Australia’s Future Fund intends to increase its private markets exposure to boost returns and help offset what is likely to be a period of deteriorating performance for equities and bonds.
Announcing its annual results to the end of June 2018, the sovereign wealth fund’s chairman Peter Costello and chief investment officer David Neal said returns from public markets look set to decline in the foreseeable future.
Neal said the Future Fund’s portfolio managers are increasingly looking to investment strategies that are uncorrelated to mainstream equity returns, although he did not specify target levels.
As of June 30, 14% of the fund’s portfolio was allocated to private equity, 6.4% was in property and 8% was invested into infrastructure and timberland. The sovereign wealth fund also had 9% in debt securities (mostly floating rate credits) and 15.4% in other alternative assets such as hedge funds.
The remaining 47.2% was invested in traditional bonds and equities.
The fund reported an annual return of 9.3% for the 12 months to June 30, which has swelled its total assets under management (AUM) to A$146 billion. Of this, A$85 billion originated from investment returns in addition to the government’s initial contributions. The fund’s 10-year return of 8.7% per annum exceeds its 6.6% benchmark.
Some of Australia’s best performing superannuation funds returned more than the Future Fund over the same period, due to higher exposures to alternative risk assets. The best performing industry fund in 2017-18 was Hostplus, which made 12.7% according to Superratings data. Over 40% of its AUM is in illiquid assets, infrastructure, property and other areas, compared to less than 30% at the Future Fund.
Neal said the fund was comfortable with its position versus such peers. “The top performing funds are those that, naturally, take a lot more risk than the Future Fund,” he said in a teleconference call.
"The way we think about risk is defined by our mandate to strive to achieve returns without taking excessive risk, which we assess against a range of potential outcomes.”
However, he noted that “the private markets are a very large opportunity set” for the fund, that have been “giving us a suitable return for the level of liquidity”.
Neal noted that Future Fund has partners around the world helping it to find investments. “We are carefully controlling the amount of liquidity in the portfolio to maintain flexibility and we take a fairly nimble approach to move between these opportunities as the relative pricing changes,” he added.
PRIVATE EQUITY POTENTIAL
The fund recorded a single percentage point increase in its private equity (PE) allocation during the year. This was partly attributable to the strengthening of the US dollar, since the bulk of the Future Fund’s PE holdings are in dollars.
Neal said the fund is investing more into PE, because “it offers the chance to generate additional returns through the application of skill”.
But it’s not easy - “Investing in the growth equity space is an area where it is hard for us to get large amounts of capital to work. Nonetheless it’s an area we continue to emphasise,” he added. It also requires being careful when choosing general partners.
“We focus on organisations that have a strong history and skill base in adding value to businesses and enhancing operational improvements. That’s a big part of risk management,” said Neal.
Future Fund's external PE and special opportunities managers include Apax Partners, Bain Capital, Quadrant Private Equity, HarbourVest Partners and Oaktree Capital Management.
For the coming year, Future Fund is most focused on macroeconomic and geopolitical issues. Costello noted the fund is keeping an eye on inflationary pressures emerging from the US, leading to rate hikes there and elsewhere to more normal levels and causing “downward pressure on asset prices”.
Plus there is the ongoing threats of a trade war. “International political and trade tensions continue to impact markets and the other great threat to investors around the world would be the tit-for-tat trade retaliation tariffs, which will be bad for global growth, bad for Australia and will certainly affect asset prices,” Costello warned.
Neal added that fixed income investments would be watched closely as they could be the first to feel the brunt of the economic fallout.