Has Aberdeen broken its emerging markets stereotype?

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The share price for Aberdeen Asset Management recently hit a 10-year high. The cliché used to run that investors were better off buying an asset management company than their funds, but – in most cases – this can’t be said of Aberdeen, whose emerging market franchise in particular has delivered some exceptional returns for investors. The problem for the past few years has been how to sustain the success of the emerging market funds and diversify the business into other areas.

The solution in the past has been to diversify the asset base through selective bolt-on acquisitions: The purchase of RBS Asset Management in 2010 brought fixed income assets, the CSAM acquisition in 2009 brought some multi-asset skill and significant pan-European distribution. Deutsche Asset Management, Glasgow Investment Managers, Murray Johnstone and Edinburgh Fund Managers were all previous purchases. However, the recent rate of acquisition has slowed and diversification of the asset base has come using existing internal resources, such as the group’s emerging market debt capability.

Neil Steadman, head of UK discretionary, says: “The lion’s share of inflows over the past three years has been into the specialist fixed income products, including emerging market debt and the Asia Pacific funds.” The vogue for emerging market debt has seen the group’s fund grow from a near-standing start to $9bn with capital raised largely from private banks, family offices and institutional investors.

Steadman sees continued growth: “We believe that it has now become a core asset class – the UK is a bit behind Europe, but more sophisticated UK investors are now looking at emerging market debt.”

The UK-domiciled Emerging Market Bond fund remains at just £37m, with the majority of flows going into the offshore range. In particular, the ‘best ideas’ fund – the Select Emerging Markets Bond fund, which draws together the strongest ideas from its local currency, hard currency and corporate emerging market debt funds – is now £2.2bn in size. Aberdeen launched an onshore version in March.

Another key area of growth has been the group’s global funds. The £2.3bn World Equity fund is top quartile over three years and, while the group is resolutely ‘team’ in its approach, strong managers such as Bruce Stout have undoubtedly helped lead the charge. The group has managed to tap into the demand for global funds over single country funds among institutional and wholesale investors.

Steadman says: “The global equity buy list is 330 stocks long – an amalgamation of each of the regional portfolios. The fund managers add them all together and do a cross-comparison to create high conviction portfolios. The global equity franchise has grown from around £3bn to £35bn of which the lion’s share has been institutional money from the US and Canada.”

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But the jewel in Aberdeen’s crown is still its emerging market funds. The Aberdeen Emerging Market fund is the sixth best-performing fund over 10 years with only five Latin American funds and one Indian fund ahead of it. It is difficult to quibble with the strength of the process that Hugh Young has devised and passed on to his team. The fund has outstripped the wider sector by nearly 60 per cent over five years and has delivered consistent, low-risk strong performance through a time when there has been huge volatility in emerging markets.

It has been well-flagged that the group undertook a vast re-engineering of its investment processes in 2002. It centralised all its investment processes under the process devised by Hugh Young. The approach is conservative, emphasising quality and value. It looks at the capital structure of companies – eschewing leverage and over-optimistic balance sheets, in favour of quality of management with a track record of implementing their plans successfully. The managers and analysts always meet management before investing, seeking out strong business franchises.

In general, this has been successful. The multi-manager funds are the only real weak spots across the group’s range. The bulk of the group’s assets are in top-quartile funds – Emerging Markets, Asia Pacific, Indian Equity, Global Equity and Multi-Asset (which draws from internal funds).

However, there are some caveats – the Aberdeen process has a number of natural biases – the funds do not tend to invest in smaller or embryonic companies, they are conservative in valuation. This has been the perfect strategy for the post-credit crunch environment, when markets have favoured exactly this type of ‘quality growth’ company.

Although no immediate change in the investment environment seems imminent, there are times in the cycle when this approach will not do as well – it may lag a rapid rise in markets, for example. The process is designed to protect on the downside and participate on the upside. “It is all about capital preservation and steady-eddie growth,” says Steadman.

That said, the process has historically had a natural bias to Asian and emerging markets, and this has not always been the best place to be over the past five years. The focus on quality has managed to counter the weakness in some of these markets.

If Aberdeen is at risk from a change in market sentiment, perhaps a more pressing worry for the emerging markets funds is the capacity issue. The Global Emerging Markets fund is £8.7bn in size and the Emerging Markets fund £3.5bn in size. There are similar amounts in the group’s offshore funds. Although the funds tend to be large-cap biased and have therefore not run into liquidity problems, they continue to experience strong inflows and be the default choice for investors in emerging markets. To date, there has been no diminution in performance, but it remains a concern.

