Q&A: Aberdeen Asset Management's Andrew McCaffery

Q: What trends do you see in LP demand for exposure to alternative assets?

A: There are broader trends that favor illiquid private markets generally. Meeting demand for yield and real growth is proving more and more difficult from where we are starting in terms of valuations. Investors are thinking about how they can hit some very distinct return targets or income profiles - one could argue that they should be revising some of those expectations, but they are still trying to find ways to achieve them. As a result, you have that undercurrent of increasing allocations towards private markets. For example, one of the reasons you have seen fairly rich valuations around secondaries is investors are trying to put capital to work and the returns are still better than for some competing asset classes. In the current environment, as long as return targets are not revised, I don't see that demand profile going away. It is more a case of how it evolves and whether investors, as they become more committed to private markets, alter their allocations further and start looking at areas such as venture capital. It has been relatively unloved - there are still a number of attachments to the turn of the century and a lot of capital being lost or having low returns for some time - but we see a new generation of investors coming to the market in a more meaningful way looking at it afresh. These people weren't investing in private equity before.

Q: What we have seen in Asia, particularly from new investors in markets like Japan and Korea, is growing interest in yield-generating assets...

A: I think of Japan in much the same way as Europe. In Europe, when you consider what has happened to government bond yields and public security yields, it's generating higher demand for multi-sector credit. They are increasing the risk for the available returns, and we see a lot of that money seeping into marginal areas and private capital in different forms. Think about the strength of direct lending, the shadow banking thought process has clearly gained from that. But it's a Europe and Japan phenomenon. It will be interesting to see how the conversations play out in broader Asia because I feel it's more mixed. And if I look at the UK and US, there is still a lot of emphasis on growth.

Q: How strong is demand for Asian exposure from investors based outside of the region?

A: We find European investors - and maybe is this just in terms of our access - are looking with great interest towards Asia. It started off as less of an emerging markets theme, but rather a discussion of where in the world do they see growth dynamics that support being more active in private markets, where do they see valuations that are more attractive compared to other areas. The development of economies here, and the capacity for income generation, is better, especially when you look to Europe. We have some mandates being formed at the moment that will look specifically at Asia and the investors will be almost entirely European. We are looking to be active in the market in 2017, with Asian accounting for a meaningful allocation in a global lower mid-market portfolio. This is in part driven by investors being more proactive and choosing Asia as a place where they want to increase investment. Five years ago we would have gone to them with ideas and maybe there would have been demand.

Q: What does this mean for the kinds of products offered by groups like Aberdeen?

A: You've seen the fund-of-fund model change dramatically from being primary-based to focusing more on secondaries, co-investment, and solution-style mandates. There will be a variety of products. If you look at the competitive landscape, there are those who really just raise funds and those who are more driven by being large advisors - with the ability to raise funds but also have much larger mandate profiles. For us, part of our evolution is the degree to which some of our fund offerings become more targeted - going from a bit of everything to targeting particular segments of the market. This might be mid-market as opposed to anywhere across the size spectrum in terms of buyouts, dedicated co-investment vehicles, dedicated secondaries vehicles, and broader funds with a higher percentage of co-investment. We need to develop more solution-style mandates where it comes down to being more customized and using the whole tool kit.

Q: What is the minimum feasible size for a separate account mandate?

A: It is $100 million and up. You can do it for smaller mandates, but what would you want in the portfolio and how diverse would it be? If you think about fund-of-fund portfolios, you can do $50-100 million quite comfortably, so you can also do that in a segregated form. The challenges are around making sure you have an effective allocation policy and an effective investment process to support that.

Q: And regarding funds with a higher percentage of co-investment, how high could that percentage go - 50%?

A: Those conversations are occurring, but I can't say they've been numerous. The other side is people come to us and ask for help managing a pure co-investment fund. It's a smaller part of a larger allocation where they have secondaries and primaries as well. They decide they can access global fund managers - they are generally comfortable with it, although they may ask for your thoughts - but as they start to move down into mid-market managers, they need more resources and expertise. As they move into secondaries and then co-investment, they need different types of expertise. The question becomes how can I outsource to get that access properly.

Q: These changes in the industry are in part a response to the emergence of sovereign wealth funds and other very large investors. What will be the long-term impact?

A: With the amount of capital flowing in they can exert influence and ensure discipline - for example, they can start to force greater transparency and they can start to force alignment of fees. Those are positive elements, making sure the cost of delivery is more commensurate with the value being generated. The dilemma is are you are pushing down returns by trying to put more capital to work?

Q: To what extent are you seeing some GPs pushing back on fund terms?

A: The more successful managers in some of their bigger fundraises are able to do things like take away performance hurdles - you've got to look at what you are paying for that potential return and what is the level of alpha coming from those managers. But it's not endemic. It is interesting that there is still so much power sitting in the hands of a relatively small number of GPs that can still call the shots, because in some instances we are not talking about an additional thin-line categories, we are talking about significant increase in fund size with those terms. It comes back to LPs trying to put capital to work. I would argue that it doesn't take much data analysis to see what happens to return profiles as managers get progressively larger, but the LPs want to take it because they see the return as a decent number. The alternative for them is competing in public equities or competing in other forms of debt or equity that are not as attractive.

Q: Is this a cyclical trend or is it here to stay?

A: There will be cycles along the trend but the trend is embedded because people have become much more comfortable with private markets and illiquidity, and what this means long-term for risk-adjusted returns. There will be a point where this becomes compromised but there is a long way to go before we reach it. I expect there will also be a point where we review how people have been investing, but I'm not sure it stops the trend of wanting to increase allocations.

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• Topics
• LPs
• Fund-of-funds
• Advisory
• Performance
• Aberdeen Asset Management
• Asia