The $700 billion Abu Dhabi Investment Authority, ADIA, is boosting its internal fixed income capabilities and scaling up capacity to run active strategies in-house, aiming to increase active management in the fixed income and treasury allocation from 40 per cent to all the portfolio actively managed in the coming years.
Active management in fixed income, where the long-term strategic allocation fluctuates out to 20 per cent in government bonds and 10 per cent in credit, is in line with growing active investment across the portfolio which stood at 55 per cent in 2018 compared with 50 per cent in 2017.
The decision to build out the strategy has been aided and abetted by portfolio simplification. Over the last year separate investment pools have been merged into one single fixed income pool allowing a more flexible allocation that reduces complexity without compromising strategic asset allocation or liquidity provisions, according to the giant fund’s recently published 2018 Review. The fund reported a lower 20-year annualised rate of return for the fund of 5.4 per cent in 2018 compared to 6.5 per cent the previous year.
The decline in rolling average returns, including the 30-year annualised rate of return dropping to 6.5 per cent in 2018 from 7 per cent in 2017, was the result of the exclusion of “strong gains in the mid-to-late 1980s and 1990s” says Sheikh Hamed bin Zayed Al Nahyan, managing director, in a letter attached to the Review. “ADIA’s real returns remained largely consistent with previous years and historical levels,” he says.
Portfolio simplification in fixed income follows on from strategy in the fund’s illiquid asset classes which already operate as single pools – as do outsourced equities.
It means that fixed income will be allocated money to invest as a whole, giving the team much greater discretion to invest across regions and strategies in contrast to the past when funds were allocated to specific mandates within the asset class determined on a top-down basis. The single pool increases the department’s flexibility to capture short and medium-term opportunities without having to request changes to their mandates in a new approach that works best with active management.
The transition to more active management in fixed income will see new hires within investment and research particularly, where the fund says its focus is on building technological and data gathering expertise.
ADIA, which manages 45 per cent of its assets internally, is also focused on filling internal positions with UAE nationals in line with its efforts to build home-grown talent, this is challenging given the size of the Gulf state’s local population.
In 2018, ADIA launched a “fundamentals” program for UAE nationals as part of an new early career development framework; of its 1700 employees most (29 per cent) are European, UAE nationals (28 per cent) or from Asia Pacific (21 per cent).
ADIA is also introducing changes in its equity allocation, considering complementing its current pool of external managers with new strategies that target “modestly” lower risk and lower returns over time.
The portfolio is split between developed and emerging markets where the strategic allocation fluctuates between 32 per cent and 42 per cent, and 10 per cent and 20 per cent respectively.
Other mooted changes include adding more single country portfolios like its Canada-focused allocation, launched last year. The idea is that this new, granular approach increases flexibility and the fund’s ability to capitalise on fleeting opportunities in a low-return environment.
It also reflects a central ambition, outlined in the Review, to enhance organisational agility so that the giant fund can respond quickly and purposefully when opportunities emerge, and which is also focused on “breaking down the barriers between asset classes” in the hunt for opportunities. In another example of this approach in action, the internal equities team is exploring creating sub mandates within some regional and country portfolios to capture specific opportunities.
Elsewhere, following a tough year for active equity management, the fund forecasts a return of a better stock-picking environment.
In hedge funds (part of the fund’s 5-10 per cent allocation to alternatives comprising just hedge funds and managed futures) ADIA aims to tap industry-wide themes like the blurred boundaries between different hedge fund strategies which has seen successful single-strategy managers develop their offerings and business models across credit default swaps, interest rate swaps, and cash equities.
“This trend is being driven in part by an increased migration of investor capital toward established and well-regarded managers, which may also look to inhabit areas that were once the sole responsibility of banks, such as providing liquidity,” states the Review.
It predicts that as more money coalesces under fewer large funds, new funds will emerge with alternative offerings. Reflecting on last year, it noted that relative value was the “most consistently successful strategy” and equity-related strategies including equity hedge and event driven ended the year “slightly down”.
The fund plays down the impact of China’s slowdown on the portfolio, expecting most growth in coming years from emerging markets.
“Demographic trends continue to favour emerging over developed economies, with India and China in particular expected to remain important engines of growth. A slowdown in China received much attention, but to date the reality does not appear to have matched the degree of concern,” it says.
And rather than focus on the “late-cycle” where Sheikh Hamed notes the financial system is “more robust than it was 10 years ago” and “that the diversity and adaptability of the global economy means that the current cycle may well surprise with its resilience,” ADIA’s eye is on navigating, and uncovering, secular themes.
None more so than the retrenchment of globalisation and deteriorating trade relations that has led to tariff increases and greater resistance to cross border flows of both capital and labour.
“The myriad potential outcomes of a less hospitable international economic system will result in new challenges – but also ample opportunities – for global long-term investors,” says Sheikh Hamed.
Arguing that it “is clear that the gains from trade have not always been shared equally within and across countries, and that forces of nationalism have gained traction at the expense of economic liberalism,” he concludes that it is imperative capital market participants, who see the benefits of globalisation first-hand, communicate its benefits.