Stewart: My name's Stewart Foley, I'll be your host. Today, we have a very, very good topic. We are going to be talking about global private markets and we're joined today by Nalaka De Silva, Head of Private Market Solutions at abrdn. Nalaka, thanks for being on, man. Thanks for taking the time.
Nalaka: Thanks, Stewart. Great to be here. Really looking forward to the conversation.
Stewart: It is May 5. You are in abrdn, and I am outside of Chicago. I always like to timestamp these things because markets are moving so quickly. I want to start this off the way we start them all. So, where did you grow up? What was your first job? Not the fancy one and a fun fact.
Nalaka: I grew up in Africa. I'm Sri Lankan originally. Dad's last posting was in New Zealand where I met my wife who's from Brazil and now, we ended up in Scotland.
Stewart: Wow.
Nalaka: So, we've got a bit of an unconventional background, but we're sort of international citizens, I guess would be the way to answer it.
Stewart: That's fantastic. How about your first job?
Nalaka: First job? Oh, I probably had a string of jobs, not the fancy one. So, I worked at what was probably the first coffee carts that used to kind of be out on the streets. I had a telemarketing job kind of raising money for a bunch of stuff, which is a great lesson in rejection.
Stewart: I had one of those. I had one of those jobs, I had a couple of them actually.
Nalaka: You built a thick skin pretty quickly, calling people on sheets and then-
Stewart: Or get treated for depression, one or the other.
Nalaka: Yeah, I think, you build it up. You build it up. Yeah. Yeah, that was sort of the first before doing you really sort of, I guess some more admin-related jobs in offices and stuff to tip the piggy bank over.
Stewart: And what's the fun fact? The global citizen thing is cool. Any hobbies or interests? Or...
Nalaka: I mean, you can imagine we love to travel as a family. Having grown up in Africa, probably a fun fact because I've been charged by an elephant twice. So-
Stewart: Wow. There you go.
Nalaka: So, I spent 15 years in Botswana in Africa growing up, and we kind of went on safari kind of every weekend. And I can't really go to a zoo now having lived life in the wilderness, but that's probably the fun fact.
Stewart: That's so cool. Growing up in Missouri, we were not charged by elephants. There were many other dangers, but they were mostly in pickups. They were mostly in pickup trucks.
Nalaka: Yeah, it was a pretty nerve-wracking experience the first time, the second time bizarrely it happened, we kind of knew what to do at that point, so we sort of stepped away briskly.
Stewart: So, abrdn has an interesting story and an interesting name. abrdn is abbreviated lowercase, a-b-r-d-n, but you pronounce it Aberdeen. That's a branding thing, right?
Nalaka: Yeah.
Stewart: And abrdn has been running insurance money for literally a couple of centuries. So, could you give us a quick background for on abrdn, just so that if folks don't know kind of much about the firm, I got a lesson when you guys came on our platform. I just think it would be helpful because your history is rich, and you run a lot more money than people I think may know on their own. And so, any of that background would be helpful as just kind of a starting point.
Nalaka: I guess was founded its roots line of business called Standard Life, which was founded in 1825, if I kind of recall correctly. And actually, the Canadian Business was founded in not shortly after 1837. So, Standard Life has been doing kind of insurance and insurance-related massive management for close to 200 years. So, we've got a very long rich heritage and in insurance product and management and asset management as a result of decades of investment in that space. There was a merger between Standard Life and Aberdeen Asset Management, which is the combination of the two businesses brought us to close to $500 billion of assets and the management, we're one of the largest asset managers in Europe.
And as a result, have a broader range of client types now from insurance companies to pensioners insurance wealth and investing across multiple asset classes, both public and private. We've got fixed income equities and then a range of private market assets and then we distribute that majority to European but have a growing presence in Asia and in the US we sort of try to bring the best of our abilities to help clients in America as we sort of look at very much things like risk management, passive hedge fund strategies, things that are a bit unique that you know can't get from local players.
So yeah, we're a really interesting shop, long history and heritage and deep, ideally, we think of ourselves as thoughtful investors have the depth of experience in history.
Stewart: That's really cool. The 500 billion number is the number that just floored me. I was like, "Wow, I didn't..." And I feel like I know this space pretty well and it's like because it's all heck I do and I was really astounded like, "Wow." I mean I just didn't realize that.
