Privately Speaking: Aberdeen's Andrew McCaffery

Aberdeen Asset Management has built its reputation on long-term, relatively low-risk investing across mainstream asset classes. Arguably, though, it is just as well known for a string of opportunistic deals under the stewardship of acquisitive chief executive, Martin Gilbert.

That strategy has propelled it over the past decade to total assets of $429 billion as of 30 September 2015, but its global alternatives business has been a relative latecomer to the party.

Andrew McCaffery, Aberdeen’s global head of alternatives, believes it’s now caught up to the firm’s other business lines.

The FTSE 100-listed firm had run relatively small-scale managed balanced portfolios, which included illiquid elements, for many years, but it was the acquisition of Scottish Widows Investment Partnership (SWIP) in early 2014 that kick-started a more rapid build-out of its alternatives capabilities.

SWIP’s alternative assets gave Aberdeen $6.8 billion and $2.2 billion of private equity and infrastructure assets respectively, and brought current head of private equity Graham McDonald to the firm.

“That was when the alternatives division went from being an add-on to a defined and separate investment division of the business,” says McCaffery.

It also brought Aberdeen strong performance in Europe, to add to its existing portfolios. Over a 20-year period to 31 March 2015, its European private equity funds delivered a net internal rate of return (IRR) of 10.3 percent to investors, outperforming the Euro STOXX600 by 660bps over the same period.

The past 12 months has seen even greater acceleration in collecting alternative assets, and crucially for the group’s strategy, greater geographic diversity.

The SWIP assets were quality assets, McCaffery says, but also very euro- and especially UK-centric.

“One of the great things about SWIP was that it was a diversified and complimentary business, but it was relatively concentrated on the UK.”

The 2015 acquisition of US private equity fund of funds business FLAG Capital Management, which had itself previously acquired Hong Kong-based rival Squadron Capital, added a further $6.3 billion of alternative assets, and gave Aberdeen new offices in Hong Kong, Boston and Stamford, Connecticut. It also gave it capabilities in venture capital, small and mid-cap private equity, Asian private equity and US real assets for the first time.

Over 10 years, FLAG’s Asian private equity funds had delivered a net IRR of 12.7 percent to investors, outperforming the MSCI Asia index by 956bps over that time. FLAG’s US performance was also strong, with its private equity funds delivering a net IRR to investors of 14.7 percent, beating the S&P 500 index return by 567bps over the same timeframe.

The FLAG deal was preceded by Aberdeen’s purchase of SVG Capital’s stake in a joint venture, Aberdeen SVG Private Equity Managers, and followed by the addition of US hedge fund business Arden Capital, which added a further $8 billion of alternative hedge fund assets.

Now, with a global team of around 50 alternatives investment professionals spread across the US, Europe and Asia, its alternative assets have hit $34 billion, and taken it much closer to what McCaffery wants it to be, a “universal provider” able to offer its clients solutions across the whole spectrum of alternative asset classes.

McCaffery rejoined Aberdeen in 2011 after three years at hedge fund group BlueCrest Capital Management, where he founded the Alignment Investors division. His previous role at Aberdeen had been head of absolute return strategies.

He was “enticed back” by chief executive Gilbert and former CIO Anne Richards, who charged him with growing the division via multi-manager hedge funds, property and private market allocations, direct infrastructure investments and pan-alternative capabilities.

FOCUS ON ORGANIC GROWTH

McCaffery is now at the stage where he believes it has reached broad provider status, and, in the future, organic growth should outstrip further acquisition growth. Given his parent company’s history of opportunistic acquisitions, however, he does not rule out further deals if they present themselves.

“We saw a desire from investors that clearly pointed to their growing interest and demand for elements that were outside the traditional business. Now, we have the strength of platform to generate organic growth but there will continue to be distressed and roll up opportunities.”

He says the question his team asked itself was this: “Is it best to stay in a capacity-managed vehicle as a boutique, with a key client base, or be part of a group [which can] properly leverage the skillset and broaden out to a more global investment, and investor, base?”

