Brendan O'Connor – Alpha Opportunities in Australia at Regal Partners (EP.485)

28:15You've probably seen a diaspora of Australians around the US, Europe, certainly in London, going off in Hong Kong, Singapore, wanting to go and apply their trade and learn and hope to succeed at some of the world's largest financial institutions. One of the nice things about Australia is that it's a long way away from the rest of the world, which is a tyranny of distance at times, but it certainly means that people can return to Australia in a very safe environment, a long way away from some of the conflicts that's existing elsewhere in the world. And frankly, it's just a beautiful place to live.

28:49We've got lovely beaches, nice weather, good rule of law, etc. We often find that when that diaspora is returning because perhaps they're married, They want to start kids. Their kids are our age where they want to go to high school, university, whatever it may be. That's a great pool of talent to come back to Australia. Early in their career, while we are probably at risk of losing them because they want to travel and go overseas and compete with the biggest in the world, we've got a privileged position to being the first call on the street for talent when they're returning to Australia to say, hey, I enjoyed my time at some of the biggest companies in the US.

29:25That's similar to what you guys are doing back here. I'd like to do that here in Regal in Australia and develop my career. When it comes to that assessment of investment performance, what have you found works in the assessing teams? It's one of the benefits of the asset management industry. It's ruthless in its objectivity. It's hard to fudge whether you've performed or underperformed. The scoreboard doesn't lie. Performance is best viewed through a risk-adjusted lens. And over the long term, I find that managing people's egos around their performance can be challenging. But making an objective call as to whether they have performed or not is one of the easy aspects of the role.

30:12Whether they acknowledge it or not, I think it's pretty clear. And then once they're inside the tent, how do you try to help them improve performance? It touches upon two key roles as part of the leadership team that I have brought on board over the last three years have been really important to that point in particular. We need to be expert risk managers to do what we're doing, not just because of the hedge funds and leverage strategies, but the origination of unique products and capabilities and protecting ourselves against the downside that can occur, making sure we're maximizing the investment returns coming out of those opportunities.

30:56Risk management needs to be a key capability for the business overall. Three years ago, I hired our very first dedicated chief risk officer. They've been on board now. They lead a team of five people across the business that are working not only with the portfolio managers to assess their risk, but their key objective is to improve risk-adjusted returns. We didn't need someone to come in and say, hey, you're outside or near risk parameters. We needed someone to say, how do we actually improve your risk-adjusted returns? In some instance, taking more risk for a given return series, whatever it may be.

31:33The other key hire that I've made in the last three years, which has been enormously powerful in generating that collaborative team achievement focus direction is a HR director. Having that constant and consistent message around communication, values, standards as to how we interact with our employees has been helpful to me and the business in advancing that culture. When you bring in these different teams, how do you think about the cooperative nature of the synergies they can get compared to wanting to incent them for their own performance? There's no easy answer to that, particularly where it may have been acquired capability have brought in place.

32:24We try and instill a culture where the individual wins where the team wins, and that's a great mantra to have. As it relates to an individual conversation one-on-one, it can sometimes break down because they're laser-focused on their own performance. Being able to structure remuneration outcomes, being able to structure a collaborative environment where staff within the bounds of protecting public, private assets and information barriers between the two sides of business are encouraged to hand off opportunities. Hey, just had a look at this company. I'm going to pass from a equity perspective, but I'm happy to provide an introduction if they want to have a chat to the debt side, for example.

33:08When we can highlight those to staff through our regular town hall meetings, we're really holding those up. These are great examples of Regal's ability to harness the best of what we do across the range of the business for the benefit of our clients. What have you found is special about the investment teams at Regal? I've never worked in a place where there has been such energy and enthusiasm for the business to succeed. Everyone at Regal from an investment perspective has a buzz, a drive around achieving. This goes back to the origins of the business, a founder-led business. That same DNA is it's things achieved by hard work, resilience, laying awake at night, worrying about what could go wrong, getting up early, making sure that those little things that you're concerned about are done, as opposed to measuring or rewarding effort.

