Adia increases focus on EMs, China, credit

Abu Dhabi’s sovereign wealth fund sees global growth driven increasingly by emerging markets, with China assuming a much greater role in the cycle, and is positioning its portfolio accordingly.

When an investor of such size – with an estimated $773 billion under management – makes such a call, it is likely to have big implications for world markets.

One example of what Abu Dhabi Investment Authority (Adia) has in mind: it received approval to raise its allocation to China A-shares under the country’s qualified foreign institutional investor programme to $1 billion from $500 million.

The SWF's annual review, released this week, sees China's current slowdown as a pause in growth because of the rebalancing of the economy.

Moreover, last year it boosted its allocation to core and emerging Europe, South Africa and to equity opportunities portfolios last year, but declined to give more detail.

Adia's strategic allocation to EM equities is a range from 10% to 20%, and to developed equities between 32% and 42%. It posted 20-year annualised returns of 7.2% as of 2013.

US and European stocks posted performance well above Adia’s expectations in 2013, as it had forecast bond markets to outperform. Equities in EMs, especially in countries running current account deficits, suffered sell-offs, as did bonds and currency markets, noted the fund.

With equities performing strongly, and sentiment shifting away from fixed income on the expectation of normalising interest rates, institutional investors seem to have begun a global allocation shift from bonds to equities, noted Adia.

That said, the fund expanded its fixed income investment universe with a view to capturing more alpha; it focused on exploiting opportunities in the stressed credit space as banks in Europe deleveraged. 

It had presaged such a broadening of its bond exposure in comments made to AsianInvestor last year.

Despite the US Federal Reserve carrying on its stimulus programme through 2013, yields rose across markets and broad market indices recorded negative total returns for the first time in 20 years, the report noted. Only Japanese government bonds bucked that trend.

And though a search for yield prompted EM inflows in the first half of the year, EM debt was hit hard by the upturn in Treasury yields and those flows reversed in the second half, Adia noted.

Meanwhile, the credit markets were not as strongly affected by changing yields as they were cushioned by confidence in economic recovery, it added. Hence lower-quality debt in the US and Europe performed strongly, returning some 5% over the year, Adia said. 

Sovereign debt in peripheral Europe also performed well as a slow economic recovery took hold.

“An important element of this was agreement on the path to unified bank regulation in the euro area, a necessary step to separate bank risk and sovereign risk in heavily indebted countries,” the report said.

Though interest rates rose last year, global government markets continue to offer historically low yields of around 2.5%.

Looking ahead, Adia argued that the outlook for bonds was clouded by the unprecedented monetary policies, but that fixed income returns over the next few years would not be much better than current low yields.

Turning to alternative investments, the fund said the asset class met its target last year and that it sees further growth this year. Its strategic allocation to alternatives is between 5% and 10%.

Adia posted strong returns in equity-linked strategies and more subdued returns from strategies affected by tapering in the US. It said its best-performing alternative managers were those who followed non-trend-focused strategies.

Notable developments cited in the report included the implementation of ‘Abenomics’ early in the year, which prompted hedge funds to turn to Japanese equities.

In its hedge fund portfolio, relative-value and macro strategies were mixed in terms of performance, while event-driven and equity hedge performed strongly.

The investment environment for managed futures was challenging for trend-following CTAs, which recorded their third year of negative returns, the report said. Profits from price trends in developed world equities were largely offset by weakness in other asset classes.

In real estate, Adia sold some assets that no longer fitted the portfolio strategy, and broadened its scope in developing countries, including Brazil and Mexico. Over the past two years the fund said it has been investing across a wide range of markets and property types in Europe.

Its strategic allocation to real estate is 5% to 10%.

“In China, the focus remains on opportunities to develop institutional quality assets, while in Australia Adia put capital to work in the retail and hospitality sectors,” the report said.

With regard to infrastructure investments, the allocation to which is 5% to 10%, the fund rebalanced part of its portfolio, which included the divestment of its stake in Sydney Airport.

Other investments were focused on large-scale core infrastructure assets in developed markets.

Adia noted that governments in DMs increased regulatory intervention, although they had previously been considered relatively stable.

Excluding a small number of very large deals, private equity returns were relatively flat last year, the report said, although volumes in emerging markets increased, with quarterly deal-making stabilising around $5 billion. Adia’s strategic private equity exposure is between 2% and 8%.

The fund focused on venture capital through a collaboration agreement it signed in 2012 with Alberta Investment Management and New Zealand Superannuation Fund.

Adia also made a couple of senior investment appointments last year. In May, Christof Rühl joined as its first global head of research. And in August last year it hired Suresh Sadasivan from Legal & General Investment Management as head of Asia ex-Japan internal equities. He replaced Lars Sorensen, who left earlier in the year for personal reasons.