Alan Kohler interviews Rob Shand, Blue Sky Alternative Investments

Alan Kohler, publisher of The Constant Investor, recently interviewed Rob Shand, CEO of Blue Sky Alternative Investments. The interview focuses on a number of questions raised by a report published by Glaucus Research Group about the operations of Blue Sky Funds.

The interview was recorded on the 10^th of April 2018 and is re-published below along with a transcript of the interview.

For more information about The Constant Investor please visit the website.

Disclaimer: Alan Kohler owns shares in the Blue Sky Alternative Access Fund

Transcript

Today’s CEO is Rob Shand of Blue Sky Alternative Investments, the company that’s been under siege from the US short-selling outfit called Glaucus Research, the one that sent Quintis broke last year and has now turned its attention to Blue Sky and a week and a half ago published a 67-page report on Blue Sky which tore strips off it and says primarily that its assets under management are a fraction of what the company says they are, that it gouges investors with extortionate fees and that it over-values assets and it is in general, way, way, over-priced and is only worth a fraction of what it was. 

In fact, the share price has now fallen by a bit less than half to today about $5.70.  It was over $11.  Obviously, a lot of people have decided to leave to sell and ask questions later and that’s fair enough, that’s what happens.  But look, the price has stabilised in the last few days.  I’ve been a supporter of Blue Sky over the years going back quite a long way to when Mark Sowerby started the business, I thought it was a terrific vehicle for investors, small investors, to get some access to alternative assets, which are generally the domain of large super funds on the whole – alternative assets by which I mean private equity, other sorts of alternative funds that you can’t normally invest in.

One of the points that Glaucus makes is that half of what they invest in is property and that property is just that, property is not alternative at all.  Anyway, Rob Shand is under the pump at the moment as CEO having taken over from Mark Sowerby.  He’s a young man, this is his first big crisis and he is having to deal with it.  He’s going around the country talking to investors and shareholders in Blue Sky, seems to be holding the line at this point.  They’ve put out a release saying that Glaucus’s effort is all completely wrong, but he also in our interview acknowledges that they could have done better with transparency and disclosure and that they are going to do better in future.

So that’s something.  He thinks to that extent at least Glaucus has a point, and that’s one of the main points that Glaucus makes of course is that they don’t disclose enough and he thinks that they may have a point in that regard and that they are going to disclose more.  But as for the rest of it, it’s all wrong.  I’ve put all the questions to Rob Shand, put him under the griller for 45 minutes, the longest interview I’ve done for the Constant Investor and he answered the questions clearly and did his best.

I think the best thing to do is to listen to the interview or read the transcript and make up your own mind.  Here’s Rob Shand, the CEO of Blue Sky Alternative Investments.  Rob, perhaps we can just start with a sort of a general question.  Do you acknowledge that you could have been more transparent so that somebody couldn’t come along and just make what appeared to be valid assertions about things that really should just be on the record and that there should be no argument about?  

Yeah, I’ll start by saying it’s clearly been very disappointing what has happened.  It’s disappointing that a group like this can come into Australia – and you mentioned the allegations – with allegations frankly, that had no basis in facts whatsoever and followed a typical play creating fear and confusion across the market.  Absolutely, as a business I think we have done a good job historically of communicating with our fund investors and doing that very, very well.  But clearly we will go back and look at how we communicate more broadly and how we disclose more broadly to the market.  That’s something that as a business we’ll be going back and having a good hard look at and we’ll do that in a very methodical and very measured way.  It’s something that we’ve been improving over the years, it’s something that we will have to obviously continue to do much more in that area.

In your response the other day that you put out to the shareholders and to the stock exchange you talked about how you needed to maintain a certain level of confidentiality for fiduciary obligations, is that really necessary?  Do you now look back on that, look at that and think, well maybe that wasn’t such a good idea after all?

All I’d say there is, as I said before, we are committed to the business to make sure that we provide the appropriate level of disclosure to the market.  We are, as I said before, going back and having a good hard look at exactly what we’ve done in the past and what we can do going forward.  For any listed business there is a limit to all of the information that you can possibly disclose, but as I said we’re committed to doing more in that regard.

So you will be disclosing more but you can’t tell us exactly how much more?

As I said, we want to make sure that we are frankly world-class in terms of the disclosure, as we are in terms of the other aspects of our business.  Our returns are very good as a business, the investments we’ve made have been very good.  They’re not perfect, clearly, but our track record over 12 years now has been very, very strong.  We want to make sure that in the same way that we’ve done a good job on the investing side of our business, done a good job of communicating to our fund investors, what we do as a business.  I think it’s also important that we have similar standards in the way that we disclose and talk about our business in property markets, that’s obviously I think.

