Welcome back to the Rate of Change with York Wealth Management.
The Rate of Change is a podcast which explores the ever shifting momentum of financial markets
through the eyes of some of the brightest minds in wealth management.
I'm your host Murdoch Gaddi and in today's podcast, we're speaking with Cullen Gunn,
CEO and a Director of Kilter Rural.
Kilter Rural operates four funds in agriculture and the water space.
But today we're talking to Cullen about investing in water and water rights,
in particular, the Kilter Water Fund, which has an annualized return of 14.58% since inception
and the Murray-Dulling Balanced Water Fund, which has an annualized return of 13.29% since inception.
We dive into detail about all things water.
Cullen covers how they go about investing in water.
What are the main factors that impact water and water markets and how to think about investing in water as an asset class?
For me, I found the conversation on the weather for once to be the most interesting of topics.
And I was also very intrigued by just how little correlation these water funds actually have
on other asset classes like the Australian share market,
especially with the inflation pressures we're seeing in the market right now and rising interest rate environment.
So before we get into the podcast, I would also encourage you to listen to the disclaimer at the end of the rockcast and to keep your feedback coming.
You can reach me at mgaddi at ywm.com.au.
So with that being said, I hope you enjoyed this conversation as much as I did.
So sit back, relax and enjoy it.
Cullen Garn, welcome to the Rated Change with the Orkworth measuring.
Thanks, Murdoch. Terrific to be here.
Look forward to the discussion.
Why don't we kick things off by telling us a little bit about yourself, your formulae and how you got into financial markets?
Ah, yeah. Well, my history is a long association, really, with natural resource management.
So coming into financial markets, I came to a back door in some respects.
So I was working for a period in government back in the early 90s.
And, you know, it was really about sustainable farmland and water management.
I guess through that period. What really struck me was just how limited the government purse was to deal with, you know, many of these issues.
You know, they sort of were moving from a doing organization to, I guess, a policy, more policy driven way.
They were setting up frameworks like water markets, for instance.
And through that process, you know, when I was there, they put a cap on water extractions and all that was really interesting.
But I guess, you know, I just felt the government purse was never going to be and deliver enough money to make the change
it was required in rural, you know, rural areas and rural environments.
And, you know, we sort of, I guess, were looking for ways we could enter a broader marketplace and capital pull.
And deploy that capital pull to sustainable land and water management.
And that that's sort of the genesis of, you know, it sort of leads on to how to kill to start.
I was very lucky, I guess, in a way, we were just sitting in a meeting with a bloke called Bob Welsh, who was head of one of the local super funds.
Terrific guy and miles ahead of his time, you know, he was the CEO.
And he sat there at a meeting one day and said, look, I run a big Victorian super fund.
I want to invest in Victoria and I want to do that sustainably.
And I want to deliver good outcomes, both environmentally and financially to our members.
And, you know, we were sitting there and we're cracking and pretty unusual.
You don't have somebody who was running a three billion fund at the time sort of just come into a meeting and say that anyway,
we left that meeting and thought somebody else would address it and then we went to a similar meeting six months later.
He said exactly the same thing. And so I went up to him with a mate.
We weren't working together. We had worked together previously.
And I said to Bob, Bob, what if we came up with something for you?
You know, we we've come up with an investment proposal for you.
And and he was terrific. He said, well, look, I'll listen.
I can't guarantee we'll do anything YouTube buffoons, but, you know, let's let's see what you can come up with.
And that really was that was the genesis of KILTA.
Really, we we then took two years and we worked pretty closely with Vic Super to develop an investment program for farmland and water and environmental protection.
And that kicked us off in that started in 2004.
And we sort of been delivering against those themes now as an organization for close enough to 19 years.
So, you know, a fortunate sort of occurrence.
But, you know, you've got to take those take those opportunities when they're in front of you.
Yeah. So can you give a bit of an insight into the approach?
Because you're talking about, you know, how it came to be.
But what's the actual philosophy of what you guys do?
Well, I guess our philosophy really is based around an inherent belief that, you know,
if you want to produce food and five are sustainably into the future,
you actually have to protect the natural capital assets on which you're allowed to produce that stuff.
So if your environment or your ecosystem collapses, you're really just degrading your assets.
You're decreasing the value of those assets.
You're not building value. And it's hard to sustain production.
And certainly through, you know, if you went back in time, even to the 50s, you know,
there's a thing called the Soil Conservation Authority in Victoria, because we cleared so much vegetation.
You had all these degradation and salinity issues happening.
And then in the 80s and 90s, when irrigation water was basically sort of it was a use it or lose it sort of paradigm,
people would use it every year or get socialized back into the system.
And they just poured it on. It was a sort of proselygate use.
It caused massive environmental degradation. So, you know, the state was actually holding inquiries
because it was worried about losing access to its irrigation farmland due to irrigation or water induced salinity.
So, you know, you look at all those things and you go, well, there's better ways to do this.
If you've got access to capital, you know, that is a that is a key constraint.
There's lots of great, great farmers out there.
But, you know, you need access to capital, you need patience, you need to be able to change things.
So that really drove certainly my working life.
You know, how do we do this farming activity more sustainably?
You know, how do we work with people, invest in landscape to generate more money,
but protect the environment at the same time?
And on the back of that sort of protection of the environment, we've now got, you know, of course, climate change mitigation.
So, you know, we know if you're looking at levers we can pull at the moment to actually take carbon out of the atmosphere,
planting trees and managing croplands in terrestrial landscapes is bloody it.
