Finance, Markets & Investing June 6, 2008, 12:01AM EST

Inside the Abu Dhabi Investment Authority

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Sheikh Ahmed bin Zayed al Nahyan, managing director of Abu Dhabi Investment Authority Tina Hager/Arabian Eye

At $875 billion and growing, ADIA is the biggest sovereign wealth fund in the world

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There are even mutterings around ADIA that such high-profile investments may be a mistake and would be better left for other smaller investment vehicles that the government has recently created, like the Abu Dhabi Investment Council and Mubadala Development Company, which bought a big stake in the Carlyle Group and Advanced Micro Devices (AMD) last year. "Every time the price goes down, someone says 'you could have invested in this or that company and done much better,'" says executive director Saeed Mubarak Al-Hajeri. "We do have those types of unsolicited advisors."

But for the most part, ADIA's close study of the markets and rigorous internal debate seems to have served the big fund well. Shortly before Al Nahyan, now 39, took charge in 1997, the fund dramatically overhauled its investment guidelines so that it would allocate its investments in line with global economic growth. That resulted in a savvy call in 1993, when its investment team determined that Japan's 40% share of the global stock markets didn't match the growth prospects of Japan's economy. The fund sold down its stake, escaping a subsequent decline in the Japanese stock market.

A Turn to Indexing

Even today, the fund's investments officers fear getting caught off guard by a huge shift in the capital markets if they fail to identify an investment bubble. "When people ask what keeps you awake at night, it is trying to avoid investing massively in another Japan in 1990," says ADIA's Villain, a Frenchman. "Are we at the beginning of something similar to what happened to Japanese equities in the 1990s? That is the way we look at the world."

More recently, Al Nahyan, who hates to be called "Your Highness" as is customary, and who worked for ADIA as a European equities analyst side-by-side with colleagues on an open floor for six years before he took charge, has encouraged his people to weed out money managers who can't cut it. In 2006, he ordered his investment committee to figure out why passive investments in indexes were outperforming some of ADIA's highly-paid fund managers. ADIA hired a consultant who found, after several months, that many endowments used index funds for as much as 80% of their investments. Through 2007, the team conducted an extensive study of its own money managers and others in the industry, and eventually concluded that few firms that invest in developed markets like the U.S. and Europe consistently outperform their benchmarks over the long haul.

With the findings in hand, ADIA has increased the amount of the portfolio that is indexed from 45% to 60% in the last six months. It has also halved the number of hedge funds in its portfolio. "ADIA is keen on identifying real management skills and real talent and is not prepared to pay the usual fees charged by hedge funds for strategies that can be replicated in an index," says Al-Hajeri.

ADIA's scrutiny of potential money managers has also intensified over the years. Not long after Tarek "Terry" Abdel-Meguid, a partner at Perella Weinberg Partners, flew to Abu Dhabi to pitch ADIA on a potential investment idea last year, people from ADIA spent a day in one of the firm's offices scrutinizing the idea, as well as the team of people who would be investing and the way they would be reporting their returns. "Everything gets checked and double checked. They are very thorough." says Meguid. "The process is no different than that of any other large, sophisticated investor." Echoes Goldman' Blankfein, who visited in April: "They're as rigorous in their analysis of potential deals as I would expect our people to be."

Tough Characters

Even after ADIA invests, monitoring continues. ADIA wants to be sure money managers are investing within agreed upon guidelines. Several years ago, ADIA warned one London-listed company meant to be investing in Europe that it had three days to get out of its core listing, which ADIA had discovered was South African. Yet, senior ADIA executives say that some financial executives still don't take them seriously enough.

"Sometimes we meet senior people who come in and think that at the end of a one hour meeting they will walk away with $1 billion," says ADIA executive director Majed Salem Al Romaithi. "They underestimate our sophistication." ADIA also has taken up its game in private equity. The fund is outmaneuvering top Wall Street investors, being invited to co-invest in high profile buyout deals as well as in buyout firms themselves. ADIA co-invested in TPG's $44.4 billion purchase of TXU Corp. in February 2007 and Kohlberg Kravis Roberts' $19.4 billion buyout of Alliance Boots in March 2007. Then last summer, it bought a 10% stake in buyout firm Apollo Management with at least $40 billion in capital committed, and a nearly 20% stake in the Los Angeles-based buyout firm Ares Management, which has $25 billion.

About a half dozen institutional investors, including large pension funds, were angling to invest in Ares after managing partner Tony Ressler briefed limited partners, including ADIA, on his expansion plans for about a year. Ressler wanted to raise capital to build out his firm's ability to invest in distressed debt and to provide rescue financing. Ressler's group selected ADIA, in part because he was convinced it was interested in Ares' long term health. While some investors inquired about getting fee discounts or special access to co-investments, "ADIA didn't ask for any special arrangements," Ressler says. ADIA executive director Hareb Al-Darmaki says the fund is talking to other firms about potentially buying stakes.

In some areas, ADIA is attempting to race ahead of the pack by stealing top talent away. Eighteen months ago, executive director Al-Hajeri personally wooed Chris Koski away from the Canadian Pension Plan Investment Board, an early player in the burgeoning area of infrastructure investing. Al-Hajeri convinced Koski to head up ADIA's own group to buy up roads, ports, and bridges by promising him the freedom to run his own show. He also showed Koski's wife around Abu Dhabi to convince her it was a good place to live. Poring through more than 1,200 applications, Koski quickly created a multinational 12-person investment team to look for plays across the globe. The group made its first purchase in North America, partnering with a couple of other firms. ADIA declined to name the investment.

ADIA is also racing to become best-in-class through training. It's spending $10 million on accounting classes and other employee training initiatives. In February, Harvard Business School professor Josh Lerner conducted a seminar on private equity. Former General Electric (GE) CEO Jack Welch (who co-authors a column for BusinessWeek) engaged in a question and answer session with 100 ADIA employees about political, economic, and management leadership issues recently. "We consider ADIA to be like the best [financial] institutions in the world," says Al Nahyan, with the asset allocations of Yale's endowment before him on a long brick-colored marble table. "Being far away around the world doesn't mean we are far away in quality."