– The fund's position in the active global debate on what are appropriate returns on infrastructure investing.
– How the fund's mandate is achievable in the post-GFC environment.
– The Future Fund's current portfolio strategy is skewed towards US equities, due to the value created by the dislocation in offshore markets as a result of the GFC.
– The fund has diversified and increased its exposure to assets like venture capital and private equity in order to maintain strong returns, but he does not believe this has meant an increase in strategic risk.
– A large part of the reason the Australian dollar hasn't come off with commodity prices is because central banks from around the world see it as a safe investment given the current volatility of the global environment.
– The fund will incur no liabilities until 2020 when the first withdrawals are to be made and so he is still focused on long-term investing.
Alan Kohler: Well Mark, when you were releasing your latest portfolio update last week you said you’d be looking for more Australian infrastructure, you can’t find it because you can’t get good stuff at the right price. Is the problem basically that you’re being outbid by the Canadians?
Mark Burgess: Yeah. I wouldn’t say that we can’t find it and clearly we’re doing some things in Australia at present, but you know I think to Australia’s credit it’s a very positive environment for foreigners looking to invest in our infrastructure down here. And at the moment, as you say, the Canadians are very keen, but there are a number of foreign investors that are looking at Australian infrastructure as well as ourselves.
AK: But does it mean that your return expectations are too high? I mean, have you got a different point of view about what you can expect from infrastructure to the foreigners who are bidding against you?
MB: Well, just to be clear, we are actually in the middle of some large transactions at the moment, so that would indicate that we certainly haven’t got too high expectations for returns. The point you’re getting to, though, is a very important one, though, which is that investors globally are struggling to come to grips with what is an appropriate return when the risk-free rate on government bonds, for example, is so low. And so, there is a very active debate, not just here for investing in Australia but investing around the world. What is an appropriate return for your investments? We’re still able to find good returning investment opportunities at the rate that we need, but that is a very active debate.
AK: But what is the appropriate return on infrastructure? Is it 10 per cent, 12 per cent, or 8 per cent now?
MB: Well, we have a mandate which is CPI plus 4½ to 5½ per cent, so we always start there when we’re looking at opportunities. We also look at the way that it affects the total portfolio.
AK: But when that mandate was set the risk-free rate was much higher than it is now.
MB: It is a very…
AK: So, should the mandate be adjusted?
MB: Well, the mandate is a very challenging mandate – there’s no doubt about that – but we can still find opportunities where we think that it’ll meet that target. But I would agree with you that with risk-free returns at the lower end of the scale it is becoming more challenging to find some returns in the environment that we would like. The most important thing is to also be very conscious of the risk you’re taking and so we monitor that very closely as well.
Robert Gottliebsen: Mark, in Australia we have an enormous number of projects that we need developed. They’ll be roads. They’ll be bridges. They could be hospitals. And it seems to me that governments are having great difficulty setting these up so that they can extract a toll or a charge of some sort to provide the return. And so there’s almost a starvation of infrastructure projects caused by governments not knowing how to do it.
MB: Yeah. Bob, as you say, I mean there’s an active debate around the issue of how you bring, particularly greenfield but even existing, infrastructure to the environment that investors are looking for. We participate in that debate in terms of giving our input, but there are a lot of other investors that are also giving inputs on this; obviously, the superannuation industry and foreign investors also. But you’re absolutely correct that there needs to be a connection between that and the opportunities. We will look at opportunities as they come up, but as always it’s very much a commercial return that we need to get. That’s our criteria. But the point you make, Bob, is correct, that there is a perceived need for infrastructure. I guess what we’d like to see is those opportunities coming to us, so that we can at least assess them.
RG: But the governments are… there are two risks. There’s the commercial construction risk for a greenfield project and then of course there’s the ongoing situation with the return. The governments must take the commercial risk in the greenfield exercises and then it becomes a pure infrastructure investment.
MB: That really depends. You’re absolutely right, though. There is higher risk for the greenfields and therefore there has to be a balance of equation between the taking of that risk and the sort of risk that we and other investors are looking for. As you would appreciate, it’s being actively debated at the moment.
RG: Just one more point on infrastructure. Have you thought about the fact that a third of our superannuation money, and going onto a half later, is now in self managed funds and they are actively looking for infrastructure projects and having the same problem as you – they can’t find it. Would you think of actually bringing them in and making it a much more Australian project and a much wider ownership basis?
