Australia, NZ state funds: lower returns ahead

After years of above-target performance, Australia's Future Fund and New Zealand Super have been de-risking their portfolios amid a worsening investment outlook.
Australia, NZ state funds: lower returns ahead

The Australian and New Zealand flagship sovereign funds expect their performance to drop in the coming year given the tougher investment climate, and the former has been steadily de-risking its portfolio. 

Australia's A$118.4 billion ($84 billion) Future Fund returned 8.4% for calendar year 2015, but performance in recent months confirms the board’s view that markets are getting harder to navigate.

Long-term performance has been consistently exceeded target returns (see chart below). But in the second half of 2015, the fund returned 1% compared to a target of 3.1%. In the fourth quarter, the return was 0.5% against the 1.4% target.

Future Fund returns to end-2015
  Per annum Target
From May 2006 7.70% 7%
Seven years 10.70% 6.80%
Five years 10.50% 6.80%
Three years 12.90% 6.50%
One year 8.40% 6.10%
Six months 1.00% 3.10%
One quarter 0.50% 1.40%

By the time of the fund's last portfolio review in September, it was already positioning for a worsening outlook by exiting successful investments and doubling its cash position from 10% to 20%, said managing director David Neal.

“In the past 12 to 15 months we have been steadily taking risk out of the portfolio," he noted yesterday. "We’ve reduced our equities portfolio quite a bit, but that is just a part of the activity that has gone on inside the portfolio. We have sold out of A$15 billion worth of investments, in public and private markets."

Peter Costello, Future Fund chairman, said the fund had had no injection of capital or revenue in the nine years since it was set up with an initial A$60 billion, noting that it had nearly doubled in size. But returns would be much harder to generate in the coming years, he added, largely as a result of the impending withdrawal of monetary stimulus by central banks globally.

Neal stressed the importance of risk management to the fund, which received an Institutional Excellence Award from AsianInvestor in December. “There’s always risk," he said, but “what’s a little different now, and what makes us cautious, is the expectation that we will not be getting adequate reward for those risks. 

"Real yields are low and risk premia are modest," he added. "Added to which the policy firepower is diminished, meaning the ability of central banks to deal with a downturn will be lessened.”

The Future Fund is scheduled to start drawing down in 2020, but Costello said the board was already in talks with the government to formulate a long-term plan. “We are thinking carefully about how to make sure the Future Fund has a permanent life past 2020.”

There are reportedly concerns that it may not last long, given that the government can, from 2020, use as much it needs of the pot to pay for unfunded pension liabilities. Costello is reportedly discussing ways to limit the extent to which money can be taken from the fund in order to preserve its long-term survival.

Meanwhile, Neal said the team is excited about the arrival of its new head of equities, Björn Kvarnskog, who will be joining in two weeks from Swedish pension fund AP4, as reported.

New Zealand Superannuation Fund, another AsianInvestor award winner in December, returned 6.5% in 2015, growing by NZ$2 billion ($1.31 billion) to end the calendar year at NZ$29.5 billion. It beat its passive reference portfolio benchmark, equivalent to a market return, by 2.8% last year. Over the past three years, the fund has returned 15.2% per annum.

However, the Guardians of NZ Super said the fund’s strong performance in recent years was the exception rather than the rule and warned that future returns would be lower.

Chief executive Adrian Orr said that based on current portfolio settings, the fund was expected to generate an average annual return of 8-9% over the long-term. Since inception in 2003 the fund has returned 9.6% per annum.

NZ Super returns to end-2015
  Per annum Target
Since inception (2003) 9.60% 8%
Ten years 8.67% 7.20%
Five years 13.02% 9.78%
Three years 15.23% 12.15%
One year 6.52% 3.72%


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