The “fragile” economic environment during the pandemic drove Australia’s Future Fund to rethink its portfolio approach and undertook a strategy to focus on diversification and short-term risks, chief investment officer Sue Brake said.

“We set about doing a one-year project to think deeply about what’s changed in the external environment and aspects of the process of putting a portfolio together and question what’s changed,” Brake said at the Imas-Bloomberg investment conference on Tuesday (March 9).

Sue Brake

The sovereign wealth fund, which has A$218 billion ($167 billion) of assets under management, identified risk factors such as geopolitical conflict, government intervention due to the pandemic, geographic divergence and fragility, she said.

“By fragility, we don’t mean volatility. It means the propensity to break from what we’ve had in the past. We’ve seen a number of these liquidity events and other such events in the market where things have been a little crazy,” she added.

“With this fragility, you can’t hide in the corner and not invest anymore because we’ve got to get our returns,” she said, adding that a portfolio needs to be very well diversified to withstand sudden market shifts.

Future Fund currently adopts a total portfolio approach, which considers returns from interest, capital gains, dividends, and distributions. Brake told AsianInvestor in an interview last month that such an approach should help the fund fight off heightened investment risks and latent inflation threats.

“We have a total portfolio management risk level targeting a certain amount of risk over the long term to make sure we don’t get risk-averse. We use that as a very loose guide for the portfolio, and as it happens, our risk levels at the moment are at their long-term neutral level," she had said.

SHORT-TERM RISK FOCUS

Last year’s events also made the fund take a short-term view on risks despite its long-term mandate.

“You can’t just keep your eyes on the horizon and ignore what’s right in front of you. Risk is multifaceted as they say,” she said at the conference. “It’s not just about the volatility of the market or whether or not you achieve your formal mandate. It’s also the risk of your mandate being taken off you because of some event.”

Future Fund posted a negative 0.9% return at the end of June 2020 - its first 12-month loss since the global financial crisis. The fund then shifted into more defensive portfolio positions and sold down international private equity and alternative assets. By the end of 2020, the fund had a fourth-quarter return of 4.9%, bringing its calendar year returns to 1.7%.

That said, the fund still has its eye on long-term outcomes. For instance, “inflation is one of those longer-term themes that we can afford to look through a current cycle and start to think about,” she said.

RECONSIDERING BONDS

Brake told AsianInvestor earlier this year that the fund had been rethinking assumed correlations between bonds and equities.

She reiterated this point at the conference, saying, “when we think about bond and stock correlations, 60/40 is the basis for building a portfolio... I don’t think any of those things are that helpful anymore because bonds had their years of generally rallying [but] a new environment really required us to have a mindset shift,” she said.

Bonds, in retrospect, have been a gift over the past four decades, she said. “But that’s over. Those bonds have different characteristics, so when you’re constructing portfolios, you need to be mindful of that and replacing it, I think, is impossible.”

She added that she does not see any asset class that could replace bonds, so investors will have to work harder to diversify away from exposure to risks that come with other return drivers such as equities.