Interview: Argyle Capital’s Kim Morison reflects on a year since Blue Sky MBO

After months of negative headlines, the Australian Competition and Consumer Commission last month vindicated investors’ involvement in the domestic water markets by backing the “substantial benefits” they have brought to the Murray-Darling Basin.

The watchdog called for greater transparency and scrutiny of the market. However, it also argued investors had played a positive role by providing new sources of capital for farmers and by increasing liquidity in the market.

One of the biggest investors in water entitlements in the Murray-Darling Basin is Argyle Capital Partners, headed by managing director Kim Morison. In its previous guise as Blue Sky Water Partners, the firm helped pioneer water rights as an institutional asset class.

Morison is talking to Agri Investor in his first interview since founding Argyle through the management buyout of Blue Sky Water Partners a year ago.

“It’s been a successful year for us,” he says. “We’ve accomplished a lot in terms of reorganization – although, fundamentally, the business has not changed a lot.”

This is the main message to which Morison returns several times during our discussion – that the business, in terms of strategy and most of its personnel, is pretty similar to Blue Sky Water Partners and he intends to continue its solid track record of real assets investment.

The firm has continued to focus on water rights as its core investment strategy, backed up by a diversified farmland fund. Although Morison has found that Australian superfunds, for built-in structural reasons, remain reluctant to tackle ag in a significant way, the sector’s strong performance during the pandemic may help to change that.

Argyle strategy

Argyle Capital Group’s assets under management stand at approximately A$830 million ($603 million; €510 million). These consist of around A$600 million invested in water through the A$370 million Water Fund and separately managed accounts, with the balance in farmland and other investments.

The firm’s farmland investment vehicle is its Strategic Australian Agriculture Fund, which reached a final close at the end of 2018 on A$112 million and was fully deployed by the end of June 2020. Alongside the fund sits a similar investment mandate worth about A$100 million that Argyle runs for Pitt Capital Partners, a subsidiary of Australian Securities Exchange-listed investment firm Washington H Soul Pattinson that the latter acquired from LGIAsuper in 2019.

The Water Fund is an open-end vehicle, with quarterly redemption opportunities providing liquidity to investors in an asset class that is normally short on it. However, the SAAF has another five years to run, with opportunities to extend its life should investors want to.

Morison says Argyle is looking at a successor fund to the SAAF that would follow the same strategy – investing in farmland assets that can be redeveloped to increase their value, with a focus on horticulture, wine grapes and citrus fruit, alongside a commitment to Argyle’s own Water Fund and other supply chain investments in facilities such as cold storage and grain processing. The vehicle is still in its early stages.

“We’re keen to continue to grow our business. The last two or three years in Australia have been clouded by a pretty pervasive drought, so our focus was making sure we got through that intact as best we could with the different investments that we have under management.

“But we’re endeavouring to grow now – we’ve been getting on with deployment [of the SAAF] and we made some acquisitions as recently as April and May this year. To be able to execute on some transactions during this period of coronavirus lockdowns and market volatility was pretty pleasing.”

Where will growth come from? Morison is clear in his view that agriculture is best suited to long-term, patient capital, and that either being directly listed, or owned by another listed entity, is not the best model for the asset class.

“We started 10 years ago looking at high-net-worth and family offices, and what in Australia we call wholesale clients, who are actually sophisticated retail clients. But a lot of those investors don’t have the patience for agricultural investment. You need to have the structures to invest over the medium to long term because of the volatility in commodity prices and, in Australia’s case, climate variability.”

Super focus

The focus now is much more on institutional clients and others with the capacity to take that long-term view. However, Morison doubts Australian superannuation funds are ever going to become big investors in the asset class under the current regulatory regime.

“Australian superannuation funds have to cater to portability,” he says, pointing out that funds have to honor transfer requests if a member wishes to switch their superannuation provider within three days. The presence of the government’s covid-19 Early Withdrawal Scheme this year has only increased liquidity concerns.

“Inherently, superfunds in Australia are much more concerned about liquidity because they have to cater to that sort of risk. If you contrast that with, say, Canadian pension funds –where contributions are made on a member’s behalf and they can’t move it to another fund – those funds have the ability and appetite to invest for 20-25 years, knowing that the capital is captive and they don’t have to cater to portability like Australian supers do.”

