The new chairman of AustraliaÆs Future Fund says returns from the fund are unlikely to hit mandated benchmarks in its first year of operation, and that future returns will depend on the boardÆs independence from government policy.

David Murray says the fund, which has been established to meet unfunded superannuation liabilities for federal government employees, is expected to return a rate of CPI plus 4.5%-5.5% but that this wonÆt be achieved in its set-up phase.

He also says the task of meeting unfunded liabilities will be challenging given that the government hasnÆt committed to making an annual injection to the fund.

Murray, who recently retired as the chief executive officer of the Commonwealth Bank of Australia after 40 years with the bank (and 13 of those in the top job), has been appointed to chair the Future Fund board of guardians.

On Wednesday he told a gathering of investment bankers and fund managers that there was still a lot to be done before tactical asset allocation decisions could be made. The fundÆs investment mandate takes effect on 22 May.

As yet, the fund hasnÆt hired an executive team nor has it appointed investment managers or a custodian. Last August the government retained Watson Wyatt to give advice on asset classes, expected rates of return and risk levels, but there is no indication that Watson Wyatt will also be charged with selecting managers.

ôWe are a complete start up and wonÆt be investing money until we have the proper infrastructure in place,ö says Murray.

He says the hiring and firing of investment managers will be the role of the fundÆs executives and not the board. ôThe trustees should be focused on the structure of the portfolio. And this is something that should be reviewed more than once a year.ö He says the fundÆs asset allocation is likely to be rebalanced frequently.

The A$18 billion of capital set aside from last yearÆs budget surplus to seed the fund is now on deposit with the Reserve Bank of Australia. Another A$12 billion is expected to flow into the fund from this yearÆs budget surplus, and the fund is also expected to collect about A$20 billion from the proceeds of the full privatisation of telephone company Telstra when it happens later this year.

Murray would not indicate the exact timing of the Telstra sale. ôAs a public servant I am now drawn into the Telstra process so the last thing I want to do is indicate market timing to the market,ö he says.

Commentators have expressed concern that the weight of the Future Fund will have a significant impact on investment markets given that it is expected to reach A$140 billion by 2020.

Murray allays these concerns, saying he doesnÆt think the fund will cause abnormal volatility in the markets. ôThere is already between A$750 billion and A$800 billion invested in Australia, so our pool isnÆt that large really.ö

However, he is worried about liquidity in the Commonwealth bond markets given the lack of supply in these securities. ôThis is one area of significant concern and something I have raised with the Treasurer, Peter Costello. The Future Fund is in a position to drain liquidity from that market, so we will have to discuss with the treasury how we can avoid this from happening.ö Murray says it is possible that the fund will resort to investing in state government bonds as an alternative.

Asked whether the fund will invest directly in public infrastructure projects, Murray says no. ôBut we can include pooled infrastructure assets in our investment mix.ö

He says the fundÆs mandate requires that all money be invested through external managers and that some money be allocated to offshore securities. It also allows for investment in alternative asset classes such as hedge funds.

Murray says the fund would not become an instrument of government policy, and nor would it be a player in the market for public and private goods. ôThe return objectives for the fund are not likely to be met if the government directly intervenes in the type of assets that we hold.ö

Another key to the fundÆs success will be restricting the government from withdrawing cash on a whim, says Murray. ôIf the fund at any time equals or exceeds the superannuation liability then the government can take funds out, but it can only take as much as it needs to match its commitments in one year."

He adds: ôIf the government is able to withdraw funds when it wants it will seriously damage our asset allocations if our risk/return stance is wrong in future years. The success of these pension funds depends on how specific the brief is for the people who are managing the money and how the money will be used down the track.ö

He says the aim of meeting superannuation liabilities by 2020 might be impeded given that the government is not committed to injecting a fixed amount into the fund each year. ôThere are some funds around the world that receive a fixed cut of GDP each year. Since this provision isnÆt made for the Future Fund, we donÆt know whether we will hit the target of matching liabilities or not.ö