The big deal

The big deal

For many months Aberdeen Asset Management has faced the same awkward question of how it will reverse its recent slump. What strategy could co-founder, CEO and famed dealmaker Martin Gilbert come up with to turn things around?

We found out on 4 March, when Aberdeen was rushed into revealing its strategy when news broke of it being deep in merger discussions with Scotland’s biggest asset manager Standard Life. The £11bn ($13.5bn) all-share merger will entail Aberdeen shareholders receiving 33.3% and Standard Life 66.7% of the combined group, for which Gilbert and Standard Life CEO Keith Skeoch will be co-CEOs.

Aberdeen has had torrid time over the past couple of years, finding itself on the wrong side of some powerful industry trends. It had been haemorrhaging assets, losing £100bn in outflows over 15 consecutive quarters, and its share price fell precipitously between April 2015 and February 2016, from a peak above 500p to a low barely above 220p, before heading to 270p on the eve of the merger announcement.

The long-term trend vexing all active managers is the steady drift to passive management and the associated pressure feeding through into active fees, which could still have much further to run. “I wish I knew the answer to that – then we could plan much more efficiently,” says Gilbert. “My instinct is that it will get tougher in the big developed markets. In emerging markets we are not seeing as much fee pressure. It’s going to get tougher.”

The second issue for Aberdeen was the cyclical shift to the resurgent US economy, where it is weak, at the expense of the long-term ‘rise of Asia’ story, where it is particularly strong. The problem is not with its performance – it perhaps does not match its glory days of the 2000s but is certainly respectable – but more that sentiment left its core markets and competitors had narrowed its edge.

“I do not think it will be the end, sadly,” says Gilbert, anticipating another quarter of outflows. “We have just got to manage the business, and there are opportunities.”

M&A experiences

Since co-founding the firm in 1983, Gilbert has made more than a dozen acquisitions including some during difficult times. Perhaps the most notable was in the wake of the split-cap miss-selling scandal in the early 2000s when it emerged from an existential threat to purchase the underperforming old Deutsche Asset Management (DeAM) business. It was a hugely successful move, against the odds achieving high levels of investor retention and giving Aberdeen back its “fighting weight”, as it was described in the cover story of Global Investor back in January 2006.

There has been a long string of deals since (including Credit Suisse and RBS businesses as well as Scottish Widows) that led to it becoming the second largest Scottish asset manager, behind Standard Life. It bought largely unloved business and consolidated their funds into Aberdeen, leaving Gilbert undisputedly in the hot-seat of a firm unified by a strong company ethos.

“We started with £50m – the only way we could grow into one of the biggest independents in the world was both organically and inorganically,” says Gilbert. “It’s not easy but hopefully we know what we are doing. It’s a pretty well-oiled machine, ready to swing into action and do what is necessary.”

This time around a big acquisition faced significant barriers. Declining revenues made it unlikely that sufficient capital for a destiny-shaping acquisition could be found internally. It also faces calls for greater regulatory capital and expectations from shareholders to return capital. A small acquisition could have been made but that could have proved a distraction and would not have addressed the fundamental issues.

Gilbert is well aware that the market is moving in the direction of managers needing a comprehensive product offering. “You have now really got to be able to manage everything across the board, because of the tremendous search for yield that is happening in the world.

“We have got to be big in alternatives and multi-asset because those are the growth areas and potentially those of the future,” he says, noting that property, absolute return bond capability and direct loans are all also important.

Standard Life

Standard Life has a complementary set of strengths and a different set of problems, while possessing a compatible culture and offering the potential for synergies and cost savings. It has been moving away from insurance into asset management, is predominantly focused on actively managed fixed income, and has successful investment platforms and asset management interests.

CEO Skeoch has a longstanding aim of turning the firm into a “world-class investment company”. It has a blockbuster offering in its £48bn AuM Global Absolute Return Strategies (GARS) fund range. It had been a darling of investors for more than a decade but after significantly underperforming last year, for the first time, its high target of cash+5% experienced outflows of £4.3bn, and now faces competition from Aviva in the sector it created.

Standard Life’s share price has followed a trajectory not dissimilar to Aberdeen’s; it peaked in May 2015 just shy of 500p and hit a low of 271p July 2016, before partially rebounding to 378p ahead of the merger announcement.

What the merger undeniably brings both firms is economies of scale. Combined, it will be the biggest asset manager in the UK, overtaking Schroders, and the second biggest in the EU, with combined AuM of £660bn. Cost savings of £200m have been mooted by analysts, suggesting job losses of around 10% of the combined firm.

The merger arrests the corrosive effect of losing AuM on Aberdeen’s profitability, which was leaving overheads spread over a dwindling revenue base.

“I think the big are going to get bigger – the place not to be is in the middle ground. You either need to be a boutique with a terrific operating margin or be very big to be able to sustain the overhead of running a big global business,” says Gilbert.

Gilbert says that scale calculations should be all about revenue, identifying the sweet spot for generating economies of scale. “I disregard AuM and look at revenues,” he says. “A global player probably needs $1bn while a domestic one can probably do well with $500m. A boutique can do very well at sub-$100m. The issue is if you are in that middle bracket.”

Aberdeen had nothing to fear in this rough calculation as he estimates revenues for the year to be $1.4bn, depending on exchange rates, but increasing scale this dramatically will certainly bring substantial savings.

