ADIA Retools to Run More of Its Own Money

June 14, 2013 by Loch Adamson

ADIA is getting bolder
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THE ABU DHABI Investment Authority (ADIA) has long been better known for its vast size than for its investing prowess. But the giant sovereign wealth fund is getting bolder, actively recruiting senior investment professionals to run more of its assets in-house and reduce its dependence on market—mirroring passive strategies. The shift is subtle but striking as ADIA retools to engage more closely with global investment markets — and reap higher potential returns as a direct investor.

In its latest annual review, released on May 27, ADIA signaled its growing disaffection for developed markets and its increasing focus on emerging economies, which are now responsible for an ever-rising share of global growth. The fund also revealed that it has reduced its exposure to index—replicating strategies, from 60 percent in 2011 to 55 percent in 2012, and has lowered the percentage of assets managed externally, from 80 percent in 2011 to 75 percent in 2012.

"ADIA is in the process of reallocating to some asset classes where in-sourcing — and having their own investment team — can buy the fund more returns," says Rachel Ziemba, London-based head of global emerging markets for New York–based macroeconomic research firm Roubini Global Economics. She sees the shift as a natural progression away from the passive, heavily indexed, listed-equity strategy ADIA established approximately six years ago. In the current market climate, Ziemba says, managing a greater percentage of listed equities and illiquid assets in-house "may just make more sense."

The shifts are subtle, but even minor adjustments in ADIA’s allocations can result in significant changes in investment dollars given the size of the fund’s portfolio. According to Institutional Investor’s Sovereign Wealth Center, ADIA oversees approximately $365 billion in assets. Admittedly, this is a conservative estimate, but at that level, even a 5 percent increase in the share of assets run by the fund’s internal teams can equate to nearly $20 billion, a tidy sum. No matter how much money ADIA currently invests in-house, the fund is clearly seeking greater flexibility to match its massive portfolio to areas of potential growth and reduce its exposure to underperforming markets, particularly in Europe.

ADIA's Portfolio Overview by Region

ADIA’s success in navigating volatile markets is difficult to gauge because the fund doesn’t disclose specific asset allocations or reveal its size or annual performance, but it does provide a long—term view of its returns. In its latest annual review, for example, ADIA disclosed its annualized returns over 20- and 30-year periods. Last year ADIA’s portfolio claimed a 20-year annualized return of 7.6 percent, indicating that the fund had achieved positive performance in 2012 — 2011’s 20-year annualized return was 6.9 percent. Its 30-year annualized return was a healthy 8.2 percent in 2012, up from 8.1 percent at the end of 2011.

According to its 2012 annual review, ADIA has once again lowered its allocation range for developed-market equities, reducing the upper and lower limits of its so—called neutral benchmark portfolio range by 3 percentage points, from 35 to 45 percent in 2011 to 32 to 42 percent in 2012. ADIA made no corresponding increases to any other asset classes in its neutral benchmark portfolio. Irrespective of asset class, ADIA has given its team leeway to reduce the fund’s regional exposure to Europe, lowering its neutral benchmark for the region across all asset classes from a range of 25 to 35 percent in 2011 to 20 to 35 percent in 2012. The shift indicates that ADIA has accepted that some of the pressures on developed markets are here to stay.

"As we enter 2013, the landscape looks much as it has for several years," wrote Sheikh Hamed bin-Zayed al-Nahyan, one of the late emir Sheikh Zayed bin–Sultan al-Nahyan’s sons and ADIA’s chief executive, in the investment letter that accompanied the latest review. "Many developed market economies are struggling with the effects and consequences of the global financial crisis. It has become clear that the challenges of unemployment, fiscal reform and deleveraging will persist for some time."

RGE’s Ziemba sees ADIA’s willingness to reduce its exposure to developed markets, particularly Europe, as a sign of the fund’s desire to be more nimble and refocus its investment efforts on areas of greater interest, such as emerging markets. "Europe is going to be a region of much slower growth — even among developed markets and the U.S. — because of its self-inflicted austerity measures," she says. "Having the flexibility to move around a bit more is important for ADIA, but I think the most critical question now is how a fund of its size takes advantage of that flexibility."

Over the past year ADIA has been staffing up to increase its in-house talent pool and deepen its expertise in specific asset classes. Since 2011 the fund’s total head count has risen from 1,275 to approximately 1,400 employees. Since January, ADIA has hired Gregory Eckersley, who previously ran New York–based AllianceBernstein’s global and large-cap growth equity portfolios, as its new global head of internal equities, and recruited John McCarthy, who was global head of Rreef Infrastructure for Deutsche Bank in its London offices, as its new global head of infrastructure.