You know, the rest of it's all still hocus pocus. We know that works.
So there's sort of some key drivers behind the organisation.
The other key thing Murdoch, I would point out, is it's a really aligned organisation.
Like we have people that absolutely love Australian landscapes and love what they do.
So, you know, our sort of philosophy is really, you know, profit with impact in improving Australian landscapes and ecosystems.
You know, that's what we're about. That's what we've been doing for, you know, close enough to 19 years.
We don't go out into other things and, you know, run become carbon aggregators or, you know, renewable energy providers or whatever.
That's our game. We're in the real assets, natural capital space and we want to improve the natural capital of Australia.
Well, let's jump into the politics.
And the reason I wouldn't want to jump into politics is probably everyone's on people's mind with water rights.
I'll give an example. I've got a lot of family over in Western Australia, all farmers.
My father, four or five generations worth of farming. I went to boarding school.
You know, a number of farmers out that particular way. I've got a number of clients that actually live on the Murray.
So we all hear the particular stories of essentially.
Some people believe they're selling off the land and the water rights for internationals to come in and access it.
Other people think it's a good thing. Other people think it's a bad, bad thing.
So what's your thoughts on the politics of water rights?
Yeah, look, it's a great question. And it's it's a big topic.
I guess the first sort of thing that occurs to me is that without international capital,
you know, there wouldn't be lots of things in Australia.
It's just one of the functions of our society.
Certainly, the European society is pretty much based on European money and was when it started.
So to say we don't want international investment is difficult, I think, you know,
to have to come back from that across a range of range of activities.
I mean, we're talking about real assets. This isn't stuff internationals can take home.
You know, that we have a government here that is, you know,
very stable considering in the relative context of the rest of the world, very stable government and politics.
And acutely aware of looking after Australia's interests.
So I don't hold necessarily the fears around international engagement in real assets here.
You know, and it's actually, you know, if you look at the biggest investors in farmland in Australia over the last,
you know, probably series of years, they're not institutions from Australia.
They're all international institutions.
So, you know, some of the Canadian pension funds have done billions of dollars over the last five years.
And, you know, they come into the communities, they work with local communities, investing heavily in those areas.
They employing lots of people.
And, you know, it's difficult, frankly, to get Australian super funds to do the same thing.
So, you know, that international capital, I think, is really important.
At a sort of more specific level around water and water rights and the tradeability of all that and markets, I certainly get it.
You know, I can understand the angst.
If you think about how this sort of market evolved, you know,
you had periods where the government supported development, the building of dams,
the allocation of water to farmers to, you know, get productive activity happening and all great initiatives.
But not without cost, you know, not without environmental cost.
And as we become better resource managers and understand more about these systems, you know,
we know that you just can't throw water out.
It's a valuable resource, you know, having no value attached to that water and encouraging people just to use it,
whether they needed to or not, did not end well in an environmental sense.
I mean, we really had some significant problems driven by overuse of irrigation water.
So actually creating a market for those entitlements, putting a value on that resource.
And you've got to remember, Murdoch, we are in the driest inhabited continent on earth.
Water is about as important as it gets.
So there's sort of two ways you can deal with that.
One is you let the government decide who gets the water.
And that's sort of pretty much how it was run until 2000, sort of 2007 really had significantly changed.
Post that, you know, individuals have options about how they deal with their water.
So prior to 2007, you could sort of trade water, you know, over certain areas.
But before that, it was really quite restricted.
So you could give it to your neighbor sort of thing.
But, you know, it was hard to transfer across states, for instance, as you can now.
Less easy, let's put it that way.
And, you know, it's just in drought times, if you're in a market, you've got an extra asset you can sell.
You know, the government has set it up now so that that water entitlement, you know,
it's a title held in the state titles office, its property, it's as rigorously protected for the individual as a land title.
And I think that's an important evolution to the individual, you know, it just permits individual choice.
Having said that, there are issues with it.
You know, if you think about the average age of farmers, they're 55 to 65.
All this happens on computers, you know, so some of them are quite a fay with it, but there are lots that aren't, you know, and they fall through the cracks.
I don't think the government's done the best job of bringing everybody up to speed.
So they have the same access to information and ability to deal in this market.
I think that is an issue. And I can see why people, you know, that didn't have to think about water was just there every year.
I get it, I use it, bang, that's it. I run my dairy farm.
To now, they've got to consider all sorts of things, got to deal with a water breaker to access water.
You know, it's a significant change in operating environment that I understand really does upset some people.
But, you know, ultimately, I think it's much better the individual has the choice about how they deal with that scarce asset than leaving it in the hands of the government to decide for them, which is pretty much the other option.
So, you know, in drought periods, if you look what happens, water just keeps trading up the value chain.
So, you know, in the millennium drought, we had a 70 per cent reduction in water availability.
We only had a 30 per cent drop in productive output.
So that water just moved up the value chain, you know, moved from mixed farming through rice, through cotton and right up just to horticultural crops.
And I think when you're talking about the scarcest resource we've got in the country, that's a pretty sensible way to deal with it.
You know, you're supporting those things that really need support in dry times and in wet times.
Everybody's got access like at the moment. So it's a long winded answer.
I don't think there's, you know, there's lots of people that won't agree with it.
But I think markets have been important, the ability to trade and the opportunity that provides to individuals, I think, is important.
And the property right that's been built around those entitlements is really fundamental.