Nalaka: Yeah, I think we've a 200 of that is insurance money as well given the background and having had Standard Life as a parent and that business was sold and we're now an independent asset management company, but we still have a very strong insurance heritage in that context.
Stewart: Yeah, it's interesting. So, your role as the head of private markets, can you talk a little bit about your strategy in global private markets? I think it's an interesting one and it would be good to get your take on where you see value, why you think it's compelling, et cetera.
Nalaka: Yeah, sure. So, I sort of founded that the solutions desk in 2014, '15. And what that was designed to do was to bring together I guess the best ideas and implementation across private markets. So, that's venture capital, private equity infrastructure, private credit match resources, and do that in a kind of systematic way so we could sort of harvest the risk premium that we're generating in that part of the market and make it one accessible to a broader range of clients. But also, we were going through a declining bond yield environment where growth and return outlooks were getting stretched. And so, you really needed to find a new source of risk premium. And so, that was the intention of doing that. We then spent quite a lot of time trying to figure out how to implement that on a global basis. So yeah, private markets have been around, before even public markets, so it's been around for a long time.
And once it became a bit more mainstream, we looked at ways of incorporating private market assets into what I describe as more traditional portfolios. So, running both public and private as hybrid portfolios and then running essentially pure play private market portfolios that were diversified by industry, by category, by geography. And that's a really interesting strategy because you diversify a lot of the risk away than investing in just one PE fund or an infrastructure fund or a real estate fund and allows you to play some really long-term themes.
So, if we look at things that are shaping the world as we go, technologies driving things which really place to the venture and PE part of the market demographics changing the world, that's in place of infrastructure, real estate, schools, hospitals, transport, energy generation. Sustainability is a major topic at the moment, decarbonization and resource scarcity. So, private markets plays a much greater role in capital formation now and the amount of new issuance coming out of the private markets has outpaced public markets for some time. So, giving investors access to that in a systematic way was really kind of the thesis and we've been pleased to have delivered that in a single strategy for our clients in Europe and on separate account basis for some of the larger clients globally.
Stewart: Outstanding, that's really helpful. And I always say on these podcasts, I'm so fortunate because I get to learn from very, very skilled individuals who have particular market expertise. And so, it's interesting the timing of this podcast because yesterday I got a call from a friend who suggested that we... And I think we're going to do this, we're going to create a podcast series called Due Dilly. And the idea is particularly given where we are in the economic cycle, I think a lot of people are talking about, "Hey, what happens if things don't go quite right? What happens if in whatever strategy it is, particularly private markets, what happens if there's defaults? What happens if there's in private structure, for example, what happens?" So, that conversation was very timely because you have a tool called PRISM, which I think stands for Private Investment Sensitivity Model and is really designed to monitor risk. So, what can you share with us about PRISM and the way that you use it in managing portfolios?
Nalaka: So, I guess PRISM to us was, it was founded in a really basic sort of format, how sensitive were private market assets to different sort of attributes or factors. And it very much started off, kind of described it as sort of 20-year overnight success because no one really cared a heck about risk when it was 2% of your portfolio, but when it's 40% of your portfolio, you kind of want to know what's going on in your private market's portfolio. So, what it aims to do is to break down systematically some of the things that are key drivers. And as you can imagine, there's a lot of opacity in private markets. You can't go and kind of download position statements, you don't know what's inside of an asset. So, we spend a lot of time looking at how to systematically break down some of these, what I call them attributes.
So, we've got three main attributes, I guess one is idiosyncratic, so what's happening at the company level, so what's happening at their corporate strategy, what's happening in their long-term business plan, how does their operating platform operate, all of those things. And I guess that manifests itself in I guess getting quite a lot of granular data around its P&L balance sheet cash flow. So, we can ask questions. What if you can't repay your debt? At what point do you go insolvent? And those are almost like credit-related questions. Gives you kind of default propensity, then you kind of step up a level to say, "Okay, well I've got a bunch of assets that happen to be operating quite use idiosyncratically, but actually they're quite connected by supply chain or connected by revenue streams. So, we look at market attributes, so what does that mean by country, by sector, by geography, things that are related to tax or political kind of regimes at the market level.
