Executives at Australia’s Future Fund are bracing for tough times ahead, despite registering a stronger than average performance in the first six months of June after increasing its exposure to emerging markets.

In a briefing on Wednesday (August 28), David Neal, chief executives of the A$162.62 billion ($109.68 billion) sovereign wealth fund, said the management team in Melbourne is prioritising diversification and a dynamic management policy in response shifting global conditions.

“The board continues to see long-term returns as unlikely to replicate the strong returns of recent years and is cautious of the risks for investors,” he said in a media call about the results. “The investment environment remains challenging and we remain alert to a range of uncertainties and the potential for shocks to investment markets.”

Future Fund executives highlighted the ongoing US-China trade tensions as the greatest threat to global economic stability.

“The US China tariff issue has undoubtedly spooked financial markets,” noted chairman Peter Costello. “Every time a new tariff is imposed, we see financial markets respond. The reason markets haven’t fallen further is that most people are expecting this to be solved, so there’s quite a lot of optimism built into global stock markets.”

Peter Costello

Costello told AsianInvestor that it’s an open question as to how long the trade war will last.

“Investors have to make their own judgements on whether it will be prolonged,” he said, adding that "if there was a view that this will continue and things will gradually deteriorate, then I think we’ll get a much more pessimistic view from the markets."

TRADE WAR COMPLACENCY

Costello added that investors have become used to the short-term market volatility that has largely emerged because of US President Donald Trump’s frequent and sometimes contrary tweets.

“Tariffs are imposed and the market falls a couple of percent. Then president Trump tweets from the G7 that things are looking positive and the markets go up again,” he noted.

“If you really thought that this was going to be a long and entrenched war, which would lead to effects on the real economy, then you would be building a lot more downside into these valuations.”

The Future Fund chairman reasoned that the market believes the trade war will be short-lived, either because of the impending US election or “they think it’s in everybody’s interests to keep the global economy ticking along”.

“I hope they’re right,” he added. “It’s gone on longer than most people thought it would."

Costello added that fallout from the trade war between the US and China has also caused strain to the Australia-China relationship. And the situation would become much worse for Australia if the trade war leads to a downturn in the Chinese economy.

“That would have a significant effect on our export industries ... if it were to continue it would definitely affect economic prospects in Australia."  

BETTER RETURNS

Despite the gloomy outlook, the Future Fund reported decent returns for the 12 months to June 30.

Over a rolling 10 year period the fund reported that it achieved a return of 10.4% per annum, exceeding its benchmark of 6.5%. It performed particularly well in the financial year to June, delivering a return of 11.5% despite volatile market conditions.

This performance was partly due to an increase in the fund’s emerging markets allocation, which rose from 7% to 10% of the portfolio, reflecting the management’s confidence in emerging markets generally. Neal explained that the exposure is gained via a passive factor-based mandate with State Street, which he said does not adhere strictly to standard cap-weighted emerging market indexes.

Costello was also asked for his view about rising criticisms over human rights abuses in China, as well as its role in fuelling tensions in Hong Kong. He noted that the fund has a governance requirement, which means it tries to avoid investments that cause social issues.

“We’re not a big enough investor to actually be used to influence China on human rights or any other issue,” he added.

Future Fund Asset Allocation Shifts 2018-2019    
Asset Class A$m % of Fund 30.6.19 % of Fund 31.12.18 % of Fund 30.6.18
Australian Equities 11,457 7 5.8 6.7
Global Equities        
Developed Markets 30,097 18.5 16.3 18.2
Emerging Markets 16,317 10 7.3 7.3
Private Equity 25,705 15.8 15.8 14.1
Property 10,886 6.7 7.2 6.4
Infrastructure & Timberland 12,215 7.5 8.5 8
Debt Securities 14,621 9 10.1 8.9
Alternatives 21,960 13.5 14.6 15.4
Cash 19,363 11.9 14.5 15.1
Total 162,621 100 100 100