While it has clearly plumped for the latter, the macro headwinds and volatile public markets currently battering its parent company are likely to slow the pace of any further acquisitions, at least in the near term, McCaffery believes.

“Looking forward, the reality is that we will be really cautious, because you don’t want to be investing in anything unless you are confident that you can create high levels of value within that business.

“But that doesn’t mean that there won’t be opportunities where you can. Aberdeen has been very good at being able to recognise opportunities, investing into the team and business, and prioritising its diversification profile.”

He adds, however: “The core aim now is to have the size of platform to build organic growth and that, in itself, should generate the strength of revenue to look around for anything that could be considered truly attractive and opportunistic.”

Following the spree of acquisitions, further organic growth should come through from right across its alternative fund vehicles and strategies, McCaffery says.

“We have strong teams and strong track records, but in order to grow it further, we need to create the shop window by getting the funds out there. We see enormous value in having the size and reach of the industry leaders.”

GLOBAL CAPABILITIES

Aberdeen closed what would have been FLAG’s sixth US private equity fund vehicle on $295 million last October, some $70 million above target, and there are a handful of other funds currently in market which reflect the breadth of the group’s newly acquired global investment capabilities.

According to industry sources, the group is marketing FLAG’s 10th venture fund, Aberdeen Global Venture Capital X, which is run out of the Stamford office by the former FLAG team under Peter Denious.

Meanwhile, a global lower mid-market fund is in market as is Aberdeen Natural Resources Fund IV, which is headed by Boston-based former FLAG manager Jim Gasperoni.

McCaffery declines to discuss fundraising, but describes Gasperoni as an “excellent manager” with a strong US endowment investment background.

A key benefit of the enlarged global investment remit is that the new teams feed back a range of fresh perspectives to the alternatives division’s strategy meetings where asset allocation decisions are made.

“One of the reasons that we are very keen on having a universal profile and not just being a bottom-up or silo provider, is that we have mandates where we are in control of managing the asset allocation,” he says.

To this end, McCaffery chairs Aberdeen’s pan-alternatives investment committee, where the various alternatives teams feed in bottom-up research; thematic and macro overlays are then applied.

The committee meets twice a month to focus on investment and governance respectively. The multi-asset and investment strategy teams also attend, along with senior members of the various alternative asset classes.

“It’s very much to think about where we are in terms of liquidity and the cycle,” he says.

“We do much more work there in terms of looking at the overall industry and working out if it is the right time to allocate to respective sectors and what the risk profiles are. It is about bringing in a top-down perspective to that [bottom-up] research.

“When you are focused on a certain part of the marketplace, it’s often difficult to step back. Even though you may have a great manager, it might be a terrible time to allocate if we expect returns will be zero.”

McCaffery believes the current volatility and uncertain macro backdrop offer significant potential to create a more global footprint for the group’s real assets capabilities, which he expects to be able to offer steadier and recurring income opportunities to concerned investors.

“Real assets is a very distinct growth area and really something we expect to grow substantially more global from its strong US base.”

McCaffery also believes the firm’s $3.3 billion property multi-manager portfolio will be able to leverage the broader firm’s $30 billion property investment portfolio, and break out from its predominantly European focus and investor base.

Like many of Aberdeen’s global peers, customised separate accounts are a key growth area, and earmarked by the firm for further sustained growth.

Currently, such mandates make up 30 percent of the group’s $16 billion of private equity portfolios, and 45 percent within the wider alternatives group.

McCaffery notes a discernible growth in this area from some North American LPs but a key driver has been demand from Asian investors who are keen to access the asset class, often for the first time.

“A lot of Korean and Japanese investors are increasing their exposure. They may have bought in a certain amount of expertise, but it is limited in terms of what they need to try to achieve.

“For them, it’s much more a case of, ‘We don’t want to buy a fund, we may own bits along the way, but the reality is that we want our own portfolio.’”

In terms of longer-term existing investors, he admits that some have been voicing concerns over how the firm can maintain its focus on performance and capacity management as its assets continue to swell.

But he believes the group is monitoring capacity closely and dealing with the issue relatively comfortably.

“If you look at all our fundraisings, they are all incremental size gains, but consistent in terms of generating the style of returns we want.”

