Equities and fixed income drove Abu Dhabi's sovereign wealth fund's returns last year, with emerging markets remaining high on its agenda looking into 2013 and beyond.

The Abu Dhabi Investment Authority (Adia), which manages an estimated $700-750 billion in assets, had 20-year annualised returns of 7.6% as of 2012, according to its annual report released yesterday.

Stock markets in the US and Europe and in emerging nations China, India, Indonesia, Mexico, Poland and Turkey were among the best performing, while Japanese and Brazilian equities lagged.

Adia’s EM stock exposure returned 18.6%, outperforming developed equities by two percentage points. Equity investors in 2012 “proved their increased resilience to external shocks by looking beyond seemingly endless debates on economic and political issues, such as the ‘US fiscal cliff’, and fears of a hard landing in China”, says the report.

And this approach paid off in an environment where global interest rates remain at record lows. Adia expects equities will remain attractive as “bond yields hover at historically low levels and investors look to deploy some of their significant cash reserves”.

In the long term, Adia says emerging markets will outperform developed markets although will likely remain volatile.

The sovereign wealth fund is putting its money where its mouth is. After receiving $300 million more quota to buy Chinese equities under the qualified foreign institutional investor (QFII) scheme (taking it up to $500 million), Adia allocated its money to its active China A-share portfolio.

The fund's fixed income portfolio also generated decent returns, with higher-yielding sectors such as credit and EM debt among the best performers.

Yields in major government bond markets “continued to confound expectations” by falling even lower, the fund notes, with yields in the US, UK, Germany and Japan “slumping to the lowest levels in modern memory”.

Slow growth combined with aggressive monetary policy made for an ideal environment for credit and emerging markets in 2012, with investment-grade corporate debt outperforming sovereigns, notes Adia. High-yield bonds and local currencies also posted double-digit returns in 2012, challenging equities as the best performing asset class.

The SWF made an undisclosed allocation to a non-investment-grade credit manager in the second half of the year.

However, whether yields rise or hold at current levels, “investors in coming years will have to manage their portfolios in ways that assume lower returns from fixed income”, the report says.

The sovereign fund’s alternatives portfolio was a mixed bag. While the hedge fund portfolio – largely relative-value, event-driven, emerging-market and multi-strategy managers – all performed well, trend-following CTAs and other commodity-focused managers faced more volatile conditions.

“In the broad range of markets traded by CTA managers, clear price trends rarely emerged and, when they did, reversed more quickly than the norm,” says the report. The best performing managers maintained their focus on short-term interest rates and selected bond markets, while managers focused on currencies and commodities tended to underperform. Still, Adia notes that its alternatives portfolio hit its overall target last year.

Real estate, meanwhile, offered an array of opportunities in 2012, with low interest rates and limited new supply attracting impressive flows to the sector.

There was a noticeable lag in activity compared to 2011 however, as uncertainty lingered, particularly in Europe where worries over the future of the euro and the stresses on the banking system plagued investors and kept them on the sidelines. London was the exception – despite the UK’s gloomy outlook, real estate prices rose higher.

While debt funding was available in 2012 to mid-sized companies, Adia anticipates more debt-focused infrastructure funds will come onto the scene in upcoming years to fill the liquidity gap.

Adia made a number of infrastructure investments, with of its subsidiaries joining a consortium that agreed to acquire Open Grid Europe, Germany’s largest gas transmission pipeline system.

The fund's private equity investments in emerging markets slowed last year, but picked up in the third quarter, notably in Asia and Latin America. Deal flow in North America was strong, boosted by cheap leveraged financing and a number of tax reforms.

Adia expects developed economies will continue to struggle, plagued by unemployment, fiscal reform and deleveraging.

Emerging markets, meanwhile, offer “exciting and attractive opportunities to deploy capital”. These economies share important characteristics – rapid growth in productivity, favourable demographics, lower levels of debt and leverage, improving institutional frameworks and substantial natural resources.

The challenge for long-term investors, Adia notes, is to remain an active participant with broad exposure. And while next year may not be as fruitful to investors as it was in 2012, the fund “believes the future remains positive”.