So, you know, if you looked at most farmers and they own, you know, most of the water still in the southern Murray-Darling Basin,
you know, it's a key part of their asset now when, you know, at one point, you know, 70s, 80s probably didn't have much value at all.
So I was going to pivot into asking about the environment because climate change is on everyone's minds.
But I will get that to my second. But you said something quite interesting how.
I'll phrase it as a question. What actually is the Australian water rights universe?
And what I mean by that is I've got a very, very close family member that works in Sydney Water.
So a lot of people are like, you know, that's government and then you have the private market.
And when I was speaking to a couple of colleagues, I had no idea.
I thought I knew quite a bit about this space that I thought you could potentially purchase water and say the Murray-Darling Basin and then essentially sell it in Western Australia.
But it appears that each particular state has their own restrictions and what they can and can't do.
So can you please give everyone a bit of color around.
What is the Australian water rights universe and how does it differ state to state?
Yep, I can. Yeah, it's a good question.
Look, it's I don't know what it will be capitalized at now, but if you look nationally,
I don't know, that's probably 50 or 60 billion.
You know, maybe if you're looking at water markets everywhere.
But I mean, the key thing to remember here, and this is an important element in the market.
And when people talk about investors investing in water, it does upset them.
They think they're just making money out of arbitrage and all that sort of stuff.
Well, ultimately, somebody absolutely has to use the water to generate a return.
You know, somebody's got to use it. Somebody's got to use it to grow something.
So it must end up at that point.
Now, you can't do that unless you can physically ultimately get the water from one one spot to another.
So the reason you can't just buy water here and trade it in ways is there's no hydrologic connection that allows you to do that.
If you look at what happens in the southern Murray-Darling Basin, we've got one river that transcends three states.
So it starts up in the Alps, New South Wales, Victoria, and then runs as the border across those states right out through South Australia.
And that river permits government and government related authorities to actually transfer water around in an accounting sense
that actually allows the delivery of real water to areas across that whole region.
So you need a hydrologic function that allows the water to be delivered.
Now, you can't, for instance, do that to Western Australia. There's no connection.
We couldn't sell it into the Northern Territory.
And similarly, you can't sort of do it up into the Northern Basin.
The Northern Basin sort of disconnects. It is connected, of course, but it's disconnected in that you don't get that hydrologic all the time connection through those systems.
So the southern Murray-Darling Basin is the area where we have the most transferability of water.
It's the biggest trading market. I think it's around 35 billion, capitalised at 35 billion.
And it's got somewhere between 700 and a billion in trade each year across allocation and entitlement.
So it's really that ability to transfer water that makes this market work and then having the rules around it that are pretty stable.
I'm not saying the rules don't change. They do.
But it's a bit like doing property development, you know, from one council to an ex.
The basics are the same, but each council has got their own little way of dealing with stuff.
So, you know, when you're talking across states, you've got to deal with three different state organisations and then a series of water authorities under that.
So that's it. In a transfer sense, that's one thing.
The other thing to just consider here is we're talking about water for agriculture.
OK, there's a series of bulk entitlements. So water for human consumption, consumption completely different.
You know, and that's what Sydney Water is doing. You know, it's a completely different thing.
It's run by state organisations. We have nothing to do with that.
We're just dealing in that market that has been put aside for generating agricultural outcomes.
And similarly, they've now got another, you know, well, it's not a market so much, but another bulk entitlement,
which they've always sort of had, but they're building up for the environment, you know,
because the environment underpins basically all the irrigation system.
So the environmental side of it collapses. We've got no irrigation system up.
So, you know, balancing those sort of three things is a challenge.
But we really we just work in that agricultural part of it.
OK, so in the agricultural part of it, let's use an example.
So you said the North Basin, right? So what commodities or farmers are in the North Basin?
And then, as you said, the South Basin is the majority.
So let's use the almond farmer as an example. Right.
So how would that contract work? Like, say, I don't know, that I want to go open an almond farm.
You know, yeah. What's the spot rate? Do I forward by contracts?
Like, you know, how do I protect myself?
Like, how does it actually work start to finish if I'm an almond farmer?
Yeah. OK. Well, it's a really good question.
Generally, the Northern Basin, it's got a bit more of that sort of permanent horticulture happening,
but not nearly as much as the Southern Basin.
Historically, the Northern Basin focused on mixed farming, cotton and rice.
There's been lots of those big areas doing covering that, and they really work when water is there.
So, you know, if it's really wet, you get lots of cotton going in.
I think Cubby Station, for instance, at the moment, has put in the largest cotton crop it's ever put in.
You know, I might not have that quite right, but it's massive compared to what's been going on for the last decade.
So and that's all the response to water availability.
So there's there's some big industries up there, but numerically not heaps.
If you look at the Southern Basin, it's got everything, almost every crop you can think of, you know,
from just growing grass to feed animals right through to, you know, almonds, olives, citrus,
almost pistachios, almost everything you can think of.
So for us, when we're looking at risk management, we like a diversity of industry, you know,
a diversity of industry exposure.
And then even within those industries, you really want a diversity of clients, you know, some at the high end, some at the low end.
You know, you want the best sort of mix of exposure you can get across both those things.
So that's that's really important for us when we're talking about the Basin.
If you were an almond grower, for instance, and they are still planting almonds down,
down sort of much tends to be in the in the area or sun rays year around Mildura.
So, you know, around that sort of that satellite city.
So, you know, New South Wales, South Australia, there's a riverland with all the grapes and then, you know,
Victoria down to boundary bend, there's olives and almonds.