One of the confusions that seems to have arisen out of this process has been around how you should be compared.  One of the accusations from Glaucus Research is that you compare yourself to other alternative asset managers like Blackstone and KKR and so on when it suits you, and then when it suits you alternatively you compare yourself to property managers.  I mean, how do you compare yourself?  Exactly what are you and how should we compare you?

I suppose to start with, this comparison with property fund managers in this country, the simple thing that we were demonstrating in our response is Glaucus tried to allege that it is not market practice in Australia for a property business to measure assets under management in the way that we do. And indeed, there are very many ASX listed businesses that disclose assets under management in the property space in exactly the same way that we do.  It’s groups like Macquarie Bank, for example, like Goodman, like Mirvac…  There are eight or nine that we listed in our response and it was just disingenuous for an allegation such as that to be made.

Your point though around how do you compare Blue Sky, that’s a valid one and it’s for our business – it’s a bit of a double edged sword.  The positive for us is we are unique in the Australian context, we are Australia’s only listed diversified alternative asset manager and we have as a result, benefitted from the enormous wave of growth towards the alternatives segment both in Australia and overseas.  So that’s been a very powerful thing for our business and has positioned us very well. 

The difficulty and the doubled edged nature of the sword is in the Australian context because there is no other business like us at the moment it’s very hard for local shareholders and investors to compare us to another group.  Our business model, it is true to say it’s the same sort of business model as some of the larger alternative asset managers overseas, but they are materially larger businesses than our own and so you do have to be a little bit careful with the comparisons.

But I suppose the point being – and I’ve checked as well with other property managers in Australia and it is the case of course that everyone does report assets under management as the gross figure including debt, and that’s what you do.  But the thing is that their valuation on the share market, their market capitalisation is generally around about the same as their NTA, a little bit more sometimes, 1.2 times, possibly up to 1.5 times.  But even after your share price fall of 45% in the last week, you’re still 3 times NTA.  And so you’re priced as something other than those property companies that you kind of compare yourself with in terms of the assets under management.  Do you acknowledge that?

Well, two things I’d say:  one is, it is fundamentally important for us as a business that when we measure our AUM whether it’s in property or whether it’s in private equity or whether it’s in any other asset class that we do so in a way that is consistent with market practice in Australia.  That’s fundamental to the way we report.  In terms of our share price it’s obviously not something that I can expand on in great detail, but what I would say is given that growth in the alternatives market and given our positioning in that market, you have seen our business on a very, very strong growth trajectory over the last couple of years.

We’ve increased from inception back in 2006 to having over $4 billion dollars in assets under management today and I think that strong growth profile of our own business coupled with the very, very strong growth of our industry, I think that is perhaps what’s being reflected in our price.

No, but isn’t it the point that you’re only half an alternative assets manager, you’re half a property manager and you’re saying because we’re a property manager we should report assets under management on a gross level like other property managers, except that you are saying you’re an alternative asset manager and that the alternative asset managers elsewhere in the world don’t do that.  I mean, as you say it’s a double-edged sword but it’s also a benefit that you’re kind of getting by being a bit of both?

Yeah, well I’m sure if we were to report our assets under management in any asset class whether it’s property or another in a way that was not consistent with market practice in Australia, I’m sure the criticisms would be far louder.  At the end of the day we are a diversified alternative asset manager.  Other groups overseas that have the same business model, property and private real estate, as we call it, is a core part of what they all do.

The other thing about this particular point is that it depends a bit on what the gearing is and also what the fee is.  I think your average management fee is 1%, right?  Which I think is a fair bit more than the property managers that you talk about in your response, they’re all charging 0.7 and 0.8%, but you’re more than that at 1%, is that correct? 

Once again, our fee structures are absolutely market standard in each of the asset classes that we operate in.  And in the property space you are remunerated as an asset manager based on the size of the building.  It doesn’t matter in which way it is financed, it is the size of the building that you’re constructing or the size of the asset that you’re managing that is relevant to that.  Our fees are absolutely in line with the market standards here and indeed, we have, as you would have seen in our disclosures, attracted capital from institutional investors both in Australia and offshore.  There are 20 institutional investors that invest with Blue Sky, that’s obviously grown over the last three or four years and helped our business grow.  These institutional investors spend a long, long, long time on due diligence.  They look at both the investment that they’re making, the fund manager itself and of course, they look at fees.  You wouldn’t have groups like these choosing to invest with a fund manager like us if the fees were anything other than the market standard.

