Full transcript of the David Murray interview

Michael Pascoe: David Murray, what’s the big challenge for you with the Future Fund?

David Murray: To get it off to a good start. It’s new in Australia, the idea of putting aside money to meet a superannuation liability; taking a very long-term view. We’ve just got to get off to a good start.

When you say getting it off to a good start, you’ve got $18 billion to start with. How do you do it?

There are two issues here. One is how we invest generally; the other is how we get started and there’s a very important part of the Government’s mandate, which is that we’re not to disrupt the market, so I think we’ll go through a transitional early phase of getting started without swamping the market and then we’ll settle into our long-term investment phase after that.

Your initial $18 billion seed funding, then the Telstra privatisation '” $30 billion maybe in shares or cash also to be put away. That has to build up though to $140 billion by 2020.

By about 2020, yep. So there’s $18 billion in, there could be more surplus money from the Government in the next few years; may or may not, depending on the priorities and then the Telstra shares '” say 25 on top of that '” so it will be quite a sizeable fund early and it’s got to grow to what we think would be to cover the liability. We think would have to be about $140 billion by 2020.

And that’s actuarial maximum it has to get to? Is it designed to then run down or to continue?

Once we get to that prescribed date, the fund will then actually start paying the year-by-year liabilities of the prescribed pensions, public service pensions, some other pensions, military pensions and so on, so it won’t actually drop all the money back. It will just actually start meeting the annual liability.

Out of its earnings? So it remains a constant?

Not necessarily. But at that time it will be important that the distribution policy not disrupt the quality of the portfolio, and the legislation has been set up on the basis that it will only meet one year’s liability each year once it gets to its end point.

Just in terms of timing: legislation’s been introduced. What happens next?

Well it’s got to pass the Senate and get royal assent and then we’ve got to figure a commencement date but we can’t commence until we’ve got a board in place, until we’ve got a chief investment officer and a small group of people with the appropriate authorities and operating arrangements to get moving. So we’ll try and do that as quickly as we can and I’m hoping we’ll get started before mid year.

So that does mean the market will top out in around mid year?

Well, the big mistake with a fund of this nature is to take a view about market timing. It’s just got to be a well run portfolio for the long term.

In terms of not disrupting the markets, does that mean initially you might have to be more offshore than perhaps ideal?

Well the one thing it does mean is that we’re not going to tell anyone how we’re going to do it because that would influence the market in some way. I’m very mindful of the whole approach that’s been taken with the Future Fund, and that is that it’s a long-term investor, it’s not an entrepreneurial participant in the financial system, and so it will be interesting the way we go about that first phase, but we’ll do it in a way that maximises the return to the fund and minimises disruption to the market.

And you’re precluded from using derivatives to try to slide into the market sideways through that method?

Yes. Actively using derivatives or borrowing money, for that matter, and that’s part of that approach that’s been set up: that the fund is not an entrepreneurial participant in the financial system in its own right. It’s not the Government starting a bank by another means, and so we can only also invest in financial assets and so, yes, we have to get into the market and find the right assets including during that transitional stage.

You can invest though in, say, hedge funds that themselves use derivatives?

Oh well, it depends whether that investment is a financial asset, and when we get started we’ll have to work off the legislation and look at those policies very carefully.

Will the Future Fund be a manager of managers or will it run its own show?

It’s intended to be a manager of managers but that cannot be done effectively without running your own show. Even if you manage managers, you have to have a portfolio model that’s distinctive to get the objectives and you have to have sufficient information and sufficient skill to be able to adapt that portfolio towards its objectives all the time. That can’t be done just by giving instructions to other people; it has to be very skillfully managed internally.

Which means the Future Fund Management Agency will have that job. So you’re going to be looking for a pretty experienced chief investment officer?

That’s right; somebody who really understands being around the market, empathises with this sort of role, with the idea of a Future Fund; there’s a few of them around the world. That will be a very important appointment and one that we can’t get involved in actively until there’s a board in place.

How big a staff will the agency management have?

Oh only small. The New Zealand fund at the moment has about $NZ8 billion. I think and it has a staff of 13. It might get to 25 or so, and so these are not huge operations in people terms. The trick to it is getting the skill right.

Philosophically, what funds managers do you admire? What sort of an operation have you looked at and thought, 'Oh, that’s pretty good, I wouldn’t mind that sort of a thing'.

Oh, I think the standouts are the university endowments in the United States. They have to think about things in the same way the Future Fund will have to. They’re dealing with an underlying cause, which is the stable funding of a university for the very long haul to maintain a level of education, and at the same time they’re dealing with peaks and troughs in the economy around that university. Typically, those universities have been through bad times; when they risk losing their great professors, it breaks down the whole fabric of their learning: the special effect that they provide their students. So they have to take some money in and earn good money for a lot of years and then be prepared to let some go in bad years but smooth that all out and take a very long-term view. The other one that’s interesting is the Norwegian Fund, because it’s built up a huge sum of money to invest the surpluses from the North Sea oil reserves while they’re there for the Norwegian economy, with the thought that one day there won’t be. So there are some fantastic examples around the world but the university endowments in America, I think, are probably the best example of what we’ve got to try and achieve.

Which is a similar answer to that given by Michael Delaney from the MTAA, that outrageously successful industry fund. That’s resulted in a lot of direct investment in infrastructure, which you are precluded from doing directly. Will it still be a major asset class for you?

Well it’s a major asset class indirectly in the economy, so it’s just as important an asset class for the fund as all others. But direct investment is part of this notion, that it is not an entrepreneurial participant in the financial system, so I think that’s a good thing to be precluded from direct investment. But our financial engineers in the market can create pooled funds, all sorts of financial instruments for investment, so I don’t think there’s any limitation because of the fantastic creativity and skill in the financial system.