34:09As a founder-led business, we concentrate and focus on rewarding achievement, as opposed to the effort that can just go on in a large business. What's the unifying DNA of the investment strategies at Regal? I'd say looking for an edge in what we're doing that often leads you to be a contrarian. I'll give you a good example. Paul Moore, who leads our global long-short equity capability, he has been running that strategy since 1998. By having a well-defined investment process and a capability that lends you to look for opportunities that are off the beaten path, that's been the essence of whether it's been equities within debt.

34:59The debt's probably an easy one to explain. The Australian market has a voracious appetite for the providing of debt to property. Australians love property, the big property investors. When we're talking about deploying debt to a lending opportunity, we have no competitive advantage trying to compete against everyone else trying to provide debt to established properties. We're looking to provide debt to agricultural opportunities or to the development of infrastructure, those opportunities that have a unique and perhaps complicated edge to them that we can actually do good due diligence and good structuring to generate returns.

35:40And it goes back to that mantra of being that original equipment manufacturer. We're not simply intermediary for someone else's originated opportunity where we're clipping the ticket. We're going out, finding those opportunities and backing ourselves with the conviction that if that opportunity wobbles and we need to stabilise it, we've got the investment capability to step into that situation, stabilise it, turn around, sell it. How about on the growth equity side? Growth equity side was that dominant position. We started that strategy in November 2016. We had always been a large provider of capital.

36:17That last institutional capital raise, about 18 months to two years before a company IPO. We decided to create a dedicated strategy around it. It's probably a strategy we've got about half a billion dollars in now as one of the largest and longest standing providers of capital to that part of the market in Australia. That company has seen some wonderful investments that have ultimately gone on to create big businesses in the States. You may be familiar with the Buy Now, Pay Later thematic that developed and companies like Zip and QuadPay, they were small technology financial institutions that sprung out of Australia and now very large businesses.

36:52It puts us at a ground floor advantage being able to be early investors in some of those great opportunities. I'd love to dive into a couple of the different types of strategies that you pursue and how you think about how they stand on themselves and how they benefit from having adjacent strategies under the umbrella? There are two ways to answer that. One is the four asset classes I talk about, whether it be long, short equities, credit and royalties, real and natural assets, and growth equities. Just across that lens, you can talk about being able to make better investment decisions because by being a proficient equity investor and understanding the risks and rewards of being long or short a company.

37:39Through your fundamental analysis, you inevitably need to understand the position of the debt provider in that balance sheet and the relative returns they're earning vis-a-vis your position as an equity owner. By being able to say, okay, well, gee, I think the equity is undervalued and I might be attracted to buy that, or I think the equity is overvalued, but have a look at the return that the debt provider is getting. For the next three years, they've just locked in a 12 % return for something that I'd be happy to own the equity of anyway, that relative risk return. The more interesting aspect though is ultimately on a sector analysis.

38:23When I sit back and think about the businesses, I think more about the coming together of the capabilities that we have. The ability to say, I can provide for any resource company globally, an equity solution, a debt solution, or a royalty solution, because I've got the technical expertise to truly assess the mine risks, the nature of the resource they're mining, an informed view of what the future prospects for that particular commodity might be, a view as to the sovereign risk we might take as to what country that mine is in. That is a unique expertise. We might be one of three companies globally from an asset management perspective that have the breadth of that capability.

39:08The other area, which is uniquely Australia, is what I'd call natural assets in Australia. Natural assets in Australia encompass everything from not only the equities, public and private in agriculture in Australia, the debt, we're one of the largest providers outside the big four banks of agricultural debt to the Australian agricultural market. One of the adjacencies to that is we're the largest owner of water rights outside the Commonwealth government in Australia. To explain what a water rights is, water in Australia, as it relates to large-scale farming operations operates under an economic cap-and-trade system.

