Money and mystery: Adia unveils its secrets
Abu Dhabi Investment Authority is one of the world’s biggest institutional investors. It is also one of the most guarded. It publishes no numbers. It seldom makes any public statements. In a rare interview, two of its most senior officials lift the lid on the organization, revealing the reasons for its success. Sudip Roy reports from Abu Dhabi.
IT’S ONE OF the most powerful financial institutions in the world but little is known about it. The Abu Dhabi Investment Authority has an influence in the markets that few investors can match. It has unrivalled access to the best strategists and advisers. Banks and fund managers fall over themselves to win its business. It can hire the brightest talent at home and abroad purely on the strength of its name. Two things make Adia special. It manages the emirate’s excess oil reserves, estimated to be as much as $500 billion. Its portfolio grows at an annual rate of about 10% compounded. As such Adia is the world’s second biggest institutional investor, behind only the Bank of Japan, according to the Oxford Business Group. Its pulling power is immense. According to a former HSBC banker, it’s one of the few organizations Stephen Green, or his predecessor as chairman of HSBC, John Bond, will drop everything to go and see. They won’t be the only senior bankers and corporate executives prepared to do this.
But what makes Adia so interesting is the veil of secrecy that shrouds its activities. In the 30 years since it was established, it has never publicly declared the amount of assets it has under management. Its website lists just its contact details; nothing more.
Money and mystery make a potent mix. It has helped Adia create a unique aura. Any hint of what it’s about to do can move markets. “That’s the power of the Adia name,” says Saeed Mubarak Al Hajeri, executive director of the organization’s emerging markets department.
There is little that catches the eye about the four grey-brown buildings on 125 Corniche Street, where Adia has its headquarters. Inside, too, the décor is plain. There is no grand reception area or waiting room. The offices are simple but spacious enough for the 1,300 people who work there. It’s standard fare for a government organization. Certainly there is nothing to suggest that this is home to one of the world’s wealthiest investors (although the organization is expected to move to a more fitting waterfront skyscraper later this year).
Adia was established in 1976 by Sheikh Zayed bin Sultan Al Nahyan, the founder of the United Arab Emirates. The goal was to invest the Abu Dhabi government’s surpluses across various asset classes, with low risk. It was a bold move. At the time it was novel for a government to invest its reserves in anything other than gold or short-term credit. Even today, investment in short-term paper remains the strategy for the vast majority of countries, although Kuwait, Singapore and Norway have followed Abu Dhabi’s lead.
Over the years, though Adia has become more sophisticated as an investor, its central tenet has not changed. “We are not speculators,” says Al Hajeri. “We don’t like to change companies or try to take out the management. We are long-term conservative investors.”
Diversification is the key to Adia’s investment ethos. It invests in all international markets – equities, fixed income, real estate, private equity and alternatives (hedge funds and commodity trading advisers – CTAs). This multi-asset approach helps to reduce risk.
Adia has one global portfolio, which is then broken down into sub-funds covering a specific asset class. In equities, for example, the specific asset classes include European equities, US equities, Japanese equities, Australian equities, regional small caps and emerging markets equities. In fixed income, the specific asset classes include global government bonds, global investment-grade credit, emerging markets and global inflation-indexed bonds. Cash is another separate asset class.
This segregation of specific asset classes allows for a more specialist approach to investing. Jean-Paul Villain, head of investment strategy, provides the example of inflation-indexed bonds. “We did not want the guys in charge of nominal government bonds to have the flexibility of investing x% in inflation-indexed bonds,” he says. “It’s a proper asset class. It has [its own] drivers.”
Each asset class has its own fund managers and in-house analysts covering it. Each has its own benchmark and guidelines. Each is managed through a range of investment strategies and techniques. In emerging market equities, for example, investments are made on a regional basis but also on a country one for China and India.
In addition, some products employ both active and passive investment styles, although the extent to which one style is favoured over the other depends on the specific asset class. Guidelines are tighter for government and inflation-linked bonds, for example, than for emerging markets debt and investment-grade credit.
What further defines Adia is its use of third-party fund managers to complement its in-house portfolio investors. Almost every asset class is managed both internally and externally. Overall between 70% and 80% of the organization’s assets are managed outside. The aim, says Al Hajeri, is to bring that down to between 60% and 70% without upsetting Adia’s low-risk profile.
“If it’s a new asset class, for example, we rely heavily on external managers but the goal is to move at least 40% internally,” he says. “We also try to diversify the risk so that 60% would not be with one manager.”
