Gonski facing a few fund issues

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