39:48You own a farm, that farm historically may be soldier-settler blocks given to soldiers returning from World War II and over the generations that have done a bit of dairy farming, things like that, i.e. dairy prices are typically low profit margins and a soldier-settler block is typically a subscale for what a modern farming enterprise would look like. We're finding that those farms are being transformed into larger farms, and they're typically migrating from dairy farming to higher value use product, table grapes, almonds, avocados. The importance of that from a water price perspective is those products that usage have higher profit margins and those therefore can sustain higher prices.

40:34As the owner of those water rights, when we're leasing that water out to farmers, we're enjoying the higher lease return from being able to lease that water out to those farmers, as well as the capital appreciation that sits behind an increasingly scarce asset in Australia. Australia is the driest continent on earth, and there's a lot less water compared to land. So water is a better way to pay the agricultural exposure. As you've developed this range of strategies and capabilities across alternative assets, all focused in Australia. As an investor comes to you and they're interested in getting exposure to the benefits of the Australian economy, the wave of AI derivative, how do you advise them of where to plug in?

41:22The best of Regal can be accessed via multi-strategy solutions. We have been running a multi-strategy capabilities in Regal since 2019. We listed a permanent capital vehicle on the ASX, subsequent to that, we have launched strategies that provide access to get access to the best of our ingredients. Often represents the first foray for those offshore investors to get access to the best of Regal's alternative investment capability. It explicitly targets high team returns with high single-digit volatility and in that way is a great entree for any investor to first get access to the best of Regal and therefore the best of alternative investments in Australia, they can then broaden that relationship.

42:12And we often find they'll subsequently dive into some of the individual strategies, whether they be hedge funds, credit royalties, or growth equity. So it's a great first start for any offshore investor. How do you think about alpha generation or the opportunity to take advantage of an efficiency in the market? Really important. I use that term, the original equipment manufacturer. Regal's edge in providing investors, not just in Australia, but around the world, access to the best of Australia's alternative investment strategies inherently or necessarily means that we need to be originating those opportunities.

42:54If I think about the equities perspective, that means we're the first call on the street to opportunities to be able to deploy capital to new events, IPOs, ECM activity, whatever it may be. That first call on the street means that we're in a position to typically influence the pricing around where some of those transactions get done. That puts us in an important position at AdAlpha. As a large provider of debt capital to the agricultural sector, to increasingly corporates in Australia, it puts us in a better position to command pricing. We're simply not a syndicate of a large debt package that, let's say, the private equity firms have put together here in Australia.

43:37We're originating those opportunities ourselves. Finally, you think about from an agricultural perspective and water, we are the dominant provider of that owner of those water rights. If someone wanted to set up a farm in Australia of scale, they're not thinking so much as their first question about where they set that farm up so much as how do I access and secure my water. That means a conversation with Regal as to how do I secure those water rights. Alpha is intrinsically linked to being that first call on the street and that origination capability. Once you have that call, what does the underwriting process look like?

44:16As an equity investor, we're a fundamental stock picker, bottom up. There's not a company, certainly domestically and increasingly from a global perspective, that we don't have a view on. We go through a four-step selection process. We start with the valuation of the company, and the valuation is the cornerstone of our investment papers that we write up. The second one is to understand the macro environment in which that company sits in. What are the macro headwinds or tailwinds that might be unique to that company and the sector they operate within. Thirdly, we look to say, well, what is the catalyst?

44:49And by forcing ourselves to identify a catalyst, it forces us to be clear-eyed as to when to time the investment for entry, but also to exit potentially if that catalyst has come and gone and your thesis hasn't played out. The fourth step is the edge, and that is to say, if the market's typically efficient, what is the market missing? What insights do we believe that we have that the market is missing? And by forcing our team to actually address that, it makes us better investors to be wide-eyed as to what the opportunity, but also what the risks are. When we're talking about that first call in the street, it's wrapped within that fundamental stock picking capability.

45:32There are first calls in the street where you say, use a cricket analogy, you let that ball go through to the keeper or a baseball analogy, you might not swing at that one. But it allows you to have high conviction and lean into those opportunities where the planets align and you've got a strong fundamental position as well as being the first call on the street. What does that look like outside of equities and credit royalties, real assets, growth equity? There's a less homogenous asset class, more heterogeneous opportunities in there. Then it becomes more around relationships. What type of borrowers are you happy to deal with?