So massive, massive planting programs down there.
If you ever take a drive down there, it's just it's it's to the horizon.
You know, you just see these these massive groves of trees, which it's amazing to look at.
Each one of those operations will treat water differently.
But on the whole, they treat it as another input to their business.
So their almond producers, you know, they want nuts and they will produce nuts the most efficient way they can.
We certainly have clients down there that sort of run a third, a third, a third.
So they'll put in an almond crop and they cost around 60 grand a hectare to put in somewhere between 40 and 60 grand a hectare.
And then at. Sort of when they're planted, they use around two to three mega litres per hectare water.
Once they're at full production, that can increase to between 12 and 14 mega litres per hectare.
So there's a big jump as the growths mature.
Some of our clients will do things like they'll own a third of the entitlement, no need for their growth.
They'll play in the spot market for a third of it, so annually just enter the allocation market and buy water, you know, if or as they need it.
And then, you know, they might use groups like us to provide them with a lease.
So most of our income, the vast majority of it is generated in our funds by leasing water to long term clients.
And in almost all cases, it's rarely the full quota of their water need.
They'll supplement it with other things, either stuff they own or in the spot market.
So that's how many deal with it. Some actually don't own any water at all.
There are some massive bloomin' plantings out there that don't own any water rights and they will just enter the spot market.
So, you know, I reckon that's an interesting strategy, certainly, you know, less capital.
You mentioned the spot market just quickly. What actually is the spot price of water?
And to give that lesson is a bit of an idea. In the past, say, I suppose, seven years, what's been the high, what's been the low and where's water been forecasted to go?
And the reason why this is interesting is just to I think there's some other competitors out there that physically trade water.
And my understanding, what Rural does is you don't physically trade water.
You're looking for essentially to purchase the asset, generate income off that asset and then the growth of that asset.
Right. So I think that might give a better understanding when looking at these farmers, you know, that there is this cycle and they're trying to forecast and hedge against this cycle.
So that'd be great if you could give a bit of an overview.
That's exactly what they're trying to do, Murdoch. It's about, you know, it's about risk management and protecting, you know, the future.
You know, what's going to happen in an uncertain future. So look, I think that's the best way to answer that.
So our water products, you're right. We, as I said, generate most of our income by leasing water to people.
Now, when we invest in water, what we're investing in primarily is something called a water entitlement or a watershed.
OK, and that's a perpetual right to access real water available in a system.
It's a bit like owning a glass in a dam. You know, you've always got that glass there. That's it. It's yours forever.
It's like your house block. And then each year, depending on how much it rains, that glass gets filled with water.
And both those things are tradable. So the entitlement, we don't trade very often.
Sometimes we sell down to rebalance portfolio and things, but that's our long term investment.
The water that comes into the entitlement or the glass each year, that's the sort of spot water or allocation water.
And that's traded quite readily by people, by farmers, each year.
You know, a farmer will get their water and they'll say, all right, do I want to use it to grow a crop this year or will I trade it?
You know, and there's, you know, that's a much more active trading market and similarly much more volatile.
So going to your question about how what's the variability in that spot market, it's quite variable.
So at the moment, I think last week or two weeks ago, the allocation or spot price for real water,
if you wanted to go into the market and buy it to grow something, was about five dollars a megaliter.
Now, that's fine at the moment because it's really wet.
You know, we've had three very wet years in a row, three La Nina events, you know, so well above average.
In fact, last October was the wettest, I think, October ever in history or European history, for sure.
So, you know, water is really cheap. A lot of it around keeps raining or has been.
So it's been down as low as five bucks for most of this year.
It's been in that 50 or probably less than that, actually, really on average, probably 30 to 50 range.
Earlier in the season, it was it was 70 dollars, you know, when it was not quite as wet before October or all that sort of stuff.
So it does vary in drought times. We have seen that get up to nine hundred dollars a megaliter.
So it's an enormous variation in the value of that allocation water or that spot water can occur each year, you know,
just depending on how much water is available.
The entitlements, on the other hand, are not quite as volatile.
But to remove the volatility altogether, you know, we could have huge volatility
if we just held entitlement and were trading in the spot market all year.
If that was our process for generating returns, we'd be getting smashed to pieces in a year like this
because you're getting five dollars a megaliter for the water.
And, you know, the entitlements can cost you between, I don't know, seven and eleven thousand dollars.
You know, that's the primary asset you're investing in.
So, as I said before, you know, we've been doing this for a long time and we prefer to
generate our returns by leasing that water through long term sort of multi years,
up to five, but generally three years to, you know, to clients, a client base of now,
I think we've probably got over five, five hundred different clients on the books.
And, you know, we just we just write these leases long term.
And what that gives us is stable income.
So the farmer will lease that entitlement from us.
They take the risk on how much allocation comes in, you know, so whether it's wet or dry,
that's their risk. But that risk doesn't change whether they own the entitlement or lease it from us.
Exactly the same risk profile, you know, whether they own it.
And it's a really low allocation year, they get a low allocation.
They lease it from us to lower allocation year, they get a low allocation.
But we just get a stable rental offered, I guess is the key thing rather than relying on the spot market.
So how does that transcend into the performance of the fund?
So I suppose what's actually been the performance?
Well, we've got two open funds at the moment.
There's the Kildare Water Fund, which was established in 2014,
and that's done over 14 percent since inception.
And it's a fund that just does, you know, it's charged with doing two main things, really.