With Eckersley now leading ADIA’s internal equity investing, the fund appears destined to become even less reliant on external equity managers. In 2012, according to the review, several internal equities teams outperformed their benchmarks and — in recognition of their success — ADIA allocated additional funds to a range of existing mandates covering Europe, emerging Europe, Latin America, South Africa and the more thematically named equity opportunities portfolio. ADIA merged its Gulf Cooperation Council and Middle East and North Africa equity portfolios to increase its ability to make tactical allocations across countries in those regions. In 2012 the fund received approval under China’s Qualified Foreign Institutional Investor (QFII) program to raise its onshore equity investment ceiling from $200 million to $500 million. In January 2013 ADIA applied for, and received, an increase in its QFII quota to $1 billion, making it one of only six institutional investors to have the maximum quota as of April 30, 2013.

In ADIA’s fixed-income and treasury department, high-yield bonds and emerging-markets debt performed particularly well in 2012, notching up double-digit returns and rivaling listed equities’ performance for the year, according to the fund’s review. During 2012, ADIA introduced an allocation to non-investment-grade credit to its strategic neutral fixed-income benchmark and subsequently sought external managers that could deliver on that strategy with strong uncorrelated returns. ADIA implemented the new sub-investment-grade credit program progressively over the second half of 2012.

ADIA’s alternatives team benefited from added intellectual firepower in 2012. Under the leadership of Benjamin Weston, who joined the fund in late 2011 as global head of alternative investments from Geneva-based asset management firm Helvetica Wealth Management Partners (where he’d served as CEO), ADIA hired staff across all three of its alternatives mandates: commodities, managed futures and hedge fund strategies. Weston’s team has also recruited investment professionals with specialist quantitative skills to enhance ADIA’s manager-level analytics and portfolio construction. In the future, ADIA says, it expects to become more active in seeking out special opportunities in alternatives that align well with its areas of existing expertise.

Like so many of its sovereign wealth fund peers, including the Qatar Investment Authority and the Government of Singapore Investment Corp. (better known as GIC), ADIA has also been active in commercial real estate markets, especially in so-called gateway cities such as London and Paris. But the competition for deals is fierce, especially in London, where prices have climbed relentlessly despite the U.K.’s weak economy. ADIA’s team opted to take advantage of the commercial real estate market’s strength to sell selectively and reallocate capital. The real estate team, in alignment with ADIA’s drive to expand its own talent pool, is working to develop its in-house systems to support more direct real estate investments. In infrastructure ADIA made a number of new investments in 2012. Most notably, it participated (through a subsidiary) in the consortium that acquired Essen, Germany-based Open Grid Europe, Germany’s largest gas transmission pipeline company, for €3.2 billion ($4 billion) from German electric utility service provider E.ON.

Last, ADIA was active in private equity in 2012, making new fund investments as a limited partner, participating in the secondary market by buying other limited partners’ stakes and making principal (direct) investments in the market. Like many large, sophisticated sovereign wealth and pension funds, ADIA has been increasingly focused on gaining more control of its deal pricing and terms by negotiating investments with external managers and companies. The fund has been on a roll, hiring senior investment professionals to enhance its capabilities in private equity and adding new heads of principal investments, emerging markets, U.S. funds and risk in 2012. ADIA disclosed in its annual review that the private equity department’s expansion will continue selectively in 2013.

The sovereign wealth fund’s increasing focus on building in-house expertise has not been limited to its investment teams. ADIA has also reorganized internally to achieve greater efficiency in executing its own trades. During 2012 it upgraded several support teams to stand-alone departments, including central dealing, which provides trade execution services for ADIA’s investment teams across a range of securities. The department is capable of executing trades in global equities, fixed income, foreign exchange, money market and related derivatives. (The human resources and general services teams also received full department status is 2012.)

The evolution of ADIA’s internal asset management team and systems may ultimately give the fund greater insight into global markets as it seeks out opportunities in far-flung regions. "ADIA has been organizing trips for its staff and sending them out to gain a clearer, more holistic view of what is happening in some countries," says RGE’s Ziemba. "The fund is really seeking to establish more points of contact to gather information."

ADIA’s Sheikh Hamed leaves little doubt that the sovereign wealth fund’s team will be conducting much of its research in emerging markets. Although ADIA last year did not raise its regional benchmark range, which permits the fund to invest 15 to 25 percent of its total portfolio (across all asset classes) in emerging markets, it remains deeply committed to these young markets. "Economic leadership is passing to emerging markets," Sheikh Hamed stated in his investment letter, "not just as their weight in the global economy passes 50 percent, but as their share of likely future global growth moves far higher." Although their individual prospects may vary, he added, emerging markets continue "to offer exciting and attractive opportunities to deploy capital."

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