Some products have a higher proportion of funds placed with external managers than others, adds Villain. “It’s clear, for example, that we’ve never had internal expertise on Latin America,” he says. “Our Latin America exposure is 100% managed by external managers.” In Asia it’s different. There, 30% is managed externally.
Choosing external managers is as important a task as managing the portfolio itself. Adia has access to consultants’ databases detailing the performance of thousands of funds. But it also has a dedicated in-house team, whose job is solely to pick third-party investors for each asset class. Most members of this team have graduated through the Adia ranks and are usually very senior specialists, with 15 or more years of investment experience. Almost all are former fund managers. “You can’t select managers unless you understand the asset class,” says Villain. “You can’t just rely on statistics.”
The selection process is rigorous. Funds need at least a five-year track record before they are even considered – unless it’s a new market. But performance is just one element of the decision-making process. “We use quantitative and qualitative measures to select external fund managers,” says Al Hajeri. “On the quantitative side we consider track records, standard deviation, tracking error, what the Sharpe ratio is. Then we look at the quality of the team, the depth of the team, and the quality of the reporting.”
He adds: “Performance, methodology and the people who are running the teams – these are things you need to consider. If the [fund manager] is consistent in the methodology, and the methodology itself underperforms, then it’s our fault for investing in it.”
Every manager is measured against an appropriate benchmark. “If a manager says he is a value investor, then we’ll give him a value [investor’s] benchmark,” says Al Hajeri. If the manager consistently underperforms, the contract is terminated.
Similar criteria are applied to the in-house portfolio managers. “If they don’t do very well we can close the fund or index it or give it to another team to manage. There are so many ways of dealing with underperformance,” says Al Hajeri.
Because Adia has one global portfolio and its own customized benchmark, it is difficult to measure its performance against other pension funds. But Villain says the structure works well for Adia. “We all know that in this business you can brag about your performance in a certain asset class but when you have everything consolidated and you have a proper performance system you know exactly what you have done across all of your assets, which is important,” he says.
Adia, he points out, has outperformed its own benchmark overall. Indeed, because the organization’s investments are spread throughout the world’s markets, its investment portfolio performs at its best across the board when oil prices remain low. Most of its returns are generated through beta, though it seeks alpha wherever it can. “No one can generate alpha in each asset class every year,” says Villain. “But on balance, over the past 15 years, we have delivered above our benchmark. Our portfolio is more diversified than most pension funds’. The real challenge is to deliver decent returns without too much volatility.”One way in which Adia delivers performance is by identifying a new asset class early and then investing in it. “When you structure a portfolio, you try to identify what you can expect from this [new] asset class, what are the drivers, how will it correlate with what we already invest in,” says Villain, who first joined Adia in 1982 before leaving to head Paribas Asset Management in 1987. He rejoined the Abu Dhabi organization in 1992.
Adia’s record shows how prescient an investor it can be. It was an early mover in inflation-indexed bonds and the emerging markets, for example. It was also an early investor in hedge funds, back in the mid-1980s, although Villain admits it was almost by accident. The organization had some physical commodities that it wanted to sell, which it did through specialist commodity traders, who were using long/short strategies. Adia found the asset class attractive and migrated from CTAs to hedge funds. As for private equity, Adia first invested in the asset class in 1992, initially in Europe, and then globally later in the decade. Today it is one of the biggest investors, possibly the biggest according to some observers, in global hedge funds and private equity in the world.
The asset allocation, which is a mix of strategy and tactical calls, is overseen by a committee comprising Al Hajeri; the head of Europe; the head of real estate; the organization’s deputy managing director; and the undersecretary of the finance department. The committee meets quarterly. Villain, who is effectively Adia’s chief investment officer, reports to it. He has great influence as it is his job to provide the broad strategy. Then it is up to the individual asset managers to implement the strategy for each asset class. “The structure is very simple,” says Al Hajeri. “Jean-Paul would say to the people managing emerging markets, for example: ‘This is your index, you have to beat it.’ If the market falls by 30%, it’s not the manager’s fault. It’s Jean-Paul’s. But the manager has to beat it. He has to make sure he’s not down 30%.” Asset allocation is the biggest macro call that Adia makes. But it is important that any changes to the asset allocation do not adversely affect the structure of the portfolio or create too much volatility in the markets.