While it’s a manager of managers, how active a shareholder do you think the Future Fund should be?

I think it has to exercise its rights as an investor independent of the Government. And there are degrees; activist would not be appropriate. On the other hand, there are situations where good voting results in superior returns and so, like anybody else '” any other investor '” the fund will have to bear that in mind, but the Government, in line with its general objective, has also limited the fund from having a controlling interest in any company.

But you can still be another major shareholder with major impact on the board, on the management?

Yes, but we would have a group of very sensible board members who understand commerce and understand voting and what to do and I don’t think that we would do anything silly.

Could you give an example of the sort of occasion where the Future Fund would actively vote on an issue? All hypothetical, of course.

Well in my mind it’s about making sure that we maximise the return from investments. The other option we have is not to invest in certain things if we feel that it’s not warranted, so you can either not invest or exercise a vote and we’ll just have to determine that as we go.

Something like remuneration reports: the Future Fund would take an active interest? It would vote?

My starting point is the sustainability of the company’s performance that we invest in and that means having good people, having good clear strategic thinking for the longer term, having a skilled board, having a highly skilled management. To me that’s the starting point for investment. At the end of the day, investment returns come from company earnings.

There’s been a lot of speculation that you may have two mandates. Future Fund 1 and then Future Fund Telstra, particularly if you get stuck with a whole pile of Telstra shares the Government can’t sell. Has that been discussed yet or worked out, or is that yet to be done?

No, that’s yet to be done because the Government is still formulating its position on the Telstra sale and, of course, the Department of Finance won’t show its hand until it’s determined its tactics, which is the right thing to do. Clearly, the fund will either get cash from sale and/or shares. If there’s a lot of shares there that don’t match a normal weighting of investment in the market, then clearly a separate mandate is needed to characterise that brief from the main one to invest the cash. So yes, there would have to be separate mandates and what’s in the mandate for any Telstra shares will come right back to the sales strategy of the Government, so I can’t predict that until they determine it.

And that would have a different interpretation of what sort of shareholder activism would be acceptable?

Well it just depends how the Government goes about that brief. It could be, 'Here’s some shares, do what you like with them', or 'Here’s some shares, sell them in a prescribed time frame'. And it really depends on their reading of the market and the advice that they get from their advisers about the market.

There had been speculation about whether the Future Fund would be allowed to invest overseas. It is allowed to? What sort of percentage weightings do you see domestic or foreign investment?

We haven’t determined that. That would be a matter for the board to determine but generally this fund should be viewed as a long-term pension fund in style and one that would have a proportion of its assets offshore and a proportion onshore, so the best lead to take is a balanced superannuation fund approach.

And the role of the board in terms of setting asset allocation as opposed to the role of the chief investment officer: how does that balance work?

Well, I’d like to think that we move in the direction that these funds are moving now where the board is less interventionist but very clear about the investment philosophy, the mandate and the conduct of the portfolio. In my time at the Commonwealth Bank, we increasingly ran credit that way with our board and, done that way, the board is actually more skilled about portfolio theory and investment than looking at individual investments all the time. There can be quite a degree of delegation to a chief investment officer if that process of management of the portfolio is set up well at the board level.

It also means the board making decisions, though, still on the broader asset classes; on alternative investments. How do you feel about the many and the growing number of alternatives around?

They’re very fashionable at the moment, alternative investments, until they’re not alternative any more. But I think that it seems that these sort of funds that do best have skilled people in them, who enjoy operating the market and get a buzz out of doing well. To achieve that you need a good research capability and the possibility of investigating alternative classes of financial assets to see whether the fund can do better and better, but it’s still got to be within that sort of pension fund mandate. The Government’s looking for a real rate of return of 4.5–5.5%, and to get that you have to keep the portfolio in good shape for a long time.

That’s a realistic target you’ve set. What does it say, perhaps, about the state of the market at the moment, the investor expectations when if you’re not getting double-digit returns? You’re seen to fail?

Well, I mean those targets have been worked out over the very, very long term and that’s the only approach that can be taken at this point. It would be nice starting if the market was less well performing than it is at the moment, but market timing needs to be ignored to do well, and that rate of return '” it’s a real rate of return '” is generally what’s achieved by balanced funds over the long term.

Chairman of the Future Fund '¦ what else have you got time for in retirement?

Well, I’ve been quite busy with this already and I haven’t really decided what else I’d like to do. I have some private interests but I’m deliberately waiting to see how I feel about other things before taking them on. This is to me a very important job, the Future Fund. It’s a way of giving back, the idea of pushing back against the kicking into touch that happens when people create pension liabilities and don’t fund them. The idea of taking that on in the opposite direction and setting aside for the future, I think, is a wonderful thing and I’m really passionate about the fund getting off to a very good start with very skilled people.

Who appoints the board: you or the Government or the Government with your consultation?

The responsible ministers who are the Treasurer and the Minister for Finance. They’ll make all those appointments and once that’s done we can have a chance to get started.

As chairman, you have some input to it?

If I’m asked, but they’re their appointments and I’ve always thought that it’s important to set down some criteria. To me the most important thing is that the people on the board understand investment and understand the commercial process.

Does being chairman of the Future Fund effectively wipe out a whole range of potential other directorships that you otherwise might have been offered?

No, not really. The legislation has been deliberately drafted to set out how to deal with conflicts of interest because in a fund like the Future Fund, which is investing in nearly everything, ultimately, there’s nobody could sit on a board without a potential conflict of some sort. So rather than try and find people with no conflicts, we’ve set up legislation that deals with conflicts of interest so it’s quite possible that I could do other things and other members of the board could do other things. I’d just have to make sure we’ve got a very good process of dealing with those conflicts.