A Future Fund fracas doesn't fly

Movements in the Future Fund's investments last year suggest a very active approach among its managers, and it's unlikely the appointment of David Gonski will change this.

Given the high-profile and politicised nature of the debate occurring around David Gonski’s appointment as chairman of the Future Fund, one could be excused for thinking that a new chairman has dramatic implications for the future of the fund. In reality, that’s unlikely to be the case.

Gonski is, it should be said, a good appointment, just as Peter Costello’s would have been had the government taken the advice of the existing board of guardians.

The new chairman, however, inherits a lesser role than the one that David Murray was given as the inaugural chairman of a fund, which was at that point a promise of some very large lumps of cash married to Costello’s desire to protect at least some of his surpluses from the vote-buying instincts of John Howard.

Murray had to create the fund from scratch; Gonski will chair a board that presides over a very well-established organisation staffed by Mark Burgess’s high-calibre team of investment professionals.

No doubt Gonski, a vastly experienced and highly respected lawyer, investment banker and company director will want to put his own stamp on the fund, but it is most unlikely that he is going to second-guess the strategies of Burgess and his team, despite some misguided criticism of the fund’s performance.

The fund’s investment managers have, given that the fund was set up in May 2006 and therefore has known only crises and volatility since, produced a quite credible performance. The fund has, since inception, returned 4.2 per cent per annum. While below its benchmark of five per cent plus the CPI, producing real positive returns through the global financial crisis and subsequent eurozone crisis is an achievement that appears to have been underestimated in some quarters.

It’s an even bigger achievement if one considers that, with about three-quarters of the $73 billion of assets within the main fund deployed offshore (the guardians are also responsible for another $17 billion or so sitting within three other funds) the Future Fund has a massive exposure to fluctuations in the value of the Australian dollar, which has been extremely volatile.

With the Rudd and Gillard governments running big deficits, the fund also has no access to external cash flows – without injections of funds from federal government surpluses it has to rely on its internal ability to generate liquidity.

The combination of the volatility in the value of the Australian dollar and that lack of access to new external funding would have made managing the fund during the past few years – and most particularly last year, when the dollar would soar every time risks in the global markets were perceived to have diminished only to tumble when they were seen to have risen.

The fund hedges its offshore exposures, which means that every time the dollar dives it needs to pump cash into its positions, putting real strain on its liquidity position. Hedging those exposures is sensible – a naked exposure would mean a purely speculative punt on the dollar’s direction – but it means the key element of the fund’s performance is probably its management of the currency exposures rather than the underlying investments.

The implications of that conclusion appear to be borne out by changes in the portfolio last year, overlaid by some finessing of the investment managers’ thinking after Mark Burgess was appointed general manager last year.

Since his appointment the fund has very significantly reduced its exposure to equities and distressed debt, particularly its holdings of equities in developed markets (its emerging markets holdings have edged up slightly), while its interests in private equity, infrastructure and forestry and alternative assets have risen.

Given that most of the fund is invested offshore, and that the Australian dollar has soared over the past year, the shifts within the portfolio are probably understated – in constant currency terms the portfolio would have been quite substantially re-oriented.

Some of that would be the natural maturing of some of the fund’s strategies – it takes time to build positions in private equity, infrastructure, property and alternative asset classes.

It would appear, however, that as the eurozone crisis emerged, the fund moved quite quickly to dial down its risk profile, hence the 760 basis point fall in the proportion of the fund held in equities between March and December last year, from just under 39 per cent to 31.6 per cent. The fund would have been responding to the potential for a financial and economic catastrophe as well as the obviously negative implications for global growth.

It wouldn’t surprise if – after the European Central Bank has hosed the eurozone with very cheap liquidity, and markets have calmed – the fund is now re-building its positions in riskier asset classes. In any event, the movements within the fund last year suggest a very active approach to managing the fund.

The fund’s guardians can provide broad guidance as to their tolerance for risk and impose pressures and disciplines on their management to deliver the kind of long-term returns that were set as the fund’s objectives in a very different investment environment, but the tactical decisions inevitably have to be made by the investment managers and it would appear that last year they made quite a few calls and some quite big ones.

One of the big ones was a $2 billion increase in the fund’s cash holdings, from $8 billion (or 11 per cent of the fund) to $10.1 billion (or 13.8 per cent of the fund), as the managers responded to the rising risk in the markets and the volatility of the dollar and built up the fund’s liquidity.

The movements within the fund last year reveal that the fund is quite dynamically and prudently managed. While its performance since inception has fallen short of its key benchmark, the fact that the fund has grown organically in real terms over that tumultuous and dangerous period for markets and investment returns says the fund’s managers have done a good job in very difficult and uncertain circumstances.

Gonski, despite some of the controversies surrounding his appointment – and some cheap and gratuitous shots at Costello by those who appointed Gonski – will no doubt be a very good chairman who, with his fellow guardians, seeks accountability from the managers and provides a very good and strong public face for a fund that contains a very big chunk of taxpayer funds. As Costello or another of the existing guardians would have done.

What he won’t do – or at least shouldn’t do and shouldn’t be expected to do – is try to second-guess the professional money managers who actually protect and manage those funds and attempt to direct their strategies and tactics.

The appointment of a new chairman to the fund was always going to be a high-profile and potentially controversial event and inevitably Gonski will bring a different personality and set of priorities to the boardroom and a different chemistry to the relationship with management than Murray. At a fundamental level, however – the investment strategies and choices the fund pursues – nothing much of significance should change.