Exposure to foreign currencies, interest rates and bespoke hedge fund strategies helped Australia’s Future Fund avoid the worst of the recent global market downturn, but it has had to sell down private equity positions to maintain asset liquidity, according to its chief investment officer.
Raphael Arndt told a teleconference on Monday (April 27) that the A$162.28 billion ($104.75 billion) sovereign wealth fund's performance for the financial year to date (the nine months up to the end of March) had left its total investment returns “broadly flat”.
"In a quarter where the ASX 200 fell 23% and the S&P 500 fell 19.7%, the Future Fund recorded a negative return of 3.4%, meaning that for the financial year to date the fund return was -0.2%," he said.
With listed equity and credit investments performing poorly, roughly in line with markets, "foreign currency positions and exposure to interest rates all worked as we would have expected and we have a series of options strategies that insulate the portfolio," he added.
The fund also benefited from certain hedge fund strategies, which brought its overall hedge fund programme back from a larger loss for the period.
“There were a few defensive funds in the mix and they did perform as expected,” Arndt said, noting that these strategies were based around volatility trading and options. The CIO said they contributed "very significant double digit returns in the period," but wouldn’t be drawn on naming individual managers.
Changes to the Future Fund's asset allocation over the period primarily consisted of a reduction in the cash balance and a rise in its private equity allocation. However, Arndt said this was predominantly due to the currency effect, as the Australian dollar has fallen precipitously against the US dollar this year.
Chart 1. Future Fund asset allocation, March 31, 2020
“We’re partly hedged and we needed pay some of that liquidity away on our hedges, but our overall position improves because the foreign assets that we own go up in value when looked at in Aussie dollar.” said Arndt.
Indeed, to maintain its high level of liquidity the sovereign wealth fund sold down $4 billion worth of private equity exposures in the secondary market, including through the recent period of market turbulence.
While the Future Fund will not mark to market any of its remaining illiquid assets until June, Arndt offered some transparency on the potential hit to the portfolio.
“We’ve got approximately a third of our assets that have not been marked to market, but if they were marked down by 7.5%, the fiscal year return [to date] would be -3.5%,” he noted, adding that the return for the last quarter was 6.6%.
One of the reasons the fund wants to keep its liquidity high is to take advantage of buying opportunities. Arndt said the recent market dislocations in listed equities and credit provided it with a brief window of opportunity.
“We did participate in some buying opportunities alongside some of our hedge funds, when opportunities opened up in the pricing of some public markets securities in the US; very liquid instruments, very briefly until the Fed stepped in and closed those arbitrages.
“We also deployed some capital to investment grade and high yield debt, modestly as spreads widened,” Arndt added. However, he was cautious about making further purchases. “We don’t think it’s a good time to be rushing out to buy things.
As the economic outlook becomes clearer and as private markets settle into a new equilibrium then we’ll be in a position to decide if we want to buy them or not.
"We are still in lockdown phase so we are really only going to discover in the coming months, whether the earnings destruction we are going to see in corporates is going to be offset by the government stimulus around the world or not.
"As the economic outlook becomes clearer and as private markets settle into a new equilibrium then we’ll be in a position to decide if we want to buy them or not. It’s definitely the case that risks remain elevated."
Arndt said the Future Fund will maintain its positive view of infrastructure assets, but he ackowledged that there are some concentrated risks in assets such as airports and toll roads as a result of the coronavirus lockdowns in many countries.
Other infrastructure assets, for example power and utilities, also stand to be affected, Arndt added.
“I think it’s worth investors thinking about an economic paradigm around the world where unemployment is going to increase significantly, in some countries perhaps to 10% or 20%.
“We see pressure on utility bills and that is partly why we decided to sell Southern Water in the UK, because we could see there was more public pressure on keeping the cost of essential services low. That's a good thing, but it goes to what you’re prepared to pay for something.
"So it is a good time for investors to question the assumptions they might have been making and ensure they are adapted to the new world that we now live in."
Arndt offered no new information on the Future Fund’s search for a new chief executive officer to replace David Neal, who left earlier this year to join IFM, beyond noting that there’s a global search process underway.
Chart 2: Future Fund performance