View: ADIA Management Insourcing Rises, Alpha Hunt Intensifies

June 08, 2015 by Loch Adamson

ADIA discloses sharp increase in internally run assets
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In its new annual report, Abu Dhabi’s biggest sovereign wealth fund disclosed a sharp increase in the percentage of assets it runs internally, plus a new "high conviction" allocation.

Sovereign wealth funds move slowly. As large long-term investors, they don’t often shift large parts of their portfolios around – or change strategies on a whim. But over the past four years a sea change has swept over one of the more cautious sovereign wealth funds: the Abu Dhabi Investment Authority (ADIA), which according to a Sovereign Wealth Center (SWC) estimate now has some $620 billion under management.

Last week the fund released its sixth annual report as evidence. ADIA started publishing such reports in 2010 as public concerns over sovereign wealth fund opacity were at a peak. True, the publications are often derided for not providing basic information like assets under management, annual returns or a precise asset allocation. But close reading proves them enlightening nevertheless, describing in detail, for example, how each investment department has reacted to global market trends over the preceding year.

From 1997 until 2011, 80 percent of ADIA’s assets were managed by external asset managers. In 2012, as the fund added new management in several asset classes, this percentage shifted slightly, with a five percent reduction in the amount of the portfolio turned over to outside investment teams. At the time, ADIA’s decision was broadly in line with those of its peers, many of which started to aggressively insource management to gain greater control of strategy, reduce fees, and facilitate the transfer of investment know-how following the financial crisis.

But in 2014, according to the annual report, ADIA took the major step by allocating a further 10 percent of its assets to internal teams, bringing the percent overseen by external managers down to 65 percent from 75 percent. This might not seem like a big deal, but even at SWC’s conservative assets under management estimate, that means ADIA has withdrawn some $62 billion worth of mandates from external firms. That’s bound to generate a lot of very unhappy portfolio managers.

Conservative Legacy

The change also speaks to ADIA’s strategy of reducing the number of managers it uses to enable it to build stronger, more transparent and increasingly meaningful relationships with a smaller number of firms and individuals. The rise in internally managed assets is also likely a function of ADIA’s expansion of its real estate and infrastructure programs, which are largely run internally, and its increased appetite for direct private equity investments, which are also managed inhouse. ADIA has been building its expertise in these types of investments since 2007. Last year, notably, the state-owned investor increased its headcount in its real estate department.

As it insources, ADIA seems to be shifting its strategy. While 55 percent of its portfolio remains indexed, the fund’s risk tolerance appears to be rising in its actively managed allocation. In a somewhat contrarian stance, ADIA has often chosen to use internal teams to oversee riskier types of investments. By doing so it has greater visibility into specific strategies and more control over individual investments.

For example, in 2013, the fund chose to add allocations to such developing markets as emerging Europe, Latin America and South Africa via its internal equities department. In 2014, this trend continued with a new and notable so-called high–conviction stock allocation, in which internal managers make sizeable bets on a small number of companies they strongly believe will outperform the market, generating so-called alpha, performance above the benchmark, as they do.

Accordingly, ADIA appears to be shedding its conservative legacy and looking to leverage both its scale and long-term time horizon to make generate higher returns. The strategy may be working: Since 2008 the fund’s 30-year annualized return has risen from to 8.4 percent from 7.6 percent, according to its annual reports. Its more-volatile, 20-year annualized return rose 7.4 percent in 2014 from 6.1 percent in 2008.


A paragraph in the managing director’s letter, from Hamed bin Zayed Al Nahyan, speaks to a more radical shift.  In 2014, Al Nahyan explained, the fund made a number of changes in its investment procedures.

"Most notably, this included the development of a new operating model for our investment departments that will increase the flexibility of managers to target 'alpha’ opportunities that may not easily be captured within the structure of ADIA’s neutral benchmark, or policy portfolio," he wrote. "These activities will empower our skilled investment managers to seek outperformance, within agreed limits."

For those who know ADIA, this is a major departure indeed. Such a strategy seems influenced by the so-called strategic tilting model that was pioneered among sovereign wealth funds by the $21.5 billion New Zealand Superannuation Fund, with which ADIA has been working on private equity deals through the Innovation Alliance.

While ADIA might not have metamorphosed into a quick-moving or risk-hungry investing dynamo, 2014 was a year of powerful change for the fund, one that has seen it adopt new models that may enable it to better leverage its strategic advantages — scale and long-term investment horizons. By doing so, it hopes to to capture the benefits of secular trends and find alpha by exploiting market dislocations.

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