And then on top of that we got what we call macro attributes. So, those are things that how do the assets sensitize when it comes to valuations, when there's movements in GDP, inflation expectations, business cycle, how much of it is cyclical, how much it is not. So, through all of that, I guess you needed to have kind of a very defined codified framework to think about that because it's quite a broad topic, it's really quite heavy from a calculation standpoint. So, we spent a lot of time architecting around that to try and get some sense around it. And we partnered with Cambridge University here in the UK, which are their Center of Risk Studies, which was the think tank that we were part of, which had insurers, banks, risk managers, all looking to price risk as part of their products. And we were coming at it from essentially the investment side.
So yeah, it's been the foundational process that allows us to underwrite each of our assets into our portfolio. And as a result of that, we can sort of create a little bit of telemetry across the portfolio that perhaps others haven't been able to do historically. Starting from the really basic questions like, "Let's look at an investment, let's look at it’s cash flow profile. When do we expect the cash flow to come back, whether it's a credited asset or a sale of a business, and what is the propensity of that cash flow to turn up on time as I describe it." Because these things are all variable and you've got differing rates of uncertainty. So, when we build a portfolio, it's not just a collection of assets, we try to synthesize that into what are the key drivers of the portfolio intrinsically from the asset level all the way up to the portfolio.
And then what are the main key risk elements that whether it be interest rate risk, if that's going to affect the cash flow by meaning the company can't pay its interest payments because it's on floating rates and it goes bust. Or on the credit side, it might be beneficial to us to have a floating rate plus spread loan in the portfolio. So yeah, it's very used very much at the center of our global private markets program because it's very difficult to provide any kind of consistency around language across even inter-asset classes by geography. So, if we're building a port in Latin America, or if we are owning a gas pipeline in the Nordic, or if we happen to have a residential building in China, we've got to try and bring all of those things together to say how much risk are you taking in the portfolio. And you've got to be quite systematic about that. And I think that's the beauty of PRISM, is it really, it's a neat acronym, but it sort of allows us to have a different lens across the portfolio mix.
Stewart: Whenever I'm talking with someone like you, I put on my CIO hat that has been lent to me by my CIO buddies that are like, "You can put this on, but just only during podcasts." I'm like, "Okay." So, if I'm an investor and I'm looking at making an allocation with abrdn and I'm trying to figure out - what does PRISM do for me as an investor or client of yours?
Nalaka: So, it really gives them, I guess, a number of lenses to look at your portfolio through. So, if you are just looking at a really basic level, how to allocate capital efficiently into the marketplace by asset class, it'll give you through all the data that we've collected in the cash flow profiles that we've seen over the years, what we think the expected draw-down distribution profile looks like. And then you've got to ask some questions around is the expected return realistic or not? And then that takes you to the next level of, I guess, understanding that if you are expecting a cash flow to turn back to you in seven years' time, that's going to be driven by a number of things. How much of that, let's say it was a private equity asset, was going to be driven by earnings growth M&A activity multiples changing, and the liquidity in the market at that time to exit the asset.
So, any of those variables change, that changes the exit about the quantum that you're going to get in the future. And because we're talking about the future, there's a high degree of uncertainty, particularly five, seven, 10 years out when some of these assets are due to mature. So, you've got that long-term perspective that you've got to kind of build in. And then there's the near-term stuff, which is like we talked about earlier, is what happens now, what happens if there's a credit crunch? What happens if there's no liquidity in the market? I can't just trade these things out of the portfolio like I can on the liquid side of the market. So, I really need to be monitoring some of these things. And what we've really tried to do there is to be more like a credit analyst in that context. Let's just monitor these assets, make sure we're getting the data in from our managers, and there's a high degree of variability of the data that you get depending on how big you are, how important you are from some of these private equity or private markets managers.
And so, we negotiate quite heavily to get high-quality of direct information from our managers. Legally we're signing that up into limited partnership agreements and things like that to make sure we have that information flow. And then just having good access to management to make sure that we really understand their strategy and leave them to do what they do best, which is to manage the assets. But at a portfolio construction level, a client will be able to say, "Actually I know what I'm exposed to because typically sometimes they don't even know where their assets are in some cases." And then be able to build a, I guess a risk framework around that. And we've taken, I guess, an enterprise risk approach to that to say, "Well, what are the things that are going to break the portfolio? What are the things that are going to impact the portfolio materially to create defaults and ultimately zero out your return."