And what about your gearing, what’s the average gearing level in your property assets?

It depends on exactly which property assets you’re talking about, but typically it’s in the range of 50%. 

You mean that’s an average, would you say?

Yeah, that’s fair.

From my kind of investigations around the market place, that’s a bit high.  Maybe you can put me right, but from what I can tell most people are talking about gearing of 30-40%, I mean 50% is not way out of line but it’s a bit higher than perhaps others who are claiming gross assets under management.

The asset classes that we’re investing in, that’s in line with the market standard.  The property assets that we manage in Australia, where there is gearing they are banked by some of Australia’s four major banks and they are in line with the market standard. 

Just on the matter of fees, I mean obviously the Glaucus Research stuff is pretty florid, they’re accusing you of gouging Australian investors with extortionate fees and so on, and the figure that they kind of mention which is getting a bit of currency is 17%, that your fees are up to 17%.  What that comes from is a business called Flora, where what they say is the management fee upfront was $0.3 million, so, $300,000.  Transaction fees, $1.1 million.  Total fees to Blue Sky, $1.4 million.  Out of capital raised $8 million, which is 17.3%, which is the largest – I mean, they’ve got a whole list of different fees of that sort.  Talk to us about that, because the $1.4 million is 17% of $8m, right?  Why is that not valid?  

It’s another example and as we said in our response to the ASX last week, this entire opinion piece is riddled with either errors, factual misunderstandings and allegations that bear no resemblance whatsoever to reality.  The assets under management allegation was absolutely one of those.  They claimed that we only have $1.5 billion in assets under management when categorically we have greater than $4b.  In the same way, these assertions on our fees are also categorically not true.  They take a piece of information and extrapolate it into something that is just a gross misrepresentation of the reality. 

The fees that they represent in Flora Street are, as I said before, absolutely in line with market standard.  Some of the fees in there are fees at the outset of a deal that compensate and basically recover costs of doing a deal, whether those are external advisers, lawyers, the accountants required to put the deals together.  They are ongoing management fees, once again, in line with market standard and they’re performance fees.  We charge a mix of those fees in line with every other fund manager in the country and Glaucus’ representation and grouping of those all into one lump and saying that that’s 17% is, as I said, a gross misrepresentation. 

But are those numbers wrong?  Is the transaction fee of $1.1 million incorrect?  Are you saying that that’s not a correct figure?

I don’t have that particular fund in front of me, Alan, but as we said in our ASX release, the allegations that they make on that particular fee structure is absolutely misleading.

Well, either the number is $1.1 million or it’s not.  I’m just looking at their report and they said they seem to be getting that number from disclosure documents, so either you raised $8 million dollars and got $1.1 million in transactions fees for that or not?

I don’t have it in front of me, Alan.  We do manage approximately 80 funds, but I can assure you that the fees that we charge on each of our funds, Flora included, are absolutely in line with market standard and we clarified that when we responded to the ASX early last week.  Our investor base, as I said before, it’s made up of a whole range of institutional investors, it’s made up of a whole range of scattered investors, high net worth and family offices, people that are well advised.  It’s not something that these groups would miss.

There was also a discussion about the Burrito business, what was it called?  I can’t remember what it’s called now, Beach Burrito?

Beach Burrito Company, yes.

They said that they’ve probably skewed your – because that was your first investment and it was a $200,000 cheque written to fund that.  I think the point they’re making about that is it possibly skews your return since inception of 15% because there were only six or there weren’t many in those early days so it kind of distorts the picture.  And you’ve kind of said, well actually it’s all weighted, it isn’t equally weighted, they’re all kind of weighted investments.

They’re weighted based on the size of the investment.  $150,000 investment 12 years ago has no material impact on our returns whatsoever.  It’s another example of this complete misunderstanding of our business, intentional or otherwise and therefore complete misrepresentation of the truth.

It just seemed to me you may have been talking at cross-purposes because I think the implication that I got out of it was that it obviously was material back then, 12 years ago it was a material investment.  Obviously, it’s not now but it would have had a material impact on your percentage performance back then is I think what the point was. 

I don’t think that was the point.  Back when it was our first investment and it was our only investment 12 years ago, your assertion is true if you only have one investment that is material, but now with… 

And if the value doubled in that first year then you got 100% return in that year which goes into your return since inception, is all I’m saying.  I mean, I don’t know exactly how it might have unfolded.

Yeah, and because we equity weight each of the investments in our portfolio, a $150,000 investment, which is, a) tiny, clearly; and b) a long time ago.  As I said, it has no material impact on our investment track record whatsoever.