MB: Again, a good question and I think the most important issue for the fund is that we have a very clearly defined mandate. And so, we’re always looking to marry the opportunities with the mandate that we have. You mentioned about self managed superannuation funds; how to pool those and bring them into the environment. So, we’re prepared to partner with anybody who’s prepared to partner with us as a long-term investor. That’s really for others to try and bring that pool together, but you’re absolutely right, bringing the pool together is to our advantage and everybody else’s in terms of having a pool of capital that can invest in these projects.
RG: Why wouldn’t you do it? Why do you exclude yourself from that? There’s no particular reason why you couldn’t help bring them together, too.
MB: As you know, Bob, the self managed super is a very large and complex pool of assets. And so, we’re looking for opportunities to bring those together. There are many players that are also looking for those opportunities to bring them together and it’s really up to the industry I think to debate and discuss and figure out how to make that happen.
Stephen Bartholomeusz: Mark, within your mandates, as I understand it, you have to invest through managers. You can’t invest directly. What’s the philosophy behind that? Is it a frustration? And in particular does it inhibit your ability to invest directly in tangible assets; infrastructure and property?
MB: Yeah. We are required to use external managers, but we also have our own investment team and we look to our investment team to add a lot of value in that equation. And so, the way we do that is that we may look at a specific investment opportunity. For sure, we need to use a manager ultimately to help us manage that over time, but in terms of developing, finding the idea, doing the work on bringing that into the portfolio, we often do that work ourselves and then match it with a manager. In other assets we may, for example, just use the manager solely. So, in equities, for example, we may use the manager for a more broadly diversified mandate, but even there we try and fit that to investment themes or long term secular themes that we have that fit our long term mandate.
SB: Does that restrict your ability to invest?
MB: It doesn’t. It doesn’t restrict it because managers are prepared to work with us, being the largest fund in Australia and having such a clearly defined mandate. But we do demand of our own people a very high level of value add because we believe that it’s at the initial investment stage, the idea generation, particularly when it comes to things like asset allocation, choosing what assets to be invested in, that’s where you make a lot of your money – and we do that internally. The manager then helps us to manage that over time.
AK: You’ve outperformed most funds in the country since you started because you had a big allocation to cash at the time of the GFC which I question whether it was accidental or deliberate – obviously, the fund says it was deliberate and that’s fine – but I just wonder whether in this environment it is even possible to make a decent return of the sort you have to make, like 5 per cent over CPI, with a liquid balanced portfolio. Or do you really have to be in cash and infrastructure and illiquid assets, have a long term view, as the Future Fund does, in order to get that sort of return?
MB: There’s no doubt that we think you need to have a long-term view and I think that applies to investors generally. And so, when we’re presenting or talking about the fund and something we want to do more of, I think is at least having people have a look at what we’re doing, comparing with perhaps what they’re doing, and I guess what we’d like to do is explain how we’re going about that. And you’re absolutely right. We think having a longer-term view almost regardless is critical to investing and particularly in the current environment where you do have to work very hard to find the returns because things like cash and very low risk assets are returning at such a low return. At present we can see it. We see that the returns in the last 12 months are good. The last five years are okay. And so, we’re able to find it, but it’s definitely hard work getting returns at present.
SB: In the last three years you actually more or less met the mandate, haven’t you, 7.8 per cent? What drove that? What sort of asset categories?
MB: There were a variety of asset categories. In fact, the way we construct the portfolio is really to get sources of return from as many places as we possibly can and you’ll see that in our fund. It is different to other funds. It doesn’t mean it’s necessarily better than others, but that’s just the approach that we’re taking and you’ll see returns in almost every asset class was contributing to that. I guess cash was probably the more disappointing. We know that. We have about 10 per cent cash for a variety of reasons, but mainly looking for future opportunities. But over that period of time I would say it was very well spread and that’s a test of a well run and managed portfolio during that period.
RG: Mark, I’d put to you, though, that in your latest portfolio approximately 23 to 24 per cent, you know, in what I would regard as high risk investments – that is, alternative assets and private equity. It seems to me that to get that return you’ve upped the risk level with those two categories.
MB: I don’t believe we have, Bob, but it’s a fair question. You should always debate the risk level that you’re taking. No doubt about that. You mentioned alternatives and private equity. They themselves are very diversified categories and it ranges all the way from say a small allocation to venture capital all the way out to private equity which in the current environment is able to pick up good value because the financial system is not operating the way it used to and so they’re able to find cheap values in some of those areas. In relation to alternatives, again I would dispute that it’s necessarily a risky area, so we include in alternatives, for example, some exposure to commodities, but we have a range of other investments in that particular category. And so, we have not upped the risk to get there. In fact, we’ve held some of those positions for a very long period of time. Your broad point, though, is at all times you should be careful with your risk management, particularly when returns are difficult to find.