And if we think about all these things as sort of streams of cash flows, it sort of simplifies it a little bit, but under the hood, there's actually quite a lot of detail that needs to go into working out if whether these private assets are going to deliver performance or not. And in the most part they will. The question is how much and whether you're getting paid for the risk.
Stewart: Yeah, it's interesting when I taught, I mean taught finance in a number of different flavors, but at the end of the day, finance is about valuing cash flows in and out and you're trying to assign a risk some probability the certainty of those cash flows, the timing of those cash flows and assign a discount rate to them that is appropriate for the risk. And then you're trying to look at the what is that NPV versus what I can buy it for in the market and what factors are going to or have the potential to impact that.
So, one of the things I've said over time, and I don't know how it will strike you, but the most dangerous risk you face is the one you aren't aware of. I think sometimes things happen in financial markets and you saw it with SVB, right? You go SVB goes down, and a couple of others have too. And there wasn't a default, there wasn't a problem with the quality of their assets, it was they didn't manage their ALM properly. So, in my notes, I have risk transparency before risk optimization. That seems like philosophically you're trying to make sure that you understand the risks that you're exposed to. Can you expand on that?
Nalaka: Yeah, absolutely. I think a lot of people try to optimize in different ways and they use methods or techniques, which grounded in good financial theory, but not particularly applicable when it comes to private market assets. So, in order to really understand these assets, you need to know what's going to break them, and that's where risk transparency is important. You need to know some stuff that you wouldn't be able to get otherwise. And once you've got that sort of minimum data set, you can enrich it. And it's going from basic financial data to then what we describe as sort of operational KPIs to then, and what we're describing is sort of real-world risk tagging things that are appropriate, how much of your revenues are coming from certain geographies? What's your headquarters, what are your logistics? Where are your assets located physically in the event of dealing with what I call the kind of localized issues, which would then become macro issues.
So, you happen to own a real estate or real asset portfolio with be infrastructure assets would've said it kind of matters where it's, and if we think about environmental issues, if there's water stresses or heat stresses or if there's geopolitical tensions, things like that, then these types of things start manifesting itself. And so, once some of this stuff, the risk transparency then allows you to optimize the portfolio in different ways. So, how much, if you want to take a lens across the portfolio to say, "Well, how much of my revenues in this portfolio are associated with a particular feature or attributes?" You can then look through the portfolio in that way, then you can run a kind of correlation engine against it to say, "Well, what happens?" In public markets some of these companies, they operate in real life, but if these events happen, how do you expect them to respond?
And the work that we did with Cambridge was really codify, I guess a taxonomy or business risk. And we probably have a separate podcast just on that because there's so many different types of things that business risks and business are trying to deal with from macro issues, supply chain, cyber security, natural disasters, all that kind of stuff. And so, that allows us to do two things. One, when you've constructed your portfolio, it was a bit like the old days when people used to say, "Well, stock selection's brilliant, I'm really good at picking names and they can make money." And then you find out they're all stuck in kind of oil and gas. When the market selling off, right? You're like, "No, no, individually they're brilliant, but actually they're clustered."
So, we're doing the same thing on the private side we're sort of understanding where the cluster of risk lies, and then trying to sensitize that. And we've done that through, I guess you described it before, it's that DCF approach around the free cash flows. What happens when you stress those free cash flows and how do you price the discount rates? And one of the metrics we sort of landed on as what we describe as EV or EV at risk, which is enterprise value or earnings value at risk. To say, when one of these events happen there's different likelihoods and severities, but when one of these events happen. How much of your earnings ultimately are going to get diminished or how much CapEx or cash flow are you going to have to apply to remedy something, which will then ultimately change it across the capital or how a market perceives you and which will then drive value.
And once you have that lens on it, you can actually say, "Well, actually this thing is pretty bulletproof, or it takes quite a lot to break this basket of assets once we've got those sort of attributes associated. And we've been running the global program and this format, so it's five years now, and we've been through probably the most volatile marketplace I've ever overseen. And having this sort of lens associated with the portfolio has really been brilliant from that standpoint. And it's good to explain it in a really a simplistic way to our clients because all of the technicals behind the hood are very complex and we do all that work.
But actually when we explain to them why we've chosen an asset, how it fits into the portfolio, why it's resilient for those features, and why we think it's going to be robust over a five, 10, 20-year period, I think it gives them a little bit more confidence that they're not buying a collection of assets, they're actually buying a portfolio that's been curated appropriately. And that's what I would say it gives to a client. It gives them ability to look at a portfolio with some confidence around its expected outcome.