Right.  They’re pretty comprehensive, the report’s 67 pages as you know, I mean you probably read it top to bottom…

Yeah, this is part of the playbook to, as I said before, to create fear and confusion, to throw out 100 allegations knowing full well that probably all 100 are incorrect.  And indeed, in our case in this particular report that is the case.  The allegations are totally incorrect and we went back to the ASX confirming as such.  This is part of the playbook to create that fear and doubt across the market and to have people reading the headlines and therefore sell the shares, drive the share price down such that an overseas group like this profits.  That’s part of the playbook irrespective of the facts.  What I’m keen to make sure the market is aware of is the facts of the situation and the facts of the situation are that we do have more than $4 billion under management, that our investment track record is 15% per annum net of fees.  That investment track record was reviewed externally by Ernst & Young in February of this year and that that track record has been one that has stood us in very good light against our global peers and therefore attracted a whole range of institutional investors into our funds. 

The final point I would say there is simply that our balance sheet as a business is in a very, very strong position and that is, that’s a great platform for our future growth.

Just talking about your performance, they do accuse you of aggressively and unjustifiably marking up the value of unrealised assets and therefore overstating your performance.

Which is once again a complete fabrication.

Well, tell us about how you do value your unrealised assets?

Every asset in our portfolio has had a minimum three levels of external review.  So, at a minimum we have an independent valuer come in and effectively sign off on the valuations, at least every 12 months for our liquid asset classes such as private equity.  In addition to that we have our audit firm, which is Ernst & Young, sign off those valuations, they’re included in the audit work they do each year which is signed off.  Our audit committee which is made up entirely of independent directors also signs off on those valuations.  It is a very rigorous approach, it’s in line with market standards. 

As I said, at a minimum there are those three levels and for certain asset classes where there are auditors at the fund level, there was institutional investors involved, there are other independent checks and balances in there.  But as I said, at a minimum there are those three independent checks through the process.

And associated with the valuation accusation is also one concerning receivables.  Now, just to explain, I think the question of receivables is that if an asset is over-valued, then the management fee that’s associated with it turns into a receivable because the asset can’t pay the cash as the management fee.  They’re saying that your receivables are ballooning which is evidence of the over-valuation of assets.  What’s your response to that?

Just before I move onto that, the true test of your valuation, you do need to have absolutely a rigorous process which we have and as I said, that’s in line with market standards.  But the true test is when you go to sell an asset.  We have realised 39 assets since our inception and on 34 out of those 39 occasions, we’ve had to mark those assets up on the way out.  In other words, they’ve been carried at a value that is less than what the actual value is and I think that is very, very strong evidence of the conservative nature of the valuations process. 

In terms of the impact of the valuations on management fees, once again, as with virtually everything in this opinion piece, it is a gross misrepresentation.  For the vast majority of our funds, valuations and how those valuations move over the course of an investment period have no impact on the management fees whatsoever.  That is relevant for open ended funds.  If you’re a traditional equities manager, if you’re managing a fund that invests in large cap Aussie stocks, yes, your management fees do move in line with the net asset value, the NAV of your fund each month.  That is true in the world of traditional funds management in open ended funds.  But you know, 76 of the 80 funds that we manage are closed ended and the management fees are set at the outset.  How the valuations move, whether they move up or down, has no impact whatsoever on the level of management fees charged.  It’s just, as I said, another demonstration of the misrepresentations and the inaccuracies in the report that you’ve got before you, Alan.

So is it the case that your receivables in FY17 were $86.9 million, which was 126% of revenue, up from 34% back in 2012?  Is that figure wrong or right?

I don’t have it in front of me, Alan, but I assume that will be right and the growth in our receivables balance simply reflects the growth in our assets under management.  As I said, since about three or four years ago we had $1 billion in assets under management.  We’re now over $4 billion, of course your receivables are going to grow as your business grows, that’s not unusual in the slightest. 

But they’ve grown as a percentage of revenue, that’s the point they’re making is it’s gone from 34% in 2012 to 126% last year as a percentage of revenue, so it’s relative rather than in absolute terms. 

What we provided to the ASX when we responded to this was a comparison of our percentage of receivables as a percentage of revenue or as a percentage of fee earning assets under management and they are absolutely in line with other listed alternative asset managers around the world the world that have the same business model as us.

Right.  I interrupted you, you were going to say something else, I’m sorry.

I was just going to say, the percentage for us is about 104%.  The range for other groups in other markets is between 80% up to 115%, we’re sort of 104%.  Our receivables balance is not unusual whatsoever and simply just reflects the growth that we’ve experienced as a business. 

