Aref Karim spent 13 years at Abu Dhabiâs main sovereign wealth fund, during which time he set up its alternatives portfolio. He tells George Mitton about those times.
It is the client every asset manager active in the Gulf wants to have, its office in a tower on the Abu Dhabi corniche seeming to act as a beacon to every fund salesperson within 1,000 miles. It is frequently described as the wealthiest sovereign wealth fund in the world, an impossible claim to confirm because it does not disclose how much it manages. Sophisticated and venerable, dating its existence to 1976, the Abu Dhabi Investment Authority (ADIA) is a formidable presence.
Given its importance in the Gulf region, it is sometimes frustrating that ADIA does not reveal more of itself to the world or the press. However, from time to time, glimpses emerge of the workings that lie behind the facade.
Aref Karim possesses such insights, having worked for ADIA between 1982 and 1995. In addition, he had the rare experience of creating an entire new division within ADIA. One of his roles there was to create an alternatives portfolio – essentially, a portfolio of hedge funds. It was the first time the fund had ventured into this terrain.
“The bulk of the [ADIA] portfolio was in the traditional asset classes,” he says. “We wanted something a bit different from what they were doing. The ability to go long and short. To have a nimbleness. To be able to liquidate positions easily and to generate non-correlated returns from the skills of the managers.”
Karim’s job was to construct a portfolio of hedge funds that would provide returns that were uncorrelated to the equity and bond markets. The concept of an alternatives portfolio is now commonplace for large institutional investors, but at the time it was relatively uncharted terrain. Karim had to answer the question: which types of funds were suitable for ADIA, and which were not?
He decided hedge funds that pursued high-frequency trading strategies were not sustainable. Instead, he preferred systematic managers that invested in a rules-based manner. A portfolio of these kinds of funds would be more consistent and free of emotional biases, he thought.
Challenges remained, even when the right types of funds were found. As well as meeting ADIA’s high standards of regulatory compliance and governance, potential hedge funds had to be large. ADIA did not want the risks that come with owning too big a chunk of a fund’s assets.
“We could not take on smaller managers because the amounts we were going to allocate were sizeable,” he says. “The issue we faced in those days was that there weren’t many sizeable managers we could consider that were available and flexible in regard to the fee structure that we wanted.”
The issue of fees was as important to large investors then as it is now. ADIA wanted an institutional-style, low-fee structure, not the management-fee-plus-performance-fee arrangement that hedge funds were used to. But, despite the cachet that came with managing money for ADIA, not every hedge fund was willing to negotiate on their fees.
In addition, Karim did not want to invest directly in fund vehicles. Instead he wanted hedge funds to provide a managed account structure.
“A lot of institutions did not have that specific infrastructure internally and were comfortable to go into buying fund shares,” he says. “But what you lose is the element of control, the transparency. In our case, it felt like it was worthwhile to build our own infrastructure, our own systems, to do the tracking and monitoring of the different managers in the portfolio.”
Karim says some hedge funds were reluctant to share all the information required for a managed account structure. They worried they were exposing too much of their strategy to their client. “We had to explain it was not our intention to mimic what they were doing, it was just for control purposes,” he says.
INTUITION
In terms of the asset classes the hedge funds pursued, Karim and his team were open-minded – so long as the manager could explain his or her strategy and were not simply running a ‘black box’. This point was important because ADIA wanted to get an intuition of how its multibillion-dollar alternatives portfolio would behave in different market environments.
With these caveats, ADIA invested in a range of funds run by currency traders, futures traders and managers doing global tactical asset allocation. Karim and his team valued diversification highly but were less concerned about volatility, reasoning that ADIA’s large portfolio and long investment time horizon could cope with short-term ups and downs. “We didn’t mind having spicier managers because we knew, at the portfolio level, we could offset that risk,” he says.
Though it is now 20 years since Karim left the Abu Dhabi fund, he says that “from my knowledge of ADIA today, the alternatives portfolio continues to do well”.
After returning to the UK in 1995, he set up his own hedge fund, Quality Capital Management (QCM), based in Weybridge. The fund applies what it calls a systematic global macro strategy and invests in listed futures. At its high point, the firm managed nearly $1 billion, but it has struggled with outflows in the post-financial crisis period and now has $80 million. Karim blames the hard times on the unusual economic environment, driven by quantitative easing, which has kept interest rates and volatility low.
“Our strategies are long volatility,” he explains. “What happened is because of this low-volatility environment, you had a lot of false breakouts. The market traded in much narrower ranges. The amplitude has not been enough for us to take advantage of. It’s not just us, many managers have gone through redemptions in this period.”
Karim says he has “streamlined and rationalised” the business and hopes to build assets under management back to their pre-crisis peak. When he spoke to Funds Global MENA in April, his fund had recently completed six months of positive returns, including a return of 19% in the first quarter of 2015.
“I’m confident we are going to get back over time a lot of those assets, especially on the back of our current upgraded strategy,” he says.
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