Steadman says: “The Asian and emerging market franchises have both been hard-closed on a segmented basis for some time. The emerging market equity strategy has also been soft-closed for around two years. We got strong inflows in January, so had to soft-close in February so we stopped actively marketing the fund and did not enter into any new distribution agreements. This addressed the problem for the time being and we would have to reconsider if flows became unsustainable again. For the most part, clients have been very supportive and the rate of flows has slowed to a sustainable level, though flows have picked up again slightly in the past few months.”

The trouble is, although not admittedly for Aberdeen, is that relatively few funds have been able to replicate the franchise. Aberdeen has been able to build people on the ground in Asia and now has a well-established fund management and analyst set-up in place. Equally, emerging market growth funds that might have taken Aberdeen’s crown have had a difficult run with the market favouring a more conservative approach.

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The group has tried to diversify the franchise with the launch of global income product. To date, the World Growth & Income fund has not been a strong performer, third quartile over three years and fourth quartile over one year, but it has raised £213m, testimony to the popularity of the approach.

Aberdeen remains one of the largest groups in the UK market. It has nearly £5bn in investment trusts, but a further £20-25bn in open-ended funds. Yet the UK forms only about a quarter of the group’s total assets under management, with significant chunks in Europe, the US and Asia. Equities still dominate at about £90bn of total assets, with roughly £45bn in fixed income, £25bn in ‘solutions’ and £20bn in property.

The business is divided into three areas – institutional, discretionary and advisory (which incorporates strategic partnerships such as platforms). Steadman says: “We are seeing the discretionary channel – which incorporates wealth managers, private banks, family offices and fund of funds, increase as a proportion of our business. This appears to be largely as a result of DFMs sub-contracting the investment decision to discretionary wealth managers.”

Steadman says the post-RDR environment will favour Aberdeen: “More assets are flowing into fewer funds. The bigger will get bigger. The ‘long tail’ of distribution with which many advisers have run is likely to disappear. Aberdeen is quite well-positioned in that respect.”

Certainly, it is a view with which UBS agreed in a recent broker’s note on the company: “Last year, in Europe, 5% of equities mutual funds attracted 56% of industry’s total net sales. Also, 38% of fixed income mutual fund sales went to 5% of funds..It is striking to note how strongly flows are linked to Lipper rankings.” It says that this concentration will favour Aberdeen’s funds, which are increasingly highly-rated by Lipper.

In terms of product development, the other major launch was the group’s Diversified Growth fund, which is designed as a key solution for the defined contribution market post auto-enrolment. Steadman says that while the group has a full suite of products, there are areas that the group is looking to expand. For example, the group has been recruiting for its emerging market corporate debt team. They currently have a $138m Luxembourg fund and may launch an onshore version if demand continues to be strong.

Multi-managers and advisers continue to use the group predominantly for emerging markets. Gavin Haynes, investment director at Whitechurch Securities, says: “The core of their business – and where we have had most exposure – has been through the Hugh Young team and the emerging market franchise. That has become the default option for emerging markets alongside First State. It has an exceptional track record.

“The only concern is capacity. It may become a victim of its own success. It has been so consistently successful. The group has taken steps to temper flows. It is something we have to be aware of and we keep a close eye on it. But it has continued to produce performance.”

Patrick Connelly, head of communications at AWD Chase de Vere says: “Aberdeen is a well respected company within the investment industry, and yet many in the industry, and certainly those outside, do not fully appreciate the size, scale and capabilities of the business. This is perhaps to do with the company name, which gives the impression of a small parochial business in Scotland.

“In fact Aberdeen manages assets of more than £180bn and uses a fairly consistent approach across most of these. They are primarily team-based long term investors adopting a bottom up research process with low turnover and they do not invest without first meeting with a firm’s management. In a nutshell they are sensible and pragmatic investment managers. Their main strengths are in Asia and the emerging markets, global funds and multi manager and we use Aberdeen, to some extent, in all of these areas in client portfolios.”

Aberdeen has grown to be more than just emerging market equities, building considerable traction in the popular areas of emerging market debt and global equity alongside the original core of the business. The investment environment has been perfect for its style. Until that changes, Aberdeen can expect to continue to ride high.