One of the things they say is that from their point of view they’re like detectives.  “We’re playing the role of financial detectives…” they say, “trying to reconstruct Blue Sky’s fee earning assets under management from the limited publicly available evidence.  So we call on Blue Sky to match the level of disclosure of other alternative asset managers like KKR and Blackstone.  Are you going to do that?

We’re absolutely committed to make sure that we’re doing the best possible job on that side.  What I would note is they call themselves detectives, but at the same time as calling themselves detectives, they have had no dialogue with us, with our business at all or senior management.  We have invited them to meet with us so they can ask us their questions and that we can take the opportunity to correct any misunderstandings that they had.  They have not taken us up on that opportunity.  It shines through in the works.  They try and build up a picture of our assets under management and miss, just as one example, miss virtually all of the institutional capital that we manage. 

The institutional capital that we manage makes up 40% of that $4 billion that we’ve got in assets under management and it’s simply missed from their report.  So I’d argue that the detective work hasn’t been that well done. 

Where do you go from here?  What’s the plan?

At the end of the day, what we’ve got to do is we’ve got a fundamentally good business.  As I said before, we’ve got a very strong balance sheet.  Our funds are closed ended, so they don’t come with redemption rights and having this sort of opinion piece land has really galvanised our team.  What we need to do as a business is make sure that we continue to do what we do best, continue to deliver on outcomes for our investors.  Delivery of exits from some of the investments that we’ve made, and we’ll obviously be announcing those as we make them.  The delivery and announcement of new institutional mandates in particular that we are awarded, but we’ve got to continue to focus on building our business in the way that we’ve done for the last 12 years and those tangible outcomes of those exits or realisations as well as new mandates, I think we’ll give the public a very good insight into where the facts lie. 

For a research group like this facts aren’t really their interest.  At the end of the day, they want to profit from the misinformation that they feed and the fear and doubt that that causes.  That’s fair game and our game is simply to stick to the delivery of outcomes based on the facts. 

Well they certainly acknowledge that, I mean they openly admit that they’re biased and that they’re out to make a profit, that’s what they’re doing.

And they admit that their report is – you have to look in the fine print for it – but are not statements of fact.  As an ASX listed business that’s obviously licensed in Australia, we’re bound to stick to the facts and that’s absolutely what we intend to do and they’re bound by no such obligation.

For investors and our subscribers the key issue comes down to, you might have a good business and I’ve always thought you have, I’ve always thought that the Blue Sky business was terrific and you guys had integrity and all that stuff, but the question I guess is what’s the correct price of the business?  Because, as I said before, it’s currently three times net assets.  Is that the right price?  It’s roughly 10% of assets under management, as described or disclosed by you?  Is that the right price?  Because $11 dollars appears not to have been the right price and now it’s $5.69 today.  Is that the right price or is the Glaucus effort of $2.69 or something the right price?  That’s the issue, isn’t it?

Yeah, and it’s not for me as the Managing Director of a publicly listed company to comment on the price.  But as I said before, some of the stuff that’s been missed are some simple facts around the growth in the business that we’ve experienced.  I’ve mentioned the AUM previously on this call, but even if you just look at our profitability, that grew by 60% last year.  The revenue of the business was up 40%, margins increased from 41.2% to just under 45%. 

That growth that we’ve seen both in terms of the assets under management and the profitability of the business, the team that you mentioned which is a team of integrity, the closed-ended nature of our funds which means we aren’t at risk of redemptions in the same way that traditional funds management businesses are.  I think these are all the sorts of themes that investors look at when evaluating the price of our shares.

You must be wishing your main company was closed in in the sense you weren’t listed…?

Not at all.

Because obviously a listed company is subject to redemptions and that’s what you’ve been getting in the past week.

Being a listed business has been a fabulous platform for our business and if we had our time over again would I have listed the business again back in 2012?  Absolutely, we would have.  This is a process, Alan, and I think one of the public commentators described it as a baptism of fire.  But we’ll emerge from this a far stronger business and a far bigger business, frankly.  So I don’t have any worries about that whatsoever.

How will you emerge from it a bigger business?  I can see how you think you’ll emerge stronger because it is definitely being forged in the fire, but how would you emerge bigger?

Over the period of time I think what you’ll see is, as I said, in a market, the alternative market that is growing as strongly as it is and with the investment track record and the institutional support and the team that we’ve got, I think at the end of the day once the dust settles on this, people will focus on those facts and we will continue to grow as a business and grow very strongly.  

That was Rob Shand, the CEO of Blue Sky Alternative Investments.

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