Australia’s Future Fund's CIO Sue Brake believes her organisation's total portfolio approach will see the sovereign wealth fund fight off heightened investment risks and the latent threats of inflation.
Having recovered from what she told AsianInvestor was “a really turbulent year” by digging deep and reevaluating its core beliefs, Brake believes that the long term return target and strategic asset allocation remain core to the A$218 billion ($167 billion) sovereign wealth fund's approach.
Having fewer defensive assets, bonds, in particular, means that, under its whole-of-portfolio approach, Future Fund has had to trim its offensive assets, which obviously weighs down on returns.
Brake emphasised that it is a key part of the fund’s mandate to focus on the 10-year return target (currently 6.2%) without taking excessive risk.
“You don’t fall into the trap of having a pro-cyclical risk appetite (selling at the bottom and buying at the top). That’s at the core of how you build a portfolio to achieve a longer-term return," she said.
“Because we take that total portfolio approach, we don’t have to chase the technology stocks within the equities market. We’ve got a great venture capital programme within our private equity investments and we’ve built this culture of always looking at the total portfolio, so we don’t have individuals going off and trying to maximise each area."
In early 2020, exposure to foreign currencies, interest rates and bespoke hedge fund strategies helped Future Fund avoid the worst of the global market downturn, but it had to sell down $4 billion worth of private equity positions and another $2 billion of infrastructure holdings to maintain asset liquidity.
The percentage of its portfolio in alternative assets dropped from 50% in 2019 to 41% in 2020.
Brake said the investment team doesn’t consider the alternative segment in percentage terms, so it’s not an issue of being over or underweight.
“What we are concerned about is the return environment and it’s getting increasingly difficult to get the returns that we’ve had in the past. As an investor, you have to start drilling down into your beliefs into how much can you make from an alpha portfolio. You need to be able to harvest the alpha otherwise you chase your tail, trying to get a return that is not true alpha.
"Our external managers are very focused on producing alpha from true skill and being at the front of the queue when it comes to allocating capital to interesting opportunities.”
Although the Future Fund’s cash position increased to almost 20% by the end of 2020 (up from 9.6% in March) Brake believes there’s a misperception of what this means in risk terms.
“There’s a (mistaken) conflation between cash levels and how invested the portfolio is in return-seeking investments. We can increase risk within the allocations and use overlays to get the risk levels where we want them.
"We have a total portfolio management risk level targeting a certain amount of risk over the long term to make sure we don’t get risk-averse," she added. "We use that as a very loose guide for the portfolio and as it happens our risk levels at the moment are at their long-term neutral level. We’re not underinvested despite those cash levels.”
"We distinguish how invested we are and how flexible the portfolio is. That flexibility means that given this new fragile world we’re expecting – there are going to be opportunities and we want to be able to participate, as well as moving the risk levels actively in response to this kind of environment. We want a flexible portfolio that’s fully invested, and that’s what the asset allocation represents."
MAINTAINING STAFF MOTIVATION
Within the sovereign fund, there have been other risks to manage and Brake echoed the thoughts of other super fund chiefs saying that initially staff were happy to work from home, but it has become harder to keep them motivated and integrated as time has gone on.
“I think we’re a mass of smaller more intimate meetings, so the internal network has become more like a neural network, with a whole lot of different nodes speaking to each other.
“Most people I’ve spoken to, not only within Future Fund but generally, were exhausted by the end of last year – and I don’t use that word lightly. We deliberately closed our office so that people could take a break and we’ve had consistent feedback that that made the world of difference. We’re in a better place now, but still very conscious of how important those connections are when it comes to making investment decisions.”
In 2021 and beyond, one of the latent risks is a return of higher inflation. Although she doesn’t think this will arise soon, Brake said: “There are large amounts of debt and we are already seeing asset price inflation in financial assets. There is a risk to that that this inflation takes hold. But at some stage, if you have a long enough investment horizon, that’s something to be looking for opportunities to hedge against.”
Meanwhile, Future Fund's total portfolio approach has proved to be a successful strategy and Brake sees it as a competitive advantage.
“Within our one portfolio mantra we have this phrase – joined-up – and I believe it adds basis points to our long term return and we are working hard to make sure we are as joined up as we ever were.”