One is investing in the entitlements and generating return from those entitlements.
And the second thing is we do that by working with really good clients, long term clients,
and delivering them lease products and other water products.
We do have some other things, but the lease is the main one.
So, you know, it's just delivered a really stable return profile.
And as I said, it's 14.1 percent since inception.
The other fund is something called the Balanced Water Fund.
And it's a collaboration between us and the Nature Conservancy.
The Nature Conservancy is one of the largest environmental organisations in the world,
based in the US, but we work with their Australian arm on this fund.
And it does exactly the same thing as the Kildare Water Fund.
It invests in entitlements and generates the vast majority of its returns through leasing water to irrigators.
So both these funds are about keeping irrigators and getting them access to water.
But the Balanced Water Fund is really quite novel in that it's trying to avoid
that complete contrasting argument that's always going on about you can either have water for the
environment or water for agriculture. You can't do both.
It delivers 60 percent of its water is in lease and actually can be up to 70 or 80 percent in lease with farmers.
But every year it also makes a donation of water for environmental and cultural watering outcomes.
So there's no other fund like it in the world.
KILTA is responsible for generating the return from leasing the water and managing the water portfolio.
Each year against unambiguous rules, we have to make a donation of water to the Nature Conservancy,
who then work with another group called the Wetlands Working Group, and they deliver
that water into important wetlands and rivers in the southern Murray-Darling Basin.
So it's a really novel fund. It's delivered over, well, close enough to 13 percent, 12.7 percent since inception.
So if you're looking for something that delivers really solid returns and is delivering also those impact outcomes,
it is an amazing fund. We like them both, of course, but it depends on where people sit.
So essentially one's an ethical fund and one's for the capitalists.
I know I'm saying that a bit cheekily, but the reason why I'm phrasing in that particular way is,
can you please give some clarity on with the metrics, like how they're different?
There's a difference in the return component. Is it a difference? And why is that difference?
Is it because the fees that are being charged in the structure?
I suppose my question is there's two very similar mandates. How are they structured differently?
I understand one gives water back to the conservationists, but are the funds' fees different?
So there are operating costs associated with that allocation of water to the environment each year.
So if you look at the Kildare Water Fund, it has a distribution profile and target of four.
I think it did six percent last year in association with the capital growth,
whereas the Balanced Water Fund has a target distribution of two. So that's really the gap.
You've got to make that environmental water allocation for environmental watering,
but it also, much of the watering they do requires pumping. I mean our systems are
quite disconnected nowadays, so it's not easy just opening a sluice and away the water goes.
Often you have to pump it from one area to a wetland that can be some distance away from the main
water source and it's dry. So there are pumping costs involved and we have to support the nature
conservancy in the wetlands working group with a cash allocation as well to get those operating
costs covered. So that's really the difference in the return profile.
Okay, so that makes a lot of sense. How much money is currently in both funds at the moment?
The Kildare Water Fund is about to tick over to 50 million in May with a good allocation coming in
later this month and the Balanced Water Fund is around 90 million and I think that'll probably
get up over 100 over the next month or so too. How big's the team?
Our team, the Kildare team in total is around 20. So in addition to the two water funds, we've got
a water mandate with a big US institutional investor which is fully deployed and we've also
got two agriculture and water funds. So across those four funds and the mandate, there's 20 of
us servicing that and this sort of farm team sort of flex a bit depending on what's going on but
yeah, around 20. Is it just Kildare or are you under an umbrella of another fund manager?
We are nowadays. It was just Kildare for a long period. Then in 2018,
when we were initiating one of our other agriculture funds, we came in contact with a guy
called two gentlemen, Phil and Andrew King, who were looking to invest in real assets and were
looking for a manager to invest with and they took a position, an early position in one of those
funds and from that, they like what we do. They love the water story, they love the sustainability
story and they invested in the company through Regal, Regal funds management. So Regal in 2018
bought 50% of the organisation and they've increased that stake more recently to around 61.
So Regal Proprietary Limited, the majority owner of the company now, myself and one of the other
co-founders own the rest of it. Yeah right. So with alignment, this is a great question.
The reason why we like asking this particular question is we've learned over time that different
ways how fund managers structure, how they get remunerated essentially dictates behaviour on how
they look to invest in assets. And as you said correctly, you just had a very, very well-respected
fund manager by 50% of the business and then now you're managing yourself. So how is the
remuneration structured within the firm and how are you aligned to investors? Thank you.
Yeah, well, I mean, we've always had a, I'd say a really responsible attitude to fees.
I'm not saying others are irresponsible, but we started with a large institutional investor,
a not-for-profit or a profit to member investor and boy did they push us hard on fees. So
we've always been, I guess, very open about our fee base and saying it's a cost plus model,
cost plus 10% on the base fee really to deliver these things. We want to get rewarded
through the performance side. So when we perform, that's when we start making some money. So
there are performance hurdles across our funds that we've got to reach. That's one element to it.
And we've always had... What are those hurdles?