SB: Mark, in the last few years you’ve had no cash infusions from the federal government. Is one of the reasons why you keep the funds liquid, as you so, the need to hedge because 75 per cent of the assets also were outside Australia, aren’t they?
MB: That’s partially correct. So, about 70 per cent of the assets are outside of Australia. We hedge about roughly half or 60 per cent of those assets. And you’re absolutely right. The mathematics of that is that if the Australian dollar was to fall, we need cash to offset the margins that would come with the hedging process. That is part of the reason. But the other reason is that we’re still continuing to search for great investment ideas and we’ve been very patient. I think the fund has done a very good job of being patient at doing that. So, a large part of that cash will be put into place in the next couple of years as we find good opportunities.
SB: You came to the fund from a background, like most of us, pre crisis, used to risk in equity market returns. Having taken up the helm last July how has your philosophy about investing changed?
MB: Well, it’s interesting you say about pre crisis. I guess if you’ve… in Australia it’s generally a pre crisis, but I’ve been fortunate to have worked overseas and, as you know, there have been lots of ups and downs in lots of markets around the world. Look, I think the philosophy that I’ve had in my career is all about understanding the need to manage risk very carefully. The diversification of the fund has is one step in that. You know, I’ve seen plenty of ups and downs in markets over the last thirty years and, you know, it really hasn’t changed my philosophy. You’ve got to be very clear about your process, explain it publically because there’ll be good and bad periods of investment performance, and then you stick to your knitting; make sure you’re very clear about what you’re trying to achieve and I think that philosophy I think applies regardless of the environment.
SB: In that pre crisis decade you would, any fund manager would have had an overexposure to equities. The next decade, where’s the value?
MB:I think the value is going to be in mixed places. You know, there is some value in equities, for example, and if you were concerned about the state of the world, there are some corporates in the world that have absolutely tremendous balance sheets. We, for example, have a very large allocation of what we call quality equities, so these are companies with very good brand positions. They do have exposure to emerging markets. They have world class governance and controls. And those returns have actually been spectacular in the last twelve or eighteen months and this doesn’t get a lot of coverage in Australia because Australia has been so biased to a correction in resource stocks, for example. And again, as I said, it’s an emphasis on really having diversification, but there’s been a hidden story here, that some equity markets have actually done spectacularly well in the last 18 months.
RG: Mark, your equity portfolio is about a third of your total assets, but it’s roughly twice skewed to overseas than Australian equities. Does that mean that you think the opportunities are much better overseas than they are in Australia?
MB: It’s partially about diversification, Bob, so…
RG: It’s more than that. Diversification is one thing. You’ve gone twice as much global as you have Australia. That appears to be a definite decision as to where you think the value is.
MB: There’s no doubt that during the GFC value emerged in other markets, not just in equities but in a whole variety of places. There was dislocation in other parts of the world as we know. With dislocation comes value and the fund positioned itself in that direction in the early stages. One of the reasons we talked about Australian infrastructure, for example, is the world has become more balanced in value. We can find better opportunities when we look around the portfolio down here in Australia.
RG: But right now you’ve got twice as many global share equities, as you do for infrastructure as Australian shares. Does that mean you think the opportunities are better overseas?
MB: When we look across the portfolio there’s no doubt that we have a better balance, we believe, by having more offshore than we do here in Australia at present. We do, of course, have other things going on in the portfolio, so the direction of the Australian dollar is important to us and that will also be influencing Australian equities. So, you have to look at the total mix of the portfolio, so when we look at Australian equities or we look at international, we don’t just look at the equity mix, we look at the way the entire portfolio is likely to behave.
AK: Well, where are you investing mostly overseas? Do you believe there are opportunities in Europe in the moment or are you mostly in the US or Asia?
MB: Yeah. In Europe we’ve got a relatively low weighting. There’s no doubt that some of our managers are starting to find opportunities in Europe. The big debate, of course, is what degree of dislocation will occur there in the next period. So, even in markets that clearly have value, so Spanish equities or Greek equities, dare I say it, there’s still a great deal of uncertainty about the shape and the way in which that will be resolved. So we have a well diversified portfolio, not much in Europe in present. So, to answer your question, it’s primarily in the US and we’re doing a lot of work obviously on emerging markets as well.
SB: Despite the level of rates around the world, there’s been an enormous flow of money into fixed interest securities and bonds and a view that somehow that the next decade is going to be the decade of the bond, but there is a huge amount of money printing going on. How do you figure that’s going to play out?
