Aberdeen has been in the shop window for well over a year and speculation has been rife in our offices as to which company would pick it up.
Many fancied that it would be one of the big US or continental European players that would take the plunge. As unsurprising as the news of a takeover is, I must admit to never having once heard Standard Life’s name mentioned as a likely suitor.
Two houses both with problems
This is surprising given their Scottish roots and that their specialties have little overlap. An elegant outcome you might say. But despite the mega-merger, it’s not all rosy at either house.
After all, let’s not forget why Aberdeen is in this position. Its key investment proposition in Asian equities, under the guidance of veteran manager Hugh Young (pictured), has had an uncharacteristic bout of sustained underperformance. This coupled with the general apathy towards broad emerging markets, where its products still consistently outperform, has resulted in colossal outflows over the last 15 consecutive quarters.
Standard Life Investments (SLI) has also had troubles of its own, though not as enduring. The underperformance of its flagship product, Gars, over the past 18 months has resulted in the firm losing out on new sales to competitors at Aviva Investors and Invesco Perpetual. While the ship steadied in the second half of 2016, as interest rate expectations turned in its favour, it’s not as infallible as it once was and investors are wary.
Jewels in the crown
When looking at this deal I can’t help but think that Standard Life is getting Aberdeen on the cheap. SLI, predominantly focused on UK equities, is merging with emerging market equity-focused Aberdeen, just as a lean period for emerging markets comes to an end.
While Aberdeen's fixed income proposition has failed to reach critical mass, who really wants to be overweight fixed income when interest rates are rising? The firm has experience and quality where it matters in fixed income markets. Both have pedigree in emerging market debt and high yield bonds, two areas that have historically performed well in a rising interest rate environment.
Some commentators are pointing to the merger as symptomatic of the problems in active asset management, but this shows a lack of understanding: UK and global emerging market equities are two areas where value can and has consistently been added by active fund managers.
The jewel in the crown from Aberdeen’s side is its global emerging markets suite of products, while SLI brings the less shiny but still impressive Gars to the table.
Global emerging markets have gotten off to a roaring start in 2017, brushing aside fears of president Trump’s protectionist rhetoric and continuing the recovery they started last year. Aberdeen’s lead manager Devan Kaloo is one of the best individuals accessible anywhere in the world. He has slightly underperformed over the past year, in part due to an overweight in Mexico, but over any meaningful time period he is either in line with or far ahead of the benchmark.
Global emerging markets is still an area where passives are costly and therefore inefficient, meaning anyone giving you benchmark returns is ahead of exchanged-traded funds (ETFs).
India is one area where Young continues to shine. Exposure to this market has generated outperformance within emerging markets managers during an otherwise lean five-year period.
I still believe Young to be a great asset to Aberdeen. He has been through his most sustained period of underperformance on the group’s flagship Asia Pacific excluding Japan funds, but his performance in Asia Pacific including Japan, India and Asian Smaller Companies is still excellent.
Moreover, his experience as we enter what many hope to be a new phase for emerging markets should prove invaluable.
Gars woes overplayed
As for SLI, their Global Absolute Return Strategies (Gars) product is the main bet. Much has been made of its underperformance over the past 18 months, but is it really that bad? From peak to today it is less than 6% down. Not great, but certainly not calamitous. Since the mid-point of 2016 it has started to recover.
Making it big in the US
Both groups share an aspiration to crack the US. The two asset managers have had their forays into the domestic 40 act market. In Aberdeen’s case, it has feet on the ground and a handful of modified strategies, while SLI has a tie-up with John Hancock Investments , which offers a white-labelled version of Gars.
So will this be the making of them? My suspicion is not yet.
That the combined group would be near the trillion dollar mark in assets will carry weight in a land where big numbers talk, but appetite for international equities is still negligible when compared to those in the Ucits market. The bulk of Americans buy either domestic US or broad global ex-US equities. This leaves little room for what in their minds adds up to an esoteric skillset in UK and Asian equities.
They do purchase emerging market equities, but in the recent rally US investors have in the main decided to go the passive route - with a 80:20 split in flows. If the rally extends we may see this change. However, there are a number of domestic active emerging market strategies with large chunks of captive market share, such as Oppenheimer, Fidelity and T Rowe Price.
So what about Gars? US investors have been much more sceptical of Alternative Ucits or ‘Liquid Alts’ as they are known locally. After an initial flurry, investment interest has died down. Their track records are shorter, but that’s not the only reason. The reality is few have wanted to pay for protection, when the returns reaped in their domestic equity market have been the envy of the world.
The combined group does though have a genuine domestic equity player in the key US smaller companies sector, in Citywire A-rated Ralph Bassett and AA-rated co-manager Joseph McFadden. However, despite the increased scope for outperformance in small cap, the move towards passives in this sector is overwhelming stateside.
When all is said and done, the two group's equity-heavy offerings put them in a good position and it is a deal that Standard Life investors should be very happy about.