It had been "a pretty tough time" in the investment markets in 2022, said the Future Fund’s chief executive Raphael Arndt at a February 1 briefing on the fund’s 12-month results.
The Australian sovereign fund’s executives have been talking down their long-term investment expectations for some time. Given the global context of equity markets being down 18% for the year and bonds also down 10%, the fund’s defensive posture delivered a “somewhat pleasing” 12-month outcome of -3.7% - and 0.9% for the half year by contrast, according to Arndt.
The A$243 billion ($172 billion) fund is still comfortably exceeding its target 10-year return of 6.7%, with a 9.1% per annum return, but Arndt reiterated its belief that institutional investors will need to work harder and employ different combinations of strategies than they have in the past.
Arndt’s team is now emphasising “genuine diversification” as well as a more granular approach in areas like the emerging markets.
“For the last 10 years leading up to Covid, macro was dominating the performance of markets everywhere. Rates were low, so we had some simple tools such as allocating to emerging markets as one allocation,” he told AsianInvestor.
They have now decided that such "superficial regional diversification may introduce unintended, poorly rewarded risks". For example, capital controls and confiscation may be more likely in certain countries.
“More recently, we have begun to manipulate newer levers across the portfolio to help make it more resilient in the face of these converging structural forces.”
Making more granular allocations means picking different countries, or types of countries. “So for instance, countries that run a current account surplus or a deficit will behave quite differently when the cost of capital is going up. Or ones that are fossil fuel importers or exporters.”
THE CHINA QUESTION
The Future Fund’s stance on China has also evolved and in recent years, it has pared back its allocation. “We have dialled back our exposure to China quite considerably and we are still evaluating that,” said Arndt.
The fund doesn’t provide individual country exposures, but AsianInvestor understands that China, as part of the fund’s emerging market equities exposure, was cut back in 2020 from A$14.2 billion (8.3% of the portfolio) to A$11.2 billion (5.7%) in 2022.
“The sort of issues we were concerned about went beyond geopolitical tensions,” said Arndt.
“The Chinese government was intervening in its market in terms of shutting down private education businesses and imposing itself on gaming businesses. They were saying: ‘We don’t want entrepreneurship in those sectors’.”
"That type of activity is concerning for any investor, especially when there’s no clarity. And at that time the market was not cheap, so it didn’t make a lot of sense to have that exposure.”
When clarity is limited, the challenge for the investment community is in how to exert any degree of influence. China poses the biggest challenge of all and the question remains: Are investors willing to turn a blind eye to China’s lagging ESG scores?
Arndt believes there are "huge opportunities still" in China and furthermore, “the Future Fund has a robust ESG policy and practice based on our belief that it supports our requirement to maximise long term returns. We exercise all of our voting rights and take board seats on private investments.”
BREAKING WITH TRADITION
Last December, the fund set out its views on how traditional portfolio construction is coming to the end of its life.
They questioned whether modern portfolio theory's well-established principles of correlation and diversification still hold true.
Global strategists already expect the traditional 60/40 portfolio to return a meagre 3-4% in the next 10 years.
Therefore, how will unconventional fiscal and monetary policy further challenge market expectations? How will the breakdown in globalisation and the disruption of capital flows, supply chains, energy markets, and migration impact real economies and financial markets?
Arndt said for example that hedge funds can provide a healthy counterpoint to traditional market exposures, for funds that have the ability to adopt absolute return strategies for at least a portion of their asset allocation. Commodities also provide a useful element of diversification.
“The portfolio continues to be positioned towards the middle of the range of risk settings,” Arndt said.
"Over the past year we have, however, made significant changes towards investments that rely more on investor skill than on market risk, in line with our thinking that such an approach will be better rewarded as rising rates and slowing growth will drag on market returns.
"We are very confident, looking forward, that we have the portfolio position to benefit from the changes."