46:08What type of counterparties are you happy to deal with? Have you had a good relationship with in the past? What type of sector may they be in? What commodity might be there? If you're talking about beef, for example, can be highly cyclical, might stay away at this time of the cycle, come back later on. And that fundamental expertise in whatever you're doing, whether it be from equity or debt or royalty perspective is the cornerstone of making that informed decision. As you've grown the firm thus far, why have you selected the particular strategies you did to implement on that opportunity in Australia?

46:46It goes back to that mantra around the right to play. What right do we have? The same way that I enforce a discipline from a merger and acquisition or an inorganic growth discipline demonstrate your edge in what you're doing, it's the same for Regal overall. We need to be able to hold ourselves accountable to have a true edge in what we're doing. And that is built around generating great investment returns for our clients. Now, the domestic market, which we sit in Australia, and so we'll start there, is very dominated by a lot of older companies built in another era that provide exposure to long-only equities or long-only public fixed income.

47:29We don't believe we've got a particular edge there. I don't believe that that's the future for investors looking to achieve growth in their portfolio. Given that backdrop of higher for longer inflation, sticky inflation, breakdown of some of the free trade agreements that were happening and lowering costs before, geopolitical risks and a higher cost of security, including defense. That all speaks to a more diversified portfolio of alternative investment strategies. That's the tailwind that Regal has playing into. That's the capability that we're building. Regal is seeking to be that collection of best-in-class investment strategies that offer alternatives or different investment strategies that can provide growth no matter what the backdrop to the market.

48:19What was the thought process about going public? It was a perhaps dual factor. One is as a privately owned business attracting talent, Phil King and I put in place a long-term incentive plan that gave employees equity in the business that vested over a period of years. The bulk of that equity was coming in its first tranche to vest. And we say, well, as much as people should take a long-term approach and appreciate the dividends coming through, we thought that they probably want to invent where they could liquidate some of that as well. That just happened to coincide with a period of time where our business had recovered well from COVID, had probably record performance.

49:03And at the same time, there was a ASX-listed hedge fund that had fallen on harder times and was looking for a bit of help to take it forward. So we engineered a reverse acquisition of that business, which basically meant a backdoor listing of Regal Partners onto ASX. That's some of the behind the scenes color as to where we are. So this is June 2022. We ended up as a ASX-listed business. The transformational piece that has come from it is really three key things. One is a step change in the governance that wraps its arms around the business as an ASX listed business. An independent board, independent chair, our risk committees, compliance committees now answer all to independent board members as opposed to reporting through to executives in the business is point one.

49:49Point two is that translates into far easier door opening opportunities, particularly from an offshore perspective. When we're talking about marketing in Asia, the US or the Middle East around demonstrating, hey, here's Regal Partners. You can independently look on the ASX website. These are our filings. This is who we are. There's a step change in profile that helps marketing. The third thing surprised me. The third thing was actually the additional spring in the step that happened from a start perspective by saying, hey, I work for that business and I can see whether the share price is up or down.

50:27There is an engagement that comes from being part of a growing listed business. That's been a real thrill. Where do you see some of the drawbacks? The governance of an independent board brings with it, by definition, a new set of stakeholders that, like any team, need to be brought along the journey, buy into the strategy, be comfortable with both the risks and also the opportunities, ultimately the strategy of how we take that forward. There's been far more of my time spent working with the board, taking them and helping them understand the strategy. They're prodding and testing the strategy and ultimately agreeing what the strategy is and taking that forward.

51:10That's a whole other aspect of it. There is the reverberations, I'll call it, from being a public company in respect of news flow. By being a large asset management business in Australia, we'd always had a profile. But that profile, particularly through the press, seems to have amplified now that we're also a public company. There are good aspects to that. There are bad aspects to that. You need a steady hand and approach to be able to navigate your way through that and not get unduly distracted on the positives or the negatives either way. The benefits being listed ultimately outweigh the negatives.

