Future Fund adds to risk assets as market fears abate

Although still wary of excessive risk, the Australian sovereign fund remains focused on the long term and continues to look for opportunities in private markets.
Future Fund adds to risk assets as market fears abate

Australia’s Future Fund has raised its public equities market exposure in the face of receding short-term threats, the fund’s executives said in a briefing to announce its annual results yesterday (February 1).

For the year ended December 31, 2017, the fund generated a return of of 8.8%, against a target return of 6.4%. 

Future Fund chairman Peter Costello said the recent investment climate has been unusually strong, which helped to prompt its asset reallocation and good returns. 

“We are having a synchronised period of growth across the world. The US, Europe, Japan, China continue to be strong. This is a coordinated upswing, the like of which we haven’t seen for a very long period of time.”

At the end of December 2017, the Future Fund had A$139 billion ($112 billion) of assets under management. Its 10-year return of 8.1% per annum exceeds the benchmark target of 6.8%. From seed capital of $60.5 billion in 2006, the fund has now earned an additional $78 billion. 

The more bullish outlook for risk assets has reversed a two-year period of 20% plus cash holdings for the fund, Costello said, noting that some of the risks the investment team saw over that period have declined. “The tightening monetary policy in the US has gone as well as anyone could have expected." 

The fund's public equities allocation rose from 27.9% in June 2017 to 32.7% by the year-end. Cash dropped from 21% to 16.4% over the same period.

Vulnerabilities existing

However, David Neal, the fund’s chief executive, emphasised that the more bullish allocation would apply only to the short-term outlook. “Central banks have shown they are prepared to be very cautious in their accommodative stance and this has helped markets,” he said.

But the underlying structural pressures remain on the medium term outlook. “There are still high debt levels, and when you put that next to relatively high asset values and very low interest rates, we still see vulnerabilities in the market environment,” said Neal.

The key uncertainty remains how the US and other developed economies respond as inflationary pressures start to increase. “When monetary accommodation needs to be removed a little more quickly, how will the economies respond, given that they retain fairly high debt levels? We don’t know, but there has to be some risk to asset prices, particularly when they are little elevated,” said Neal.

The fund's executives continue to expect long-term prospective returns to be lower relative to previous levels. “As the fund has matured, risk has become a bigger issue and the government has always been clear that because this is a long term endowment, we should avoid excessive risk," Costello said. 

They have discussed the market conditions with the federal government, which has resulted in a reduction of the fund’s investment mandate benchmark return—from a range of 4.5% to 5.5% over consumer price inflation (CPI) per annum down to 4% to 5% over CPI.

The other key structural change for the Future Fund in 2017 was the extension of its active lifespan, prior to the government starting to drawdown on the fund's reserves. The original mandate would have seen the government starting to withdraw funds in 2020. The federal budget in May 2017 extended the life of the fund until 2026.

“This gives the fund almost another decade,” said Costello, “and we think we can extract an illiquidity premium that we wouldn’t have been able to if the drawdowns were going to begin in 2020.”

With this greater investment freedom, Neal emphasised that the investment team continues to look at opportunities in private markets, particularly in infrastructure and emerging markets.

“We are very interested in select markets for private equity and we put a lot of effort into finding those opportunities," Costello noted. "But it’s quite hard to get meaningful capital [invested] with good quality managers. It takes a lot of time and effort.” 

Source: Future Fund

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