Stewart: You are in a unique position to have a global perspective and $500 billion behind you. As you look out today, where do you see value in private markets, and what concerns you?
Nalaka: So, it depends over, I guess, what timeframe, but in terms of deploying capital over the next 6 to 12 months, I think the rates in inflation environment is probably the biggest concern about what that does it'll... from an asset allocation perspective, you don't have to carry the same amount of risk to generate, let's call it mid-5, 6% returns now. So, what that means is that a repricing exercise is likely to happen in the near term to deal with, let's call the inflection point of inflation rates. And the next, where we think the lower bound that it sits, if the lower bound is high, where it's going to be rough, if the low band is low, we'll end up going back to kind of a world where asset and risk assets are probably okay. So, that's sort of the macro piece of that. And I think that's sort of where we see value could lie in short duration, private credit, for example, where you've got high base rates and high margin as a result of people paying out for flexibility of finance, the ability to deal with working capital more effectively.
So, we're seeing quite good spreads in total returns in private credit. And I think the interesting thing about that is that whilst those returns are good, as well as the default propensity that's associated with the underlying corporates, so whilst capital formation is happening in a different way now and the banks perhaps have less balance sheet capacity and the traditional lenders are being kind of taken by private credit lenders, the risk that those underlying corporates are under or the stresses that they're under is actually potentially mispriced in some parts of the market. So, we're sort of looking at that quite carefully, but there is quite strong value to be had in private credit markets. The looking at private equity and venture capital. Venture capital probably got a bit frothy a little while ago and continues to be frothy in some segments. But we've just seen, I think, we're on the cusp we're probably working through some form of fourth industrial revolution with AI and automation really kind of taking to the force.
So, we will see some really productive companies come out of the use of digitization, and that really excites us from our where can some of these companies generate growth and profits and reduce their overheads and CapEx requirements, but actually have strong earnings growth. So that, I think value lies at that. I think multiples are still pretty expensive, so we'll sort of see how that comes through. But there's some very strong indications that private equity and venture capital will continue to generate strong returns, but don't get caught up in the hype cycle. Make sure you look at the assets and understand which of these businesses are going to be transformational. I think infrastructure, because of decarbonization and what's going around globally and the policy responses that are happening to either fund transitional assets or moving from carbon to less carbon-intensive will have very long-term drivers which show value.
And I think at different points in the cycle, depending on the policy responses are playing out by country, by country, we've seen lots of subsidies put in place that have been released. But as these things become more mainstream, the risk of stranded assets is something that you need to be conscious of. And then looking at the next generation of energy, both generation and distribution and carbon-intensive sort of industries, I think will be really interesting space going forward. So yeah, there's a lot happening globally and by asset class. I think there's definitely nuances in which segments in markets are being driven by public policy as well as local initiatives, but it's a pretty fascinating place to be investing at the moment.
Stewart: I have learned so much from you. I really appreciate you being on. I've got one more wrap question. I've got two. You can take your pick. Best piece of advice you ever got, or who would you most like to have lunch with alive or dead?
Nalaka: Ooh.
Stewart: You like the latter question. I love it. That's great.
Nalaka: If I could and if I could speak Italian, I would love to have sat down with Leonardo da Vinci.
Stewart: Wow, there you go. That's so cool.
Nalaka: Yeah, people that are visionaries in their space and can do the things that they did at that time would be-
Stewart: It's remarkable.
Nalaka: ... would be fascinating.
Stewart: That's so cool. Well, I've learned a lot today, and I really appreciate you being on, Nalaka. Seriously, thanks for taking the time.
Nalaka: Thanks for having us. And yeah, look, if anyone wants to discuss this type of topic, and if you want to grab a table, kind of like-minded, thoughtful investors that want to kind of trade notes, would love to do that and we can do it again.
Stewart: Absolutely. Thank you so much. We've been joined by Nalaka De Silva, Head of Private Market Solutions at abrdn. Thanks for listening. If you have ideas for podcasts, please shoot me a note at podcast@insuranceaum.com. Please rate us, like us, and review us on Apple Podcasts. We certainly appreciate it. My name's Stewart Foley and this is the InsuranceAUM.com podcast.
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