For the first time over a full financial year, after generating a return of 15.4 per cent in the year to June, the Future Fund‘s performance has exceeded its mandated targets.
The 2012-13 performance of the fund is exceptional, given that a key objective of the fund is to protect its capital and therefore there is a defensive skew to its investment strategies.
With no access to external cash flows (because there have been no federal budget surpluses under the Rudd-Gillard-Rudd governments) and about 70 per cent of its assets offshore and 72 per cent of those exposures hedged, the fund needs to remain both defensive and liquid. When the Australian dollar falls — as it has, heavily, this year — the fund has to inject substantial amounts of cash into its positions.
The strong returns from the fund in the last financial year mean that it has now generated a three-year return of 10 per cent per annum and a five-year return of 7.1 per cent. Its mandate is to return the CPI plus 4.5 per cent to 5.5 per cent a year over the long term, which equates to a targeted return of about 6.8 per cent over both the three and five-year periods.
While it was established by Peter Costello in 2006, the fund only really became operational in 2007-08, just ahead of the financial crisis. Despite the timing and the continuing volatility of financial markets since the crisis, the fund — without any further contributions from government — has grown from $60.5 billion to $88.9 billion.
Its portfolio has also evolved considerably. In its early years, the fund retained high levels of cash and focused on debt securities because of the uncertainty and risk associated with that period post-crisis. That helped preserve its capital but held back its absolute returns.
Over the past year, there have been some significant shifts in its strategy and the construction of the portfolio.
There is more risk in it. About 40.6 per cent of the portfolio is now invested in equities and a further 7.3 per cent in private equity investments. A year ago, the equities component of the fund was about 33 per cent and the private equity component 6.4 per cent.
Within the equity exposures there have been some shifts, with the proportion of the fund invested in Australian equities sliding from 10.4 per cent to 9.7 per cent, but the share assigned to global developed markets rising from 17.5 per cent to 23.8 per cent. Emerging market equity holdings rose from five per cent of the fund to 7.1 per cent.
Conversely, the fund’s exposure to debt securities fell from 18.3 per cent to 15.6 per cent and its cash from 10.6 per cent of the portfolio to 5.8 per cent as returns on debt and cash dwindled under the weight of the expansive monetary policies being pursued in most of the developed economies.
With its approximate $1 billion acquisition of the Australian Infrastructure Fund’s assets, the Future Fund has been making a big push into infrastructure investments. It sees infrastructure, timberland and alternative assets as a more stable core to the portfolio generating CPI-plus style returns that provide protection for its capital.
The fund’s managing director, Mark Burgess, and his relatively small team would be well-pleased with their performance given the extreme volatility in financial markets that was a feature of the past financial year. That volatility has continued in the current year as markets respond to perceptions about the likelihood and timing of the US Federal Reserve Board’s tapering of its quantitative easing program.
While that program helped push investors out of government debt securities and into riskier asset classes in search of positive returns (and inflating the value of higher-yielding assets in the process), it has also injected uncertainty and risk into the markets.
The fund appears to have navigated the tricky trade-offs between risks and returns well. The fund, despite its size, has shown considerable agility in recent years. There have been some quite material shifts within the portfolio in recent years, although they do appear generally more strategic than tactical or opportunistic.
The Future Fund’s guardians and investment managers are also responsible for another $11.3 billion within three other ‘’nation-building’’ funds: the Education Investment Fund, the Building Australia Fund and the Health and Hospitals Fund.
In 2012-13, those funds, where the mandate is to minimise the probability of capital loss rather than generate significant positive returns, produced returns of 4.2 per cent compared with their target benchmark return of 3.6 per cent.
There remains a high level of risk in the global investment environment, with the Fed’s tapering expected to commence shortly; still-unresolved and potentially destabilising issues in Europe that may emerge after the German election; the success or otherwise of Japan’s ‘’three arrows’’ program; and continuing queries over China’s growth rate and attempted reorientation of its economy from investment and exports to domestic consumption.
But since its inception, the fund has known nothing else. Its recent performance would suggest that it has learned how not just live with those risks, but how to exploit them.