“What we have tried to do in terms of the asset allocation,” says Villain, “is to put in place a structure where we will have the asset allocation strategy systematically rebalancing to the benchmark and tactical bets taken as an overlay.”
One way Adia likes to buy or sell securities is through using derivatives, such as futures. Adia can use futures without hitting the market and without moving the price against itself. This approach also allows Adia to be more discreet, as most of these futures contracts will not be exchange-listed.
However, this approach is proving a challenge because of the large amount of money that Adia receives. Last year alone, it took on about $30 billion from the Abu Dhabi government, assuming an average oil price of $60 a barrel. This means that there is constant rebalancing of the portfolio. If Adia’s managers want to reduce its weighting in a particular asset it can do so automatically every time the portfolio’s size increases, through the monthly instalments of fresh funds. Conversely, if Adia wants to maintain its allocation in an asset, it has to invest more in it. “We try to manage the portfolio based on the outlook for the next six to 12 months and not on the current situation,” says Villain.
Supporting the asset allocation strategy is thorough research. Each asset class has its own set of about 10 analysts armed with PhDs and MBAs. Adia has particularly strengthened its credit research team over the past two years, with at least six hires from leading investment banks in Europe. In addition, Adia’s analysts have access to the best research put out by brokerages worldwide, although Villain questions how helpful outside research can be.
Although he reckons the quality of external research is relatively good, one problem is that it tends to be too insular from a global portfolio point of view. “If you are an analyst on the banking sector,” he says, “how can you recommend an overweight position in banks if you don’t know the rest of the market? Very often people make mistakes in portfolio management because they take too many bets that they don’t control.”
Still, research is a very powerful element in Adia’s investment process. “Everything we do is driven by research,” says Al Hajeri. There are two approaches to research. One is the bottom-up approach that focuses on companies and sectors. The other is top down that looks at the global picture. “These approaches match, and that’s where the stock selection and decision-making come in,” says Al Hajeri. “A big layer on top of that is the asset allocation.”
Adia’s asset allocation split is roughly 50% to 60% in equities, 20% to 25% in fixed income, 5% to 8% in real estate, 5% to 10% in private equity and 5% to 10% in alternatives.
One trend over the past few years has been a greater allocation towards fixed income.
“Historically, Adia has allocated more to equities,” says Villain. In days gone by, it was not unheard of for 65% to be invested in equities, although today its biggest exposure is to non-US equities. That’s because Villain reckons that, on a relative basis, equities offer better value than bonds. It’s reckoned that Adia has investments in much of the Fortune Global 500.
What is interesting about Adia’s asset allocation split is how similar it is to other big institutional investors. Take the California Public Employees’ Retirement System (Calpers), which has just over $200 billion of assets under management – about 63% invested in equities, 25% in fixed income and 4.5% in real estate. But, as Villain says about Adia: “What’s important is not so much the vision, because I think most investors share the vision, but that you execute it and that you put in place the structure and the organization.”
One of the most impressive aspects of Adia’s asset allocation strategy is that it has the courage of its convictions. “I think everyone is agreed that Asia represents a growing part of the world economy but most people don’t do anything about it,” says Villain. “I like HSBC very much but they have 12 or 15 pages on why Asia is going to grow over the next 25 years and then the recommendation is, the benchmark is 4.5%, to put 5%. If you believe in the story and you have done your research you should have a different allocation. So it’s not that we’re different. We try to [implement our views] in our portfolio, though it’s not an easy task.”
“If you have a view that an asset class is attractive over the long term,” he adds, “you should reflect it in your benchmark.”
One of Adia’s favourite asset classes is emerging markets. It is overweight in both emerging markets debt and equities, and this is reflected in the benchmark. Its exposure to emerging markets equities accounts for 14% of the fund’s equity portfolio. “What we have invested in emerging markets equities is far greater than what the biggest US pension fund would have – many times more,” says Villain. Adia is bidding for a 2.5% stake in state-owned Industrial and Commercial Bank of China and plans to invest more in India and Russia.
|“If the fund manager is consistent in the methodology, and the methodology itself underperforms, then it’s our fault for investing in it” Saeed Mubarak Al Hajeri
“If you look at how the world is going to develop over the next 15 years, it’s clear that one-third of economic growth will come from the emerging markets, one-third from America and the rest will be split between Europe and Japan. At the end of the day, when we invest in equities, we have to invest in economic growth. Of course, the bet you have to take is that economic growth will be reflected in the financial markets,” adds Villain.
