ONE thing David Gonski could do when he replaces David Murray as chairman of the $73 billion Future Fund is rename the board he leads. I don't know who came up with the title "board of guardians", but it sounds like an overblown, superannuated Marvel comic superhero team.
The board actually is a "super" hero of sorts. Its job is to cover unfunded super liabilities in the Commonwealth public service. But it's a job, not a sacred mission, and the board of guardians is a board, like any other: "The board" will do nicely in future if that's at all possible, Mr Gonski.
David Gonski will take a lower profile than David Murray, partly because the fund has sold off its Telstra share overhang (it was an active, critical investor when overweight, with mixed results) and partly because that is his style. But another thing he can do when he takes the chair is conduct a stocktake of the Future Fund's investment strategy.
The Future Fund has the job of building asset values to cover public service retirement cheques that begin to flow in about eight years. It is not competing with other managers for new money, and does not need to market itself using quarterly performance figures.
It was established by the then treasurer Peter Costello (he was appointed to the fund's board by the Rudd government, and was an internal contender to take over from Murray), and its task is to achieve an after-inflation return of at least 4.5 per cent a year in the long term.
The fund defines "long term" as a rolling 10-year average, and it leverages its unusually long-term investment horizon to build a portfolio that would be too risky for most private sector fund managers.
At December 31, for example, it was defensively sitting on cash equal to 13.8 per cent of total funds, but another 20 per cent was invested in so-called "alternative assets". Funds invested in alternatives rose from $9.8 billion to $13.7 billion in the year to June 2011, and to $14.5 billion at December 31 last year, the date of the most recent update.
The fund is still expanding its alternative exposure, which includes "macro-directional" trading, commodity-oriented trading, "distressed and event-driven" investment, "relative value" trading and "event-driven" investment.
Macro-directional trading is a punt, albeit an educated one, on which way the market will move. Relative value trading is computer-driven price arbitrage, structured around matching buy and sell contracts that net out at nil exposure. Event-driven trading is most usually takeover arbitrage a bet on the outcome of a bid. And distressed trading is the acquisition of discounted debt, bank loans, for example, in highly geared companies that are attempting a reconstruction: investors using this technique took over the debt of Centro for example, and then painstakingly negotiated the property group's bailout.
They are all hedge fund investment strategies. And while the fund doesn't describe them openly as such, it says it likes them because they are "an attractive way of taking risk which offers diversifying outcomes from already embedded major market risks". That's an oblique reference to Alpha, the additional, absolute return that hedge funds promise to deliver in return for higher management fees.
The Future Fund is also a relatively aggressive private equity investor, with 5.1 per cent of its funds invested in that sector at the end of last year, and it is a heavy direct investor, with 12 per cent of its money in tangible assets, including properties and infrastructure.
Its fixed interest portfolio, almost 18 per cent of assets at December 31, is also increasingly weighted towards less liquid specialty debt markets, including property and infrastructure that have been deserted by the banks post-crisis.
The asset mix reflects the fund's long investment horizon. It is making higher-risk, higher-return investments in the belief that short-term losses will be ironed out in time.
So far, it's worked. The fund's return since inception in May 2006 has averaged 4.2 per cent a year. In calendar 2011, however, the return was down to just 1.6 per cent, and in the final six months of the year it was minus 3.1 per cent.
Gonski (pictured) could ask whether the push into alternative strategies and private equity should continue, given the lower returns hedge funds have been posting since the crisis, and a possible longer wait for private equity paybacks post-crisis.
An alternative would be to directly and indirectly invest in more infrastructure and other utility assets with the aim of locking in lower, safer, post-crisis returns. Australia certainly needs capital in that area, and the fund could be a leader: the board's other new member, Morgan Stanley Australia boss Steve Harker, could assist the review.
mmaiden@theage.com.au
Frequently Asked Questions about this Article…
What is the Future Fund and what is its main purpose?
The Future Fund is Australia’s sovereign wealth fund set up to cover unfunded Commonwealth public service superannuation liabilities. Its job is to build asset values so retirement cheques for public servants can be paid when they start in about eight years, aiming for an after‑inflation return of at least 4.5% a year measured on a rolling 10‑year average.
Who is David Gonski and what might change when he becomes Future Fund chairman?
David Gonski is the incoming chair replacing David Murray. The article says Gonski is likely to take a lower public profile than Murray and could conduct a stocktake of the fund’s investment strategy — reviewing the push into alternatives and private equity and whether to re‑weight into other asset types such as infrastructure.
How much of the Future Fund is held in cash and alternative assets?
At December 31 the fund was holding cash equal to 13.8% of its total assets and around 20% of the fund was invested in alternative assets. Alternatives grew from about $9.8 billion to $13.7 billion in the year to June 2011 and were reported at roughly $14.5 billion at the most recent update.
What kinds of alternative or ‘hedge‑fund‑style’ strategies does the Future Fund use?
The fund’s alternatives include macro‑directional trading, commodity‑oriented trading, relative‑value (computer‑driven arbitrage), event‑driven strategies (often takeover arbitrage) and distressed investing (buying discounted debt in highly geared companies). The fund says these strategies offer diversifying outcomes and potential alpha.
How has the Future Fund performed since it started and what were recent returns?
Since inception in May 2006 the fund’s average return has been about 4.2% a year. More recently, calendar 2011 returns were down to 1.6% and the fund recorded a -3.1% return in the final six months of that year.
Why does the Future Fund invest in private equity, property and infrastructure?
Because the fund has an unusually long investment horizon it can take higher‑risk, higher‑return positions that many private managers avoid. At the end of the last reporting period it had about 5.1% in private equity and roughly 12% in tangible assets such as property and infrastructure, with the idea that short‑term losses can be smoothed out over time.
Should everyday investors worry about the Future Fund’s use of hedge‑fund strategies?
The fund uses hedge‑fund‑style strategies to diversify risk and seek additional returns (alpha). The article notes hedge funds have posted lower returns since the crisis, which is a legitimate reason for review, but the fund views these approaches as ways to achieve outcomes that differ from mainstream market risks rather than speculative gambles.
Could the Future Fund shift more into infrastructure and why would that matter?
Yes — the article suggests an alternative to the current push into alternatives would be to invest more directly and indirectly in infrastructure and utility assets to lock in lower, safer post‑crisis returns. Increased infrastructure investment could help Australia’s capital needs while offering the fund steadier cashflows aligned with its long‑term liabilities.
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