51:50The other benefit I'd say is that it's given us a currency, i.e. the share price, that we can use to help acquire investment capability. And that has been powerful in helping us grow. What goals have you espoused for the business over the next several years? That's a challenging one in some respects because I find that a common failure in markets, at least asset management markets here domestically, is for people to fall into the trap of saying, flag on the hill, we're going to be$100 billion the next five years. it's a crude measure, but it's not necessarily the best measure to demonstrate the success or capability investment business you're building.

52:28So as much as people want you to throw out there, here's a number, we're going to be X billion in five years time, you can set your clock by it and come back in five years time, you'll see us. A better measure is more nuanced than that. Our success will be continuing to develop and acquire additional investment capability where we are generating great investment returns for our clients. If we can do that within our existing product sets, in the additional investment capabilities we think naturally sit as part of our platform, I've got no doubt that we'll be over$50 billion over the years ahead.

53:03But it's important that I word it around investment returns as opposed to simply asset gathering. Because the thing that makes us unique, given that founder-led business and alternative focus is we eat our own cooking. We don't want to be the leader of$100 billion of low margin underperforming fund. We want to be the leaders of a business that is generating great returns for our clients and therefore ourselves and be proud of that. Whether that's $20 billion or$50 billion or$100 billion, that's the second derivative. Well, Brendan, I want to make sure I get a chance to ask you a couple of fun closing questions.

53:45What is your favorite hobby or activity outside of work and family? That's an easy one, surfing. Our whole family surfs. I picked up surfing probably the last 15 years. I didn't grow up surfing. I'm particularly proud of the fact that I learned to surf later in life. If I could surf every morning before work, I would. I try and get out surfing as often as I can. It's that great hallmark of a hobby where not only is it incredibly distracting because It's hard to think of anything else when you're popping up on that wave, but it's also got a nice fitness element to it. Less time in the gym, more time surfing is my heaven.

54:23What was your first paid job and what'd you learn from it? My first regular paid job was paper delivery. This is the local newspaper. The papers were delivered on a Tuesday evening. On a Wednesday morning, I had to go out and start delivering them. I was 13 years old. I had my basket at the front of my bike going around the suburbs doing it. What I learned from it was people were happy to pay me to do things if I could be consistently reliable and be honest with what I'm doing. Because I found that they said, oh, Brendan, thank you for doing that. We found other workers that would do it for a few months and they stop it or they dump the papers into the creek and things like that.

55:01Call me naive. That truly surprised me. Hard work I learned was a pathway to earning money. I needed money. I wanted money. So it was self-fulfilling. What was the best advice you've ever received? I've received a lot of advice over the years. The two pieces that come back to my mother and father. My mum had a great expression, Brendan, if a job's worth doing, it's worth doing really well. I hear myself saying that to my kids a lot. And dad, particularly from a construction perspective, was always, Brendan, measure twice, cut once. They're two little truisms that I take with me that can be broadly applied to many aspects of life.

55:41What life lessons have you learned that you wish you knew a lot earlier in life? There are no shortcuts at the end of the day. To build anything truly successful, focus on that achievement as opposed to just the effort around it, there are no shortcuts. Building things properly in a sustainable way is the only sustainable way to build a great business. Brendan, last one. If the next five years are a chapter in your life, what's that chapter about? It's the continued evolution of Regal Partners. It will become a far more highly recognized brand of best-in-class active management capability located in Australia with a much larger non-Australian client base than it does today.

56:27Great. Brendan, thanks so much for sharing this very Regal story. Thank you very much, Ted. I've really enjoyed it. Thanks for listening to this sponsored insight. Sponsored episodes are paid opportunities for another 12 to 18 managers a year to appear on the podcast. If you're interested in telling your story in front of the largest audience of investors in the industry, please email us at team at capital allocators dot com to apply for one of the slots. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms.

57:06This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.