Inflation, market fragility and charting increased regulation are the three key factors driving Future Fund’s investment strategy planning, chief investment officer Sue Brake told AsianInvestor in an exclusive interview.

Sue Brake

“All of those things have implications for how you think about portfolios and how you put a portfolio together,” Brake said, adding that the Australian sovereign wealth fund would rely on flexibility to sidestep equity market risks as well as lean into the opportunities offered by private markets in response.

"Covid has pushed us into a new regime, some of those facets are intertwined with the reflation theme around the geopolitical core; we have looked at the fragility of markets, the increased regulation, the end of laissez faire government and the fact that governments look to be a bigger part of everything going forward," she explained.

She added that interest rates, in particular, were a concern, and that the coming year would be more difficult than the last.

“It’s going to be increasingly hard to achieve our mandates, because while financial assets have had this remarkable year, going forward, you can't count on interest rates going lower,” she said.

The CIO of the A$179 billion ($133.3 billion) sovereign wealth fund observed that financial assets have had a “massive return year” because the market had priced in lower-for-longer interest rates. But if interest rates rise, “we’re going to have a positive correlation between everything… and everything else will sell off”.

“So there's a lot of risk in financial assets at the moment in relation to that interest rate movement,” Brake said.

ASYMMETRIC PAYOFF

A global equity rally has so far boosted several asset owners’ results this year - including AustralianSuper, Japan’s Government Pension Investment Fund (GPIF), and Singaporean state investor Temasek - which each reported more than 20% returns for the past 12 months.

Future Fund’s latest quarterly result has not been released, but its quarterly results ending March 31 had a 10.1% one-year return, compared with a 1.7% return the previous quarter. The sovereign wealth fund has 7% of its portfolio allocated to Australian equities, and 25.1% to global equities.

However, Brake is not counting on equities to keep returns buoyant.

“There's this asymmetric payoff, and to put all your hopes on our return on the equities market, as a whole, is a particularly risky thing to do,” she said. “So we've given a lot of thought to how to add more return ... given that outlook.

“Generally speaking, that means more active management, and that's not just hedge funds [but also] private markets, and timing strategies.”

Brake sees private markets as a relative advantage, and takes a more rounded approach to the fund’s private investments.

“We don't choose an asset class that we decide that we don't like, and decide we don't do that,” she said, in response to being asked which alternative asset class she was most keen on. “[We are looking at] all of them and again, on that bottom-up basis (we look) at the broad themes and say here are the things that we think we need in the portfolio."

She added that private assets provide a “premium that is uncorrelated with the equities market, which is what we’re concerned about – that if you put all your eggs in that basket, it’s particularly risky at the moment.”

In addition, Future Fund already has a strong team that has managed its private assets using external parties well, she said, "so it just made sense for us to to lean more into private assets".

For its alternatives assets, the fund had 14.6% of its total portfolio allocated to private equity, 6% to property, 7.3% to infrastructure and timberland, and 14.4% to other alternatives, as of March 31. 

EXTRA STAFF REQUIRED 

Future Fund reportedly has plans to add 70 people to its 80-strong investment team to help manage mandates for its private assets, which Brake said will not take away jobs from their external managers. 

"It's more about this dynamic process that I talked about. It's more about the balance sheet management and the treasury that I talked about, doing all of that better," she said.

"We need to manage those assets, and being a responsible owner, that requires staff. So the bigger we get, and the more assets we get on the portfolio, the more people we need to make sure that we're managing those assets well, so there's organic growth in that area," she said.

At the start of the pandemic, the sovereign wealth fund shifted into more defensive portfolio positions but still wound up posting its first loss since the 2008 financial crisis with a negative 0.9% 12-month return at the end of June 2020. 

However, Brake sees it as a "flexible" portfolio positioning rather than a defensive play.

"We think in terms of flexibility, how much do we need to rebalance? And then how much could we increase the risk - that's a measure of the flexibility that we run," she said.

The fund's results have since bounced back from mid-2020, with a 10.1% per annum return as of March this year. Neverthless, Brake isn't breathing a sigh of relief just yet.

"I'm a risk manager so there's always going to be something that I'm worried about. But I do think when you're at that cusp between two paradigms or two regimes, I think you hit maximum uncertainty.

"When you jump into the new regime, or you get tipped into the new rate regime, there is a little bit more clarity, because you can  go 'Okay, we're here now.' And interestingly, I think Covid did give us some of that, we know the world is different, we know some aspects of that new different world.

"Gradually, maybe I am a little less uncertain," she said.