An eye on the Future
The Future Fund’s annual report provides the first real insight into the fund’s investment philosophies and strategies. It is going to be a different kind of investor.
The fund’s mandate from government for the investment of its $63.4 billion of assets is deceptively simple. It is to achieve an average return of CPI plus between 4.5 per cent and 5.5 per cent over the long-term with an acceptable, but not excessive, level of risk.
The fund’s guardians have interpreted long-term as rolling 10-year periods. The amount of risk they are prepared to contemplate taking is assessed by reference to ‘’downside outcomes’’ over rolling three-year and 10-year periods.
The fund’s management has fleshed that out by concluding that the base case against which the relationship between risk and reward will be assessed is the worst five per cent of scenarios over a rolling three-year period produced by thinking about the most pessimistic outcomes that might occur. As they say, the approach captures not just the probability of a bad outcome but its likely severity.
The political sensitivities – and the fact that the fund contains a massive lump of taxpayer funds – make the focus on downside imperative. The ability to think and invest over far longer time-frames than most of its funds management peers, however, means that it can pursue, and is now pursuing, quite different strategies to those conventionally used.
As the fund says, it isn’t subject to the same competitive and liquidity issues that face most Australian superannuation funds, which creates an opportunity for it to construct a portfolio that is highly efficient in terms of its return for risk.
The fund is still in its infancy and the credit crisis has slowed its deployment of its funds, which is why nearly 60 per cent of the fund is still held as cash. Its targeted long-term asset allocation is, however, revealing.
In the long-term it wants to have about 35 per cent of the fund invested in equities, with about 10 per cent of the fund devoted to Australian equities. That is a significantly lower allocation than would be the case in most super funds – even though, unusually, the fund includes private equity within its overall allocation to equities.
It is operating on the basis that, while there is a particular appeal to Australian equities, given dividend imputation, the size of the Australian market is small relative to the global market for equities and therefore the fund’s weighting should reflect that.
The fund is aiming to have 30 per cent invested in what it calls ‘’tangible assets,’’ mainly property, infrastructure and utilities, both listed and unlisted.
About 20 per cent of the fund will be invested in debt -- government and non-government fixed interest securities, mortgage-backed securities, high-yield credit and corporate debt – and 15 per cent in alternative assets like commodities, futures, insurance-based activities and absolute return investments.
So far the fund is close to its targeted allocation only in equities, where it is possible to use index-related strategies to get invested quite quickly. It has commitments of more than $1 billion to its private equity and venture capital program but only $2 million of that had been drawn down at year’s end. As it builds its internal resource base and skills it will become easier for it to achieve the portfolio balance it is pursuing in the longer term.
The early opportunity for the fund to move differently to the investment herd was in debt markets, which have been traumatized by the credit crisis. The fund has invested more than $1.8 billion in long-term debt securities issued by the major Australian banks and just under $500 million in a portfolio of global bank debt. It has also pumped $1.85 billion into Australian residential mortgages.
The dysfunctional credit markets have created the opportunity for a long-term investor to grab spreads that may not be available again for a long time, if ever. The fund was perfectly placed to take advantage.
As it says, it believes it can afford to take a patient, opportunistic and selective approach to building its portfolio at the moment, in the meantime maintaining high levels of cash and near-cash.
It isn’t immune to the global headwinds. It returned a modest 1.54 per cent for the year to June and had a negative 1.81 per cent return for the September quarter, although both those outcomes look very solid compared with the ravaged returns of most super and investment funds.
The Future Fund’s time horizons, of course, mean that its performance shouldn’t be measured in the near-term, and certainly not on the basis of quarterly numbers. The nature of its strategy and the focus on assets other than listed equities means that it will have a low correlation with other funds.
In taking advantage of the opportunities available in distressed markets, its timing is unlikely to be perfect and therefore its near-term performance may not be indicative of the longer-term returns available from buying when most others are selling.
In the meantime, cash in the bank – more than $30 billion of it – isn’t a bad fallback position in such uncertain times.