In his new role as global head of property at Aberdeen Asset Management, Andrew Smith has a packed agenda, and his appointment comes at a critical time for the company's £23bn (€28bn) real estate business, as new opportunities emerge in an investment climate still fraught with uncertainty. He talks to Martin Hurst
The environment is clearly challenging but Aberdeen is better placed than some. "We're fortunate that our focus is on core to value add and we haven't been exposed to the opportunity funds segment," notes Andrew Smith in his new role as global head of property at Aberdeen Asset Management. "We do have debt but lower levels of exposure."
Smith was appointed to the position in May at a time of changing patterns of client demand. "Part of this is cyclical and part is advances the industry is making in taking on different ways of investing in property," he explains. "Our focus is on three areas of pooled property funds: diversified or specialist vehicles; segregated mandates - in markets where that is more in demand; and the multi-manager
He adds: "The downturn produced a reaction against the use of pooled funds where investors feel they don't have as much control as they would like. We have seen a significant growth of interest in multi-manager, while for some this has sparked a reinvention of direct property segregated mandates although this is more a temporary reaction to changing market circumstances - a de-risking to concentrate on things that are more familiar. But I don't think that that will stop property becoming more global in the long term and we are seeing some of that coming back already."
Smith is encouraged by renewed interest in Asia where Aberdeen's multi-manager business has been particularly active. He is also seeing new interest in the US which, he says, "has always been a difficult market for European investors who have been waiting for markets to stabilise, and that is now happening."
Other interesting opportunities are emerging. Property is an important asset class for Aberdeen but is dominated by its European business. "Aberdeen is a global business with clients all over the world and I am sure our property business can benefit from the contacts we have in other markets," he argues, and the rationale is clear. Aberdeen has a lot of clients in the US for its fixed income and equities products. As Smith explains, these clients are now also looking to diversify their property exposure. "Before the downturn the interest on the part of US pension funds in Europe was driven by opportunity funds. The argument for them was that if you want diversification the US offers it all - you can get diversification at home so why would you want to bother with overseas markets which are less understood? The answer was that the opportunity funds can get the best deals. Now some US investors are interested in global expansion of core strategies and they are looking for - and finding - good opportunities in other markets."
Another key trend Smith identifies is the "shift away from the single-country single-sector specialist fund to the generic core balanced fund." But again this is likely to be temporary. "As fund managers get active again and investors think about how to build their strategies there will probably be a role for the specialist fund again," he says.
Leverage in real estate funds has been a key talking point and it is well known that the downturn has presented a strong case for many funds to deleverage. "We will see a much more controlled approach to gearing with 60-70% becoming 40-50% and we will see more funds with no debt at all if that is what investor appetite dictates," Smith says. "Most segregated funds have no debt at all; what these investors want is the plain vanilla product. At pooled fund level the argument is that you can get access to a bigger diversified portfolio with debt, but some research challenges the assumption that scale offsets the risk from debt."
For those that are in the market for core product there is a perception that it is in short supply. But Smith argues the contrary. "The recovery in values has started to create a bit of liquidity by sparing vendors the embarrassment of crystallising losses at the bottom of the market," he notes. "When the UK burst into life, we found that the volume of deals introduced to us was not far short of the boom, though perhaps for a narrower range of assets from a narrower range of sellers. Elsewhere in Europe things are picking up more slowly; more legwork is needed to find the opportunities but I do think they are there."
Other questions are whether the banks will release what Smith refers to as "the mythical mountain of assets" that they have to sell. "There will be a more regulated trickle; banks are aware of the risks of releasing assets too quickly so it may be some years until they have worked the assets through."
The uncertainty in the financial markets has been exacerbated by the euro crisis and the termination of government stimulus packages. "Property yields look attractive compared with other markets and the asset class is considered a reasonable safe haven but investors are not rushing to commit and due diligence is taking longer," Smith says. "They are having a good look round the market before doing anything and I can't see that changing very much while there is so much uncertainty around. Governments are all pushing their austerity programmes and are trying to make us feel a little less cheerful."
What impact would a major default have on the property market? "If Greece and Spain default the impact on property will be one of local impacts and general malaise," Smith says. "Rather than a manageable crisis we would have another event that may trigger a bad recession. The question is: how far does the crisis spread? Greece is in trouble but it is a small economy and the rescue package is keeping it under control. Meanwhile Spain is under attack and there are questions over Portugal, Italy and Ireland, but so far they have convinced the markets that they too have got things under control. But I wouldn't be surprised if the strain proves to be such that somebody has to drop out of the euro at some point; the lessons of currency unions in the past is that is usually what happens."