CHANGING THE DIALOGUE

In terms of many of the newer clients the group has acquired, McCaffery says many of the conversations have become relatively more sophisticated, but so too has Aberdeen’s ability to offer investment solutions.

“It has created the opportunity to have much broader conversations than perhaps we could have done previously [and] we are proud to be able to discuss the whole investment tool kit with them,” he says.

“We are having many more conversations around the current levels of secondary pricing, various co-investment opportunities and how to access Asia opportunities that can’t be accessed through the private markets.”

Current uncertain public markets, low bond yields, increased levels of leverage and expectation among some LPs that the best returns have already been gleaned from traditional private equity funds are behind a recent heightened appetite for venture capital, he believes.

This growing interest in venture capital strategies is especially pronounced in the US, he says.

“Overall, investors are definitely more cautious in terms of leverage multiples, distribution profiles and a belief that most of the easier returns have already been harvested, especially over the past year.

“It is also driven by the evolution of businesses to have more tools to access the marketplace more quickly and efficiently.”

Alongside greater interest in venture, the need to find greater income streams to match investment liabilities is also fuelling greater client demand for private equity and private debt in particular.

While McCaffery says interest from sovereign wealth funds in Aberdeen’s illiquid products has also been on the rise over the past couple of years, the larger flows continue to come from endowments, family offices and defined benefit pension funds.

How to better serve the defined contribution market with innovative new products has been taking up much of the recent strategy conversations both internally, and with clients, although Aberdeen has yet to create a vehicle offering the sufficient liquidity that is required for this investor base (see story below).

The interest in accessing the retail market will remain a key focus, but the firm already has to monitor and understand its existing “mid-single figure hundreds of relationships”, ranging from individual high net worth investors and small family offices through to large pension plans.

The move by many of them to rationalise their LP relationships will remain a double-edged sword for the group, he says.

“For our LPs, they want fewer managers and mandates and more capital allocated within the remaining ones.

“We hope to benefit from that challenge, but understand that sometimes we may be on the wrong side of that strategy. That is why depth of client relationship and investment expertise is very important.

“If that trend continues, we are going to have to make sure we are very proactive with them.”

THE TROUBLE WITH DRY POWDER
McCaffery has some concerns about high levels of dry powder in the private equity market.

“I never see record dry powder as a particularly good signal. For example, if you look at how covenants have declined and deteriorated in quality, and if you look at the amount of leveraged debt increase, plus the nature of what it is being used for, it’s a concern.

“When you add those together, a lot of things are fully priced. It’s the greater fool theory: how much of that money is being used to chase returns? If investors start to get wary, the question is how much they may want to review commitments.”

When it does, McCaffery says distressed assets opportunities are likely to present themselves to those who can take full advantage.

“If you roll forward, a significant amount of money that has supported natural resources and energy in recent years could be at risk. The default cycle has not kicked in yet but we are starting to see some distress here, which could finally create great buying opportunities over the next few years.”

When it does, McCaffery says distressed assets opportunities are likely to present themselves to those, like his firm, who can take full advantage.

DEFINED OPPORTUNITIES
A key area of focus for Aberdeen is around creating vehicles and portfolios for the defined contribution (DC) benefit market.

Partners Group and Pantheon are among the fellow funds of funds already working on retail products in the DC field.

For McCaffery, however, the jury is still out as to whether such retail-focused products are yet completely effective in dealing with the specific liquidity requirements of the defined contribution retail pension market.

“We are more than just monitoring this area, but the difficulty remains that while there is a long-term need for pensions to access illiquid assets, the regulatory ‘Catch-22’ revolves around liquidity mismatch and valuation needs.”

Questions remain as to how you achieve quarterly liquidity, and how to make the trustees comfortable with the liquidity requirements, he says. But the firm’s experience with liquid alternatives on the hedge fund side has encouraged the firm to keep working on a DC product.

“This is a potential Holy Grail for us, because you are gaining access in part to the retail market. Unfortunately, we won’t be there tomorrow, but it is very firmly on our radar screens because it speaks to that need to be the universal provider.”