Broadly, there were two plausible types of deal under consideration – strategic and consolidation. A strategic deal, such as Henderson’s $2.6bn transatlantic purchase of Janus announced last October, could have provided internal diversification and opened up new markets. “America is the place because half of the world’s wealth is there,” he says. “It’s why the Henderson-Janus deal is such a clever deal in a lot of ways.”

The timing was perhaps not right for a transatlantic partnership – if Gilbert intended to retain control, which is hard to imagine not being the case – given the Brexit-induced sterling slump and Trump-elevated dollar.

Merging with another UK entity, with a share price denominated in pounds and under similar pressure, meant both could enter an all-share deal in a position commensurate with their longer-term relative values. The size of the combined group also makes it a less likely target for unwanted buyers.

Cultural compatibility

Aberdeen is inseparable from its ethos of research-based, high-conviction active management. The top layer of management has remained largely together for three decades – including Hugh Young, Andrew Laing and Bill Rattray among others – although there were some key departures last year including CIO Anne Richards.

“We have never, ever questioned whether being a long-term, bottom-up fundamental investor is the right approach,” says Gilbert, who notes that the firm’s ranks are full of people that joined via the graduate trainee scheme.

Aberdeen is famed for its team-based approach, which some have suggested could lead it be vulnerable to losing its leading lights. In reality, this has rarely happened (technology fund manager Ben Rogoff is a notable exception) and has protected against style drift. 

It is demonstrably committed to true active management and cannot be accused, as many have been following an FCA study last year, of charging active fees for passive performance.

“Our tracking errors are so large that no one can accuse us of being a closet indexer,” he says (confirmed by Morningstar data). “I agree with everything in the FCA report.”

It puts him in the same camp as Daniel Godfrey, who acrimoniously left the chief executive role at the Investment Association in 2015 after some members complained of an undue focus on consumer protection. “I agreed with everything that Daniel suggested. I am totally in favour of transparency, totally in favour of a single fee,” says Gilbert.

With such as strong culture it was important to find a partner with a compatible outlook. “You have got to have a similar philosophy, because if you don’t it just doesn’t work,” he says.

It is hard to imagine Aberdeen integrating a hedge fund business given its aversion to star managers: “Probably not, just because of the cultural differences.” Likewise, an ETF business would sit awkwardly with its reputation and anyway “that is for the really big guys, such as BlackRock”.

The merger with Standard Life is a better fit than some previous Aberdeen acquisitions. However, for the first time, it will be the junior partner and the process will not be a one-sided imposition of its culture on a struggling firm.

Emerging markets

Where Aberdeen really brought strength to the negotiating table was of course in Asia and emerging markets; it is still very much a leading player. Periodic downturns should be expected in emerging markets. Indeed, flows stated to return in the latter part of last year, so they may already be turning a corner.

The nagging concern it that since 2015 flows have predominantly been into passive funds while money continues to be taken out of active, according to EPFR Global data.

One reading is that flows into passive funds are signalling returning sentiment that will ultimately benefit Aberdeen. “It starts with taking shorts off, which happened last year. Then money goes into passive, then it goes into active,” says Gilbert.

The third stage is the contentious bit. Investors, increasingly comfortable with passive, may no longer be convinced that active is appropriate in less efficient markets any more than it is in the US. There could be a ratcheting-down effect as each wave of money leaves active and remerges in passive.

Nonetheless, Aberdeen reported inflows in the third calendar quarter of last year. “I thought we had turned the corner,” says Gilbert. “Up until the Trump election sentiment was improving and money was coming back into emerging markets. But since then it’s really been put on hold.”

Gilbert is remarkably relaxed about the situation, perhaps because he knows President Trump personally, having played golf with him at his controversial course in Aberdeen. “I don’t think he is protectionist… he has an issue with people moving jobs offshore and big balance of payment surpluses with the US.”

While “it’s not great news” for emerging markets “it will be okay,” he says. “If America sneezes, the world catches cold – but the opposite is true as well. We see good earnings growth, strong balance sheets and good economic growth. There is huge scope to outperform because they are so comparatively diverse and inefficient.”

It has been an eventful decade for Gilbert; lauded when AuMs were peaking, Asia was roaring and for taking a commendably long-term approach – to facing persistent questions about outflows.

He could be forgiven for having some regrets, but that is not really in his character. “Quite the reverse. I think we are the victims of our success. We just grew so rapidly because of the emerging market cycle. We are going through tough times at the moment – but it’s a result of previous success, not a result of anything we’ve done .

nothing compared to split caps, I can assure you. Nothing. 2002-2004 was really difficult. What makes or breaks you is how you deal with the tough times. You have got to really manage the business. I prefer the tough times actually.”

In that case, he should enjoy the next couple of years. The integration of the businesses is a formidable task, although one for which Gilbert is ideally experienced. The two firms complement each other and will provide useful cost savings – but the real challenge is arresting long-term AuM drift to passive funds and maintaining fee levels. In the final analysis, it is not the whole solution.

Gilbert remains as committed as ever to the cause, and one would not bet against further deals. “I’ll keep working, I love it. I do not know how long I will do so but I have got to keep going. I always used Alex Ferguson , until he retired.”

Whether he goes down in history like the legendary Manchester United manager, famed for building multiple winning teams over his 26-year tenure (or Arsene Wenger, who rigidly stuck to a strategy without recapturing Arsenal’s golden era) will depend on what he achieves in the next chapter with Standard Life.