MB: Yeah. The decade of the bond has really been going for a lot of decades now. In fact, you know, there was a thesis a decade or so ago that it would be the decade of the bond and the decade of yielding assets, dividend yielding assets for example. And if you look back, we’ve had that playing itself out for some period of time. I think it’s a challenge because effectively the other thing that’s going on here is that central banks are keeping interest rates down, somewhat artificially, to resolve the debt leveraging imbalances. And to explain that, it could be a good outcome for the world if we have nominal GDP growing faster than interest rates. It’ll gradually fix the over-leverage situation. The trouble is if you own interest rate assets, you’re going to be a loser in that process. And so, we are actively searching to mix the portfolio to get the right balance there. Insurance companies that are very biased to bonds, for example, are going to find this environment tough because it’s going to be an artificial environment of relatively low yields, particularly on the safe assets, but that may resolve our big picture issue. So, they’re the debates that are going on as an investor.
SB: One of the things that your board has taken on board in the last little while, I think partly as a result of this controversy about your investing in tobacco stocks, has been this whole sort of the ESG overlay. What do you expect to come out of that and is that going to be an inhibitor to what you can do?
MB: Oh, I don’t think it’s going to be an inhibitor to what we do. There are active questions and we get asked this obviously on occasion about what do we exclude in the portfolio and what do we keep in it. And I think the message that our board would put out there is that you need to have a strategic approach to that. There are a lot of opinions about those kinds of issues. We announced last week, for example, that we in the series of work that we’re doing are going to look at the tobacco issue. Well, we’ll look at that over the next few months or whatever period and come back and explain our decision on that. But exclusions have to be considered very, very carefully because it’s an area of great debate. There are a lot of opinions about it. On ESG itself, though, that’s also an area of opportunity. As a long-term investor you can look through the cycles and think through the issues which come with potentially changes in the environment, changes in corporate governance, what effect that can have on creating value in the financial investment. So, we look at it both in a very positive and proactive way in terms of the way it affects the portfolio, but clearly we also think about exclusions and how to manage that process.
RG: What’s your view on the Australian dollar? Do you think it’s too high, too low or what do you think might happen?
MB: Well, we wouldn’t be caught , Bob, making a prediction on the direction of the Australian dollar per se, but what I can describe, and you’d be well familiar with this, is that there’s a tussle going on here at present that there is a clear consensus that the Australian dollar should be under some pressure because commodity prices have been under pressure. On the other hand, and this is one of the advantages of being involved with the fund, is we do meet other sovereign funds is we do meet central bankers and other players in the market and there's no secret, but we certainly hear this, is that they like the Australian dollar at present and in fact. I would think at the margins they still believe that they’re relatively underinvested in the Australian dollar in terms of weighing their own diversified portfolios. So, you’ve got those two dynamics; a normal cyclical dynamic, but the other dynamic is the capital flows that are occurring courtesy of other players positioning themselves according to their own portfolio and central bankers, as you know, with the way money printing is going on, some currency control in places like Switzerland is really having an effect on currency markets globally, including the Australian dollar.
RG: Just why do the central bankers like the Australian dollar? What are the features of the Australian dollar situation that they particularly like?
MB: In a world where there’s a shortage of good places to invest, Bob, I think that’s one factor. The other is, I think, you know, quite possibly Australia wasn’t on the radar for a very long period of time and so there’s a bit of a catch up effect, that they need to get themselves better balanced in terms of their portfolios. And I think Australia at the margins being a relatively small currency, certainly on the global scale, is getting the benefits of those flows and that’s what appears to us at least to be a factor in keeping the dollar where it currently is.
RG: But what about interest rates? Our interest rates are higher than in many other parts of the world, does that also suck the money in?
MB: Again, no question that that’s been a driver, particularly in recent times, but it is interesting that the Australian dollar has held up even with changes in interest rates recently and again that would tend to suggest that it’s capital flows that’s also a factor, that it’s not just being driven by the gap in interest rates which you mentioned.
AK: We’ve talked a lot about your assets. What’s happening on the liabilities side? I mean at what point will the government start making withdrawals for pensions?
MB: Well, the good news for the fund is that it’s a very clearly defined mandate, as you’d appreciate, which is that withdrawals will not be made until 2020. Now, are we going to be even closer to that date? We’re obviously heading into 2013 soon. But for our investable horizon it is still a fair way out, gives us the chance to be a long-term investor, and even then there’s some clearly controlled aspects about the way in which flows may come out of the fund from 2020. In terms of the liability side, fortunately we don’t focus on that. We focus simply on investing and that’s our target.
AK: That’ll do. Thanks very much, Mark.
MB: Thanks very much. Good.
RG: Thank you very much.
MB: Thanks, Bob.
SB: Thank you, Mark.
Follow @AlanKohler on Twitter