On the fixed-income side, Villain says US treasuries are attractive at the current level of interest rates. The UAE central bank might be planning to switch 10% of its foreign reserves from dollars to euros, interpreted by some observers as a response to Washington’s snub for Dubai Ports World’s bid for P&O (the central bank governor denies this and says it’s just part of its diversification strategy). For Adia, though, investing in US government bonds make sense, especially as 10-year US treasuries are yielding 4.74% and the US will continue to be one of the main engines of global growth. Moreover, as Villain points out, there is no real alternative to the US dollar as a reserve currency. As a long-term investor he is uncertain about Japan’s and Europe’s economic prospects, especially as they both face demographic issues. Instead, he is turning his attention to the world’s two most populous countries. “The world needs an Asian currency to emerge as a real reserve currency. As long as the currencies of India and China do not become alternatives, I don’t think there will be a real change in currencies.”
Villain says that Adia is reviewing its fixed-income exposure in two ways. First, with so many Latin American sovereigns buying back their dollar-denominated Brady debt, Adia will have to incorporate local currency bonds in the emerging markets benchmark. The other issue concerns G7 government debt. “The current common benchmarks such as JPMorgan’s and Citigroup’s are allocating one-third of their portfolios to Japan and 20% to the US, which in my view does not reflect the underlying economies of those two countries,” says Villain. “We will look at a different benchmark and certainly one with a higher content in US treasuries.”
As a low-risk investor, Adia has so far not invested systematically in high-yield bonds. “That is still under consideration,” says Villain. “A couple of external managers have flexibility to move into this sub-asset class on an opportunistic basis and for a limited part of their risk budget.”
Avoidance techniques Two areas Adia tends to steer clear of, at least directly, are commodities and the Middle East markets. Investing in either is not prohibited but the organization feels uncomfortable placing money in areas so close to home.
“We have an intellectual issue with commodities,” says Villain. “Should we invest strategically? Should we have a commodities portfolio? It’s a difficult one.”
Similar issues present themselves with investing locally. As a custodian of the Abu Dhabi government, Adia does have some local investments, most notably a 73% stake in the National Bank of Abu Dhabi. It also holds a 97.9% stake in Abu Dhabi Investment Company, which carries out investment and merchant banking activities in the Middle East. Adia says it will consider buying into privatizations in Saudi Arabia, Kuwait and Tunisia but so far has not invested in local stock markets.
The main reason why Adia is reluctant to have a bigger exposure directly in the Middle East is its size, potentially its most visible characteristic. This visibility can become a problem, especially as the minimum ticket size for many of its equity investments is $50 million, according to one observer (which in itself can cause problems in some markets in ensuring that there is sufficient liquidity). Although Adia is not necessarily becoming so big as to become unwieldy, its size is a challenge. And that’s one reason why it declines to state how much money it has under management.
“It gives us the advantage of moving assets,” says Al Hajeri. “It also gives us the advantage of getting access to investments through our network without really affecting prices. Disclosing how much you have might hurt performance. We like to move without affecting the volatility of the markets. We like to position ourselves and sometimes if you disclose [the amount of funds] you might send the wrong signals.”
“It’s very difficult to convey the right message,” agrees Villain. “We might be selling something not because we don’t like it but because we have too much of it.” Moreover, as a government-owned organization Adia has to be mindful that its actions are not interpreted as in any way political.
Another facet of its low profile is that it keeps its equity investments in any particular company below 4.5% of the shares in issue, which means that it does not have to disclose its holdings. Villain says that this is not a written rule but a strategy that Adia has pursued for some time. In the mid-1980s it did have bigger single investments, such as a 10% holding in French oil group Total. At one point it even had a declarable stake in English football club Manchester United. “That was a pain in the neck, I can tell you,” says Villain, laughing. “Twenty guys would call on the weekend after the results, asking what we were going to do!”
But there are few signs that Adia will take up more than a 4.5% stake in any company today. “In the 1980s we could identify companies that were really cheap or mispriced. Today it’s much more difficult. To identify a mispricing you have to take a long-term bet on the company,” says Villain. “We might [take declarable stakes] again but because the market has become more efficient it has become much more difficult to take big bets.”
The lesson to draw, though, is that nothing is written in stone. In the fast-changing world of the financial markets, Adia will have to remain flexible. Throughout its history, it has demonstrated its robustness. Today it is a much more sophisticated investor than it was in 1976. But as Adia becomes open, it will be fascinating to see if its approach will continue to achieve such success.