Oh, they vary. But look, a standard sort of approach would be 15% over 8%
for these sorts of assets, which is pretty standard. I think you'll find across,
you know, much of our industry. But just more specifically at a staffing level,
we've always had an employee share trust as an organisation. Merging with Regal actually allowed
us to, I think, make that a much better opportunity for our staff. So they actually get a small
portion of ownership in Regal over, you know, after three years in the organisation, which I think is
a great outcome. And then, you know, annually the organisation, Kilter itself, has its own bonus
pool. So if the company makes a profit, 10% of that is available for staff involved in delivering
the activity. So it's been a pretty good sort of aligned process there, I think, at all levels
across various teams and successful at this point. And I think the Regal alignment or relationship
is really helpful for that too. Let's pivot into beta. Not many people are familiar with beta,
but it's essentially the correlation between a fund and how it behaves towards a specific market,
right? Zero to one. So the one thing I always found very interesting about the water space,
it's kind of like correlated to not much. It's like its own little unique ecosystem, right? So,
you know, it's very turbulent times out there, we have, you know, a tightening environment. So if
you don't mind covering, you know, how does inflation impact the portfolio? And then secondly,
why does the fund have such a low beta? Yeah, well, I think if you're looking at either of the funds,
you know, the sort of correlation is, it's close to, as you said, zero, you know, I mean, you could
argue it's 0.01 or 0.02, I guess, you know, you can model that way. But it's really, you know,
in the context of other things, if you look at ASX, REITs, Gold, that's top 300, S&P 500,
the volatility is a lot less, you know, it's around that sort of 6, 7%, generally. And you're
getting a good return, you know, in our funds anyway, you know, you're getting between that 12
and 14% return. So what it's really correlated with is the blooming weather, you know, that's it.
You know, it doesn't really matter what's going on in the rest of the world. If people are producing
food, which is the key driver in all this, you know, it's this water is used to grow stuff.
If they continue to produce food, well, it's really correlation with the weather that generates,
you know, and moves the market. And that's where we are at the moment. As I explained before,
you know, that there's been so much water, the spot price is $5 or $10 a megalitre, you know,
it's as low as I've seen it for a very long time, actually beyond my memory, but my memory is
shocking. So, you know, let's get into this. Let's let's get into this. I was talking to you
off air and I said, on a funny note, in polite society, they always say never discuss the
weather in small talk, but turns out it's probably the most important topic of this conversation.
It is it is really important. And it's not something we've got control over, which is
a nuisance. So, you know, what do we do? We just all we can do is arm ourselves with the best
available information. So, you know, the water team look at, you know, they don't do it themselves,
but obviously review all the climate models that are coming in and the BOM outlooks. And,
you know, there's eight or 10 different models used across the world to try and determine,
determine and predict, predict the future. I mean, it is it's a bit like listening to economists.
I find Murdoch, you know, I'm like, look, on the one hand, we are heading into a massive recession,
or on the other hand, we could be looking at a period of extended growth. You do get a lot
of that sort of stuff. So, you know, it's going to be really wet. It's going to be really dry.
I think I was reading this morning, actually, the latest BOM outlook, which is suggesting we
may be going into an extreme El Nino. So, an extreme drought period or dry period,
which is pretty amazing having just come out of a, you know, what would be described as an
extreme wet period. But then it goes on to say, but this is not a guarantee, and it may not happen.
If we get the right westerly wind, it will blow this El Nino away. You know, so it's difficult
to say, but all we can do is use the best available information. Each year we put, we you know,
we're obviously looking at that every month, but each year we look at the storages, we look at the
available outlook, and then determine how we're going to manage the portfolio for the coming year.
But that gets reviewed every month just based on, you know, because weather can change very
quickly and the outlook can change very quickly. Let's keep going on this weather topic, because
there's one thing that I found very interesting. I don't know if any of our listeners or yourself
saw the Netflix series with Graham Hancock. He's been featured on Joe Rogan quite a bit,
discussing the Yunga Dryas, essentially the comet that hit like 12 and a half thousand years ago.
And then one thing I found very interesting about that comment, he essentially created a
scientific case discussing how when a comet hits, a volcanic eruption pushes a plume of
material into the stratosphere and then drops into the ionosphere. And then essentially,
what he's saying about three months, there was just so much of it, it essentially changed the
entire climate of the globe into this cold and brought on the deep freeze, right? You know,
the frozen years, woolly mammoths, all that type of jazz. And the reason why I'm bringing this up
is, and we're just discussing it off and I sent you the article. In 2022, there was a very, very
unfortunate event of Tonga's volcano disaster. And essentially another plume got shot into the
atmosphere. And I think I was reading articles from ABC and also Sky News essentially saying,
I think there was a couple of geologists even saying that that particular event may disrupt
or impact Australia's weather patterns for potentially up to eight years. And there was
another article that even said that this particular event made this summer a very, very
event made this summer one of the wetter summers of all time. Right. So as you said, you're in the
business of weather and weather is the main correlation. So have you done, what are your
thoughts on that? And do you want, and if you want to give a bit of an understanding on the
science behind that as well? Yeah, well, look, I mean, it's happened before. So if you go back to
the 1880s and I only just was interested in you put that article, brought that to my attention
because I did read this book on Krakatoa not that long ago, but 1883 when that thing went off and
much bigger than that recent volcanic, this thing, the noise went around the world, I think seven
times, you know, when it exploded, just a massive event. And it did, it created a volcanic winter
that lasted four years. How long did it last? About four years. Four years. Yeah, yeah,
significantly blocked out light, made things colder, lizards, all that sort of stuff. It did have a
did have a massive impact. And even if you look at art that was done through that period, paintings
that were done through that period, they've all got quite a different light because of all the
particulate matter in the atmosphere. You know, it just made the light quite different to any other
period. So look, it has happened. I think the event you're talking about is probably not big enough
to have, you know, it will have an effect, but it's probably going to be at the margins.
