what that I've been doing this for 2030 years, I've got my, I've got my broker, he's a great bloke. Why the hell do I this fun? Because I'm getting all the issues because they're absolute weapons. Right? That's the conversation.

Nick Chaplin (01:15:33.673)
Yeah. Yeah, I have to agree.

Nick Chaplin (01:15:54.239)
Yep. No, you're absolutely right. think the arbitrage opportunities, it comes down to whether you can see them or not in listed hybrids or even any, there have been aspects when subordinated notes have been listed as well. Certainly senior, I've got some listed senior now in the portfolio. The arbitrages are there. I've had, this might surprise you, but there's been situations where someone will say to me, well, look, my buyer price on that particular hybrid beta Bank of Queensland.

BOQPC is $101.50 but it's been trading at $103 now for weeks and weeks and weeks. I refuse to buy at that level. By the way, the distribution is $1.50. So you're waiting and waiting and waiting and then one day they wake up and it's at $101.50. They go, right, that's my buy price. I'm in.

And there's enough of those people to actually take some of these instruments at certain times from the 101.50 that they woke up with back to 103 within a few days. I'm not kidding. What happened? Well, they went X distribution. So instead of buying something with where they're going to get the distribution, paying 103 for it, they're now going to get no distribution, but you can buy it at 101.50, right? That's fairly standard. It works in equities.

It works in subordinated bonds, which I traded over the counter. The difference between the hybrid market or the listed, anything listed bond market and the over the counter market is if you trade something over the counter in the wholesale market, you must pay the seller the precise accrued amount of distribution that is in it. And if you, if you are the buyer, you must pay the seller that amount in the hybrid market. You must just pay that whatever it's trading.

There's no calculation of you must pay the accrued amount to me. It's buyer beware in the listed market. It's buyer beware in the equities market as well. But you've got this protection in the wholesale market such that if I go and buy a tier two instrument today and I'm halfway between the last dividend payment and the next one, I must pay the person I buy it off half of that accrued distribution. It's a calculation. But the arbitrages are much more

Nick Chaplin (01:18:20.103)
available in the listed hybrid market. And I would say to the investor that says, can do this myself, I'd say there's a ton of fund managers even out there that are passive fund managers. So in other words, they might be even guided by the fact that when you buy a hybrid, there's a sales fee at the moment that is paid down to that broker. And that's what's actually interesting to the broker, because they're going to get that.

I would be passing that onto the investors personally, because it's their money that's allowed them to achieve it. But let's after it phases out these listed hybrids, that fee is going to disappear. I think there's going to be a lot of wealth managers out there in Australia that will just not want to bother managing this stuff anymore because they've lost that income. what they were doing previously was simply passive buying and holding and just taking the running yield for the investor anyway.

I think there's actually a lot less active managers of a listed market, particularly in hybrids in Australia than there are passive investors. And that's really, really important because you are going to be able to take that. I only gave you one example of an arbitrage, but there's plenty of others. Sometimes depending on the instrument, normally not the big banks or the regionals, but the smaller guys, you can get it. You can get an instrument that pays its dividend, goes ex-div.

The price doesn't move. Now, can you imagine that in a BHB share? It's not going to happen. But in the listed hybrid market, it can happen and does happen. And so all of a sudden, you've taken your div and you've basically got a second one for free because the stock didn't drop its dividend value. Now, that happens in very illiquid stuff, but it happens. And some investors won't be aware of that.

There's a variety of arbitrages that are available. So my answer to you there is, sure, there are people that say, I'll just do this myself. But I think you have to have an understanding, particularly in the listed instruments. But it's important also for the wholesale ones to understand the accrual of the distribution, know where you are at any point in time, understand the liquidity of it. So let's say you have a liquidity event, you really need cash, you've got to get out.

Nick Chaplin (01:20:47.669)
might be a large amount. Let's say it's more than half a million dollars. You need to have that knowledge of multiple brokers to go to. Who's the guy that actually is the one that is going to give you the best price for it? Who's the one that is going to trade that off the screens because they've got a large buyer that they had? You need to be aware that that's happening. Otherwise, you go through the screen and sell it and you'll find yourself forcing your own price down.

because these things are fairly illiquid. They trade about $2 million a day per security. It's not much. So, you know, just saying, I think there's...

Murdoch Gatti (01:21:25.875)
And then the market maker steps in and rips you blind if you're not careful.