Questions over future membership also feature in what might first seem like a much less likely setting. Smith believes that Germany is "the only country that would benefit from leaving the euro; the mystery to me is why the German voters have for so long been so supportive of everybody else in Europe. In the early days of the euro Germany missed out on the recovery because the interest rate for the euro was higher than the interest rate for the Deutschmark. They were paying for the recovery in other places and stimulus in Ireland and Spain but it has now reached a point - especially with the bailout of Greece - that public opinion in Germany is not in favour of sustaining that approach. The electorate is at loggerheads with the government which is still trying to prop up the European dream, and you do have to wonder how long that is sustainable politically.
"It would certainly be easier for the euro-zone if some of the fringe countries that are having problems would drop out. However, in the case of Germany, as German banks hold a lot of fringe country debt, a bailout would be cheap compared with a collapse. We might scrape through one electoral cycle in Germany with that intact."
The euro crisis is having an effect on how individual European markets are viewed - and on the case for investing further afield. "In Finland there was the perception that being in the euro-zone was beneficial given it is a very small market, and being in the euro put it more on the map than would have been otherwise so to some extent it punched above its weight," Smith explains. But he contrasts this with two of Finland's neighbours: "Now, some feel that there is less risk attached to Sweden and Norway because they are outside the euro and questions are now being asked about Finland. Finland is still a very attractive transparent market and one of the most stable economies in the euro-zone, but clearly the uncertainty doesn't help."
Given Spain's image problem it should, as a market which "repriced mightily, look very cheap in a historic context," Smith says. "But people don't want to commit there because of the economic turmoil."
Besides the currency issue Smith also points to Spain and Italy's "serious labour market problems: Spanish unemployment of 20% and Italy's demographic timebomb with its ageing workforce and higher welfare costs. So it's not surprising in this context that Asia is coming back onto the agenda given that a lot of the problems that people are grappling with in Europe are not issues there."
The complexion of Central and Eastern Europe (CEE) has also changed. "Another concern about investment in Europe is that the idea that the CEE nations would benefit from EU stimulus packages when they joined a few years ago now seems like a forlorn hope."
Uncertainty in the market has been exacerbated by ongoing regulatory pressure and the discussions concerning the Alternative Investment Fund Managers (AIFM) directive. "Whether this really helps transparency is questionable," Smith says. "At the moment it is having the opposite effect because it is so uncertain where we are going to end up. It does affect perceptions, and until people can really see what the results are going to be they are going to play safe. Lack of clarity is never a good thing."
Proponents of the AIFM argue that investors need protecting from themselves. Apart from the cost burden for the fund management industry, opponents of the AIFM argue that institutional investors are, as professional investors, are able to manage risk themselves.
But there is a huge range in the levels of governance among investors. "There is a big spread of knowledge of property; many investors are not at first base on the differences between direct and indirect investing, the risks of indirect investing and the more liquid ways of getting access to the market, so there is a lot of education to be done."
Referring to UK pension funds, Smith notes: "Pension fund trustees are not always investment experts - they just care about the value of the fund they're administering and want an investment manager to explain clearly what they are doing. But to do the best job for them we need them to have sufficient understanding, when we're recommending something a bit unfamiliar to them, to judge whether that is an appropriate strategy for them or not. Some investors are very well informed, but at the other end of the spectrum there can be a serious lack of knowledge. Sometimes people feel they know property because they own a house and their perception is that the whole market is guided by headlines in papers about house prices. We have to explain how the commercial sector is different and what opportunities might be available in international markets. There are also those who understand commercial property and international economics but don't necessarily appreciate the intricacies of indirect investment and why sometimes it is more liquid or less liquid than the underlying asset. We have to constantly understand who we are talking to and try to communicate at the right level."
In some markets the investment consultant plays a big role in education and communicating investment concepts. "While this can be helpful, the risk is that the fund manager is then a further step away from the client," Smith says. "Furthermore, in the US it is quite normal for a consultant to have an advisory arm that does manager selection and another that does investment management, posing a risk of conflicts of interest. Direct property fund managers with multi-manager investment businesses are in a similar position, and care is needed to prevent such conflicts occurring." he concludes.