You know, much more, much more important, and I think much less predictable is how climate change,
you know, changes everything. So what does it do to ocean currents? How does that change weather
patterns? You know, they're probably a much more likely, I think, and somewhat unpredictable
threat to climate systems everywhere. The only thing we're certain of at the moment, and, you
know, we, we take and have done for many years, annually taken a presentation from the CSIRO or
representative from on there, you know, and IPCC authors, representations from them on what the
climate modelling suggesting and what the outlook is. And almost without fail every year, they say,
it's moving faster than our models, the impacts and the changes, you know, the changes they predicted
are pretty right, but it tends to be in front of the sort of average modelling. So, you know, I
think that's, that's what we spend a lot of time looking at, much more so than the sort of black
swan event, which is completely outside our control. We can't do much about that at all.
You don't know when it's going to happen. You don't know if it's going to happen. You don't know how
big it's going to be. Climate change, we know is happening. So we do build that into our risk
management framework every year and almost every month, really, really looking at what's going on.
But every year, you know, we do look at the risk management and response around either the outlook
for dry or wet in the short term, but long term, you know, it is absolutely, I think, a fundamental
truth. We are looking at more extremes. So you're going to have really big swings from dry to wet
and wet to dry. And those events are going to be much bigger. You know, we've been through some just
amazing climatic events in our farming history over 18 years. So one of the biggest floods we
ever had, Murdoch, occurred in January and February, you know, in 2010-11, which is pretty
unusual to get a flood in the middle of summer in, you know, what is ostensibly desert in Australia.
You know, it's not unheard of, but, you know, it was the biggest flood that had been in that part of
North West Victoria for many decades. So the climate, you know, I think that's the bigger risk.
You know, that's what we've got to really prepare for and manage for. I think investing in an asset
like water in that, you know, given that outlook's really important, we could almost consider it a
climate change hedge because what they're suggesting is water is going to be scarcer in Australia.
You're going to have much bigger events. So you will get massive rainfall events, but, you know,
the long term trend will be dry. So in summary, what you're thinking the forecast might be is
essentially a lot more volatile periods of potentially a lot of pre-longed wet environments
followed by a very pre-long dry environment. Is that what you're thinking?
Well, potentially, yeah. Yeah. I mean, you know, I've been around that long. I'm only 56 or something,
but you've been through some wet things, so 73, 74, 75, you know, that was a pretty wet period.
But if you'd ask me, Murdoch, what's the thing that could really sink our funds,
you know, make it really challenging for us? I would have said three wet years in a row,
you know, really wet years in a row. So three La Nina events in a row. You know, that's what we used
to say five years ago. That's what would make it really challenging. We've just been through them
and these funds did, one of them did 22% last year and the other one did 70% last year.
And the other one did 17%. So what's that tell you? It tells you that the market is becoming
much more sophisticated about the outlook. I don't think we'll get those sort of returns this year.
I think last year, you know, people thought the wet would stop and we'd start moving on and it
didn't. It got wetter. So that was a bit unusual. But, you know, I think what that tells you is the
market and the water market and the operators and users in the market are taking a quite different
outlook to the variability and the opportunities provided by water than they did say even back in
2016, you know, 2010, 11 in that big flood period, water prices dropped 30 or 40%. Some entitlements
2016, another wet period, they dropped, you know, eight to 12. This time when it started, they dropped
about six or eight percent, but they bounced back, you know, they went up 16% some entitlements last
year. So yeah, but you have to ask the question why. And then I think it's the markets that we've
done. I believe it was part of the Labor's campaign that they essentially said that they'll come in and
buy 6% of the water rights back, right? To essentially protect farmers, everything equivalent. And then
there's a couple of my colleagues did some research and that's like $11 billion. I don't think the
government has the funds available to even execute on that particular thing. So my question to you
then, right, is do you think, as you say correctly, it's been three dry seasons, wet season, sorry,
that essentially the government coming and making those comments is essentially put support or
floor underneath these prices and essentially propped everything up. And if that's the case,
do you think the government has the capacity to execute on purchasing that 6% worth of water
rights? Is it sustainable or essentially has that run its course? Good question. Look, I think it's,
I'll come back to the government question in more detail, but the other key thing you've got to
remember in the change in the market, you know, people are more statistic about the outlook and
they reckon it's going to get dry. So, you know, that's a fundamental truth. The other thing that
has changed is the amount of permanent horticulture that's now in the system. So if you went back to
the sort of 80s and 90s, the biggest water user, particularly in the South, was dairy, you know,
and dairy farmers can choose to use water or buy and feed, you know, they could buy and feed and
trade water, that's an option for them. But once you plant a horticultural plantation, there's no
discretion, you know, you spend 40 or 60 grand a hectare, whatever it is to put them in the ground,
you have to water them every year. And those trees have gone in since we began, I think there was
probably less than 10,000 hectares of almonds, now there's close to 65,000 hectares of almonds,
and they're predicting that will be 75 by 2030. That's a massive change at the top end of water
use and that is driving market change and market sentiment. You know, people understand that those
trees will always need water, same with olives, the olives are still being planted in the basin,
citrus, wine grapes, all those sort of things, they need water all the time. So that horticultural
component has completely transformed the demand side, you know, so you've got supply side issues
with climate change, and you've got a demand side change, which is just extraordinary, you know,
the outlook, there's still 20% of water in the system that almond trees will need to take out
that they haven't accessed yet, as those trees mature. So trees already in the ground that go
from two megs to 12 megs per hectare are so mature, that's locked in demand. So I think there's, you
know, just some fundamentals in the market that have changed. But coming back to the government,
they have bought a lot of water in the past, and they did drive up prices in the past. So if you
went back to eight, nine, 10, they were buying a lot of water back then, I can't actually remember
Murdoch how many billions they spent, but it was billions of dollars. And they recovered around
2100 megalitres through that and other avenues. The federal government, what they're saying is
exactly what the Libs were saying in a different way, they all said we're committed to completing
the plan. So, you know, whichever government was in, they both signed off on it. I think this
government's just been more active since it arrived about saying we'll enter the market if we have to.