Consolidation in Australian superannuation could help because, as funds get larger, they have greater capacity to lock away capital in long-term illiquid investments. Certain types of funds will be less vulnerable to redemption risk during a recession, too.

“The Early Withdrawal Scheme has [generally] not been a big issue, but it depends who [each fund] represents. If you’re a default fund for teachers or doctors, no-one has really lost their jobs. But if you’re a default fund for hospitality or travel, you have far greater risk.”

First State Super is one of those default funds for public-sector workers in New South Wales – and now Victoria, given the merger with VicSuper and the imminent rebranding to Aware Super. First State Super and VicSuper have been two of the biggest superannuation investors in Australian ag: VicSuper has built up a portfolio with Kilter Rural and First State Super has employed Blue Sky, latterly Argyle, to manage a portfolio of water and almond assets.

First State recently decided to bring the management of its almond orchards in-house, after Argyle’s period of active management to convert the land caused it to massively increase in value. With the orchards fully developed and leased to ASX-listed Select Harvests for 20-plus years, First State Super chose to bring the investment in-house because of its consciousness over fees – another typical trait for Australian superfunds.

“We were engaged in the initial investment and development phase from August 2015 to October 2019, which involved the development of five different almond orchards along the Murray River which are operated and leased long-term to Select Harvests. Given the more active investment management phase was complete, First State Super’s preference is to manage those long-term property leases ‘in-house’.”

This internalization accounts for a fall in Argyle’s overall AUM from approximately A$900 million a year ago to A$830 million now – although with the almond orchards likely to be worth far more than that drop in AUM, it shows that the investment manager has continued to pick up mandates.

Water has remained Argyle’s most consistent performer. Morison says his experience in cotton trading earlier in his career led to his belief that water availability would underpin the growth of other commodities in the Murray-Darling Basin.

“We saw that if you want to establish a reliable supply chain for the cotton export market, you have to be able to supply product every year – and you can’t rely on Australia’s rainfall to provide that.” He says this applies not just to cotton, but to all irrigated production commodities.

“So we decided to invest in a basket of farms and farmers, and the water rights that underpin them, whatever that commodity might be. In 2008 and 2011 it was cotton. In 2015 it was almonds. Now it’s table grapes, citrus and even wine grapes, for example. Different products go through different cycles of production, but if we can be the supplier of water to those enterprises, then we can earn a margin on that particular investment year in, year out – including through droughts and floods if we manage our portfolio well by forward selling and leasing out water.”

None of that has so far been significantly challenged by the coronavirus, with some product shifting away from the food service sector and into retail. As Morison puts it: “People still have to eat. They’re just eating in a different place.”

Looking back on Blue Sky

Reflecting on what was a difficult period for him personally, as well as for Blue Sky at a corporate level, Morison is clearly still hurt by how the broader business unravelled in a very public way.

He was asked to step up to interim managing director and chief executive of the listed parent after it was attacked by short seller Glaucus. The US-based company accused Blue Sky of inflating asset values and charging clients “extortionate fees”. The firm eventually entered into receivership after breaching a covenant on a loan it had taken out from Oaktree Capital Management at the height of its internal crisis.

Morison’s time in charge drew him into the broader controversies that were, it is fair to say, not directly associated with the performance of the firm’s water and farmland assets that he previously oversaw.

“We went through a pretty challenging time where, regrettably, the parent company we were attached to became the subject of a lot of innuendo that was very frustrating for us. I’m disappointed, absolutely, that we weren’t able to rectify it for the shareholders in that company – but for the investors in the funds we were managing, we got on with the job and tried to deliver the best possible outcomes we could under the circumstances.

“At Blue Sky, we were sitting alongside vastly different subsidiaries making investments in venture capital, private equity and student accommodation. VC is very, very risky in comparison to farmland – but it didn’t mean that was how we were managing our agriculture and water investments, for example.”

With Blue Sky behind him, Morison is now trying to combine a fresh start with the strength of his team’s previous track record – but without the glare of public markets.

“Our public markets do not like volatility. In Australia, they want a dividend check every six months – and if you can’t do that, you’re going to get penalized.

“It does create real challenges in attracting capital to agriculture, because it’s one of the only public records available for performance. When Aussie supers and their advisors look at agriculture, they can only find the examples of volatile agricultural stocks, many of which have eventually delisted.

“We saw that the only way we could continue to [deliver the best outcomes for fund investors] was to take the company private again, and it had an immediate impact.”