Nick Chaplin (01:21:28.367)
Well, exactly. By the way, just on that topic, I think if any bank is out there looking to do, if APRA takes away listed hybrids and you're left with basically an investment mainly in wholesale instruments for your fixed income, which is quite attractive because the higher proportion of issuance now that will go into subordinated notes in the next eight years is really material. It's going to force the margins on tier two out.

quite materially, more than what you're getting on tier one now, I suspect. As a hammer that you can actually still replace your hybrids with subnodes, higher risk, sorry, lower risk up the spectrum, but you're getting the same return as you are in September of 2024. Not what you were getting in September of 2023, but in September of 2024, because hybrid margins have come in so far. So there's even an argument that

say ANZ got one due in March for refinancing. The general statement is that they won't refinance that hybrid because APRA has said from, if they proceed with this proposal in January of 2027, that tier one hybrid will be counted as tier two. So you'd be paying a tier one price for something that counts as tier two for you. Why would anyone do that? Well, they will do it for two reasons. They could do it for two reasons, I should say.

They'll do it because tier one margins, hybrid margins have come in so far. Five year average in secondary now is below 200 over. A new tier two subordinated node issue from the same bank is probably in roundabout starting around 175. So you're 25, 20 points, maybe up to 30 points cheaper only in subnodes than you are in a hybrid. And a hybrid has franking credits in it, which means your cash.

Cost is 0.7 of that, which means you can actually issue a hybrid now cheaper than you can tier two. So there's a reason why ANZ might actually still refinance that deal. The other one is the credit rating agencies give them credit for these instruments as well. So getting away from just APRA and capital, the agencies give you support for your rating by issuing these perps. So there's another reason for what's called RAT capital.

Nick Chaplin (01:23:56.971)
RAC for the rating agency calculations that they you might see ANZ and CBA roll over their deals in March and April next year. I don't want to bore you with that Murdoch. It's this is this is just super super exciting for me and I hope you can hear that in my voice.

Murdoch Gatti (01:24:15.871)
Sounds like you're having a lot of fun. Is there anything that we haven't covered that you want to leave? Any thoughts that you have you want to leave listeners with?

Nick Chaplin (01:24:23.381)
Just some generic stuff like general stuff. The fund at the moment has about 16 issuers. All of those banks we've mentioned insurers, IAG, QBE, Suncorp, Australian Unity, probably the smallest issuer I have is Police and Nurses Bank, which was and is a mutual, the largest mutual in WA. But again, it has to, it's regulated by APRA. So everyone loves that. So the yield, that's why I can.

get the above 8 % yields while still buying upper regulated banks in Australia. So think about that. I hold about 41 securities. I'd like to keep it below 45 and somewhere between 35 and 45 will be natural for the holdings here. The liquidity on these at the moment in the portfolio is such I can get out of the entire portfolio generally within two days. So if I had to, I cannot think of a

situation where I would need to do that. But the liquidity is actually very good by expanding into those higher asset classes. And again, it's for people that if people are interested in taking some additional, if let's say they've got a cash portfolio of that's fairly material, because they're worried about what's going on, what could happen in the market if Middle East blows up or if the equity ball run just suddenly ends.

By the way, I don't understand why the US dollar is as strong as it is at the moment. I think currency traders of the AUD do not understand the AUD. They just trade it on the historic commodity values and that's it. So there you are. But I won't go into currency now. We're hour and 20 minutes in. But when the youth...

Murdoch Gatti (01:26:14.847)
I was about to say like if you want me to start kicking off in currency you heard my comments about you know, this them smugly money through Ukraine, right? So like

Nick Chaplin (01:26:19.247)
I heard you. heard you. But if the US can drop interest rates by half a percent and it doesn't move the currency at all in AUD, then misunderstanding something fundamental about the Australian market.

Murdoch Gatti (01:26:35.487)
I there's a bigger game being played by globalists that are essentially trying to, I think they're trying to create a scenario. If you read the tea leaves, if Harris gets in, she's discussing unrealized capital gains tax. You we tried that in Australia, Australia told everyone get nicked. But if you look at what happened in Canada, it's up near 66%. Right? So I think with BlackRock buying 40 % of Rezzy last year via the funds, you've heard the expression, you own nothing and be happy. I think there is a play out there to

reset financial markets if you haven't seen since World War II. And my concern, it's been screwed.

Nick Chaplin (01:27:08.339)
If Harris gets in, if Harris gets in, honestly, that's going to be the event everyone's worried about.