Now, has that underpinned prices? I think there certainly is, they look like getting elected,
there was probably a bit of a spike there, you know, people thought, crikey, they're going to
come in and last time the government paid between 1.5 and 1.7 times the value of entitlement to get
it. And maybe some people thought that would happen, you know, really quickly and, you know,
so I think there might have been a short term little blip there, but not a long standing thing.
Will it underpin prices? I think if they do start buying, it will absolutely certainly, you know,
put a bit of a floor in the market. It's hard to know how they'll do it or how they'll do it quickly.
The last time they did it, they basically, you know, had to set up a whole new section of the department
with experienced people. Now all that's been dismantled since, so there's probably going to
be a bit of a ramp up period while they get themselves back in order and actually understand
how water markets work and who does what and how they'll get it. So I think there's probably
some changes there. I know they're in the market now in the Northern Basin,
buying entitlement or putting entitlement, offers for entitlement out there and there are willing
sellers. I mean, that's the other thing. Everybody makes a lot of noise about it, but somebody's got
to sell to them. So people are making decisions to do that. I don't know if they're the noisy ones or
not, but you know, that's how it works. They're not forcing people to sell. They could, but I think
it's a real vindication in the market that the government is protecting the property right of
the individual and saying, if you want to sell it, we'll buy it rather than just walking into the
market and taking it, which they could ostensibly do, but that no government has ever even suggested
that. So I think in one sense, it's a good thing that they're protecting the property right, the
individual, but look, 6% is a lot of water main. It is, it's huge. So if they actually, I mean,
they're supposed to do it by next year. So I don't think that's going to happen.
I don't think even if they had billions of dollars ready to invest in water entitlements to buy it
back, I think it would still be a challenge to buy it back in that timeframe. There's a good portion
of this water that was supposed to be recovered through state efficiency programs, works and
measures programs where you have perhaps an engineering solution that delivers the same
outcome, but saves a heap of water. And they had a series of those on the go, but they're expensive.
They take a long time to enact. States have had a lot of trouble delivering on them. And I think at
the moment, you're at a bit of a crossroad where the feds are saying, we've got to meet this target
next year. The states are saying, well, we can do it through these efficiency measures, but we need
more time. Will you give us more time? And there's just a bit of a stalemate at the moment. So
look, I think it will put upward pressure on prices. Ultimately, if they're in the market,
it seems a likely outcome to me. But when they're in the market, to what scale, how that plays out,
I don't know. I don't know. I mean, it's not like the budget's full of ready cash at the moment,
is it? Where do the billions come from is one question. So look, the intensity, and I think
we're fully supportive of the Basin Plan. Don't get me wrong. We think it's really important.
Without a functioning ecosystem and river system, we don't have irrigation. So we're absolutely
supportive of the Basin Plan. I think they could have gone about it perhaps differently, but
that's what the Balanced Water Fund is sort of there to show. There are other ways to do this,
recover water and deliver it, deliver water to irrigators at the same time.
So is there any thoughts you want to leave our listeners with?
Look, I think as an asset class, real assets make sense. We're not here to argue that
your whole portfolio needs to be in them. That just wouldn't make any sense at all. But
if you're sort of thinking somewhere between 2% and 5% of a portfolio and real assets that
are alternatives, they're uncorrelated, they're not going to be a good portfolio.
They're uncorrelated generally to everything else that's going on in the market, particularly with
ag assets. You do get inflation protection as well because commodity prices tend to go up. So
you've got that inflation hedge. And if you're looking at water and you're thinking about
climate change, well, water is a pretty good climate change too. You would expect with less
of it around, it will go up in value. So I think we love what we do. We love working with clients
that are philosophically aligned. So the more the merrier in that sense. But you do have to take a
realistic view with this stuff. Farmland's not that liquid. Water's, well, excuse the pun,
much more liquid. You can get in and out of that pretty quickly. But it's just an uncorrelated
inflation protected asset class that, personally, I've got my superfund in it. And I reckon most
people should have a portion of alternatives in their portfolio. If anyone wants to learn more
about what you guys girls do, how can they reach you? I think the simplest thing would be,
I was going to give out everyone's telephone number Murdoch, but they might get upset with me
if I do that. So probably the simplest thing is just to go to the website, which is www.kilderrural.com.
And there's just an information request form there. And we'll contact them if they want to
be contacted or provide information. They can actually just request information if they want
to go down that path or actually we'll give them a call and follow them up.
All right, Colin, well, thank you very much for your time. I've really enjoyed this conversation.
I hope everyone else has as well. Thanks, Murdoch. Terrific. Really
appreciate the opportunity. Thank you, Colin.
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and other sole personal opinions of the speaker. Any reference to financial product does not
constitute advice or recommendation. And before any action, you should seek proper advice from
your financial professional. Australian listeners should head to www.moneysmart.gov.au to find more
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