Murdoch Gatti (01:27:17.573)
Yeah, and why I'm a bit terrified about this is everyone, you know, you can kind of see a theme here. Everyone's leverage themselves to a heel, borrow to the gills, you know, debt inflation, everything's running up. And what I'm really concerned about is there's a play because I think BlackRock, State Street and Vanguard own practically like 20 % every single business, which is terrifying in itself. And then if they decide at some point to bring in unrealized capital gains, that could potentially just pop this gigantic debt bubble.

crash everything, then they take a huge cash balance and just go buy up the rest. And then there's just this gigantic divide between rich and poor. And I find that quite concerning. hopefully there's a line in the sand with people like Trump or the liberal government in Australia, or you're starting to see the pushback in the UK, even the Hungarians and the Polish are essentially cottoning on. there's Nick and

Nick Chaplin (01:27:54.155)
Yeah, I think you're on the money.

Nick Chaplin (01:28:09.749)
and the Argentinians.

Murdoch Gatti (01:28:12.317)
in the Argentineans, there's not economic war going on and there's a line in the sand. think people just need to start waking up to the risks that they don't actually see are there. There's a game being played.

Nick Chaplin (01:28:21.131)
Well, you've got to have real policies and actual policies that work. Maybe you don't need, maybe the president of the USA doesn't actually need to have any capacity to run a country, which is what you'd end up with if the Democrats win, because there's a machine working behind them. I think that is the situation you've got to, but at the end of the day, that machine needs to take advantage of...

needs to be acknowledging the fundamentals of how the economy works. And I think the threat that you've mentioned there is very, very real. It is terrifying.

Murdoch Gatti (01:29:02.943)
And it's terrifying in all all seriousness. It is the number one thing that I think about the most because if that event plays out and it's what a couple of months away, it is.

Nick Chaplin (01:29:14.243)
Well, that's why I like these asset classes Murdoch because they will have price values go down and they can go down like they did during 2015 when you had the resource issues and price issues for resources in Australia. You had the euro falling apart and margins on hybrids went from 280 to 520 if you were a CBA. So that meant that the prices for those instruments went from

$100 to $80. Some of them went to $75. And again, I mentioned earlier, people start selling. said, don't sell. Buy. Because these instruments are pulled apart. You will get to that call date. You'll get your $100. You can't sit in front of an equity guy and say, on November 29, 2029, I'm giving people $100 for that instrument. What are you giving them for that share? Obviously, they laugh at you. But horses for courses. I'm not critical. I own equity.

But not much, but I own some. if that catastrophic event occurs, which would start with the wrong person being elected in the US in November, and I'm being a bit subjective, but I'm doing this for an example reason, you end up with a situation, all of that gets triggered. I think you're right.

At least I sit here running a portfolio that I know over time, which is why I say to people, look, it's a five to seven year investment horizon for the hybrid income fund because that's roughly the terms of the instruments to their call dates. So I've got of those 41 instruments, one's due in a couple of months and one's due in eight years and everything in between. So all of these events can occur, but those instruments will still come back to their power.

on their date of refinance or calling. And by the way, if they go ahead with these proposals, they've more or less guaranteed the calls now on these instruments. So they've suddenly become bonds and that's why they're trading under 200. So I can sit back, this might seem ridiculous to you, but I can sit back with a little bit more, maybe a lot more comfort that the world will blow up.

Nick Chaplin (01:31:38.306)
A lot of asset classes will get damaged but ultimately each one in this particular portfolio will come around to its call date. I do not believe it will blow the banks up but as I said, subjective.

Murdoch Gatti (01:31:57.183)
Well, this is the reason why I find it so interesting, discussing with financial like yourself. Hence the reason why the podcast is called the rate of change is literally, you know, the mathematical formula of, know, when essentially markets change one out of one asset class into another and you know how to scale to where the puck's going. Right. And then essentially have an understanding of different asset classes, who's really good in this space. If and when a scenario plays out, you safe havens or the opportunities. Anyway, but look, Chris,

Nick Chaplin (01:32:14.028)
Yeah.

Murdoch Gatti (01:32:26.331)
Sorry, Nick. I really, really appreciate your time. That was brilliant. And I learned quite a lot. So hopefully people listening took in a lot of information as well. Cause I found that quite fascinating and I was well due for an update on what's happening with the hybrid income space. So I really, really appreciate you coming on.

Nick Chaplin (01:32:45.96)
I was going to say you probably needed to have an electric shock button for me to whenever I use jargon, just zap. I apologize for that. The other thing I'd say I do mean, I meant what I said, if I can talk to the investors, there's nothing better for me. And this opportunity you've provided for me has been invaluable. Really appreciate it Murdoch. And if anyone wants to ask any more questions about this fund, they can contact me directly.

Murdoch Gatti (01:32:53.011)
Hahaha

Murdoch Gatti (01:33:14.685)
Fantastic. Well, Nick, thank you very much again for your time and I hope you have a great day.

Nick Chaplin (01:33:19.143)
Thanks so much, Motocool.