Surprise lessons from the Future Fund

The all-powerful Future Fund has managed just 1.2% for five years if you adjust for inflation– you may have done better! Still new figures offer a fascinating insight into its allocations.

PORTFOLIO POINT: It has managed a real annual return of just 1.2% for five years, but its figures offer a fascinating insight into its allocations.

With $73 billion in assets, the Future Fund ranks as one of the biggest investment portfolios in Australia. It has the important task of securing future public service superannuation liabilities. The fund has both a well set out investment policy – not unlike the investment strategy document needed for a self-managed super fund – and regular investment updates.

Indeed, SMSF operators who have been struggling with poor returns on the markets in recent years may well feel considerable assurance from the recent performance of the Future Fund. For despite its massive size, market power and the undoubted skills of all concerned – including former Commonwealth Bank CEO David Murray as chairman – the Future Fund has not managed to achieve its desired target return for the past five years.

The Future Fund has set itself a target return of 4.5–5.5% per annum above the rate of inflation over the long term. It does note that in the “transition period”, while the portfolio is being built, returns are expected to be lower '¦ and indeed they are!

To be exact, the fund’s stated target is a return of at least 4.5% above the rate of inflation over rolling 10-year periods. (For a more realistic reading of recent market returns and an introduction of the principle of rolling returns, see today’s feature by Doug Turek, Rolling with the punches).

The portfolio update to the end of 2011 shows that the fund had posted returns of only 4.2% per annum over its life of five years and eight months. Subtracting inflation of about 3% a year brings the fund’s real return back to about 1.2%, well below the 4.5% target.

Maybe you – or your DIY fund – have done better than this. In any event, it puts the experience of the Future Fund in the same basket as most investors over the past five to seven years

Still, as the pre-eminent investment fund in Australia and a model for the most sophisticated approach to investment markets, there is a lot to learn from the latest portfolio allocation of the Future Fund released earlier this week.

First, the focus on “after inflation” returns used by the future fund provides an interesting point of reflection for investors. If we were told that our own portfolio was going to return 11% a year over the next six years, we would probably be thrilled (and a touch relieved). However, that number is really meaningless. If inflation over the next six years was 2% a year, then the purchasing power of our portfolio would have increased strongly – which is great. However, if inflation averaged 12% a year (admittedly a highly unlikely scenario, although Australia has seen periods of double-digit inflation in the past), then the purchasing power of our portfolio would actually have declined.

As we assess the performance of our own portfolios, it is worth taking a leaf out of the Future Fund investment book and keeping an eye on returns after inflation because those returns dictate the value of our portfolio.

Second, the fund’s publicly available asset allocation offers an insight into how our own portfolio allocations match up with a key benchmark fund. So what is under the bonnet of this $73 billion investment portfolio? The asset allocation at the end of December is show in the following graph: Australian shares are only at 10.8%; international shares are high at 15.7%; the fund also has a massive 19.8% in “alternative investments” and another 5.3% in private equity.

The allocation has several points of interest for Eureka subscribers: the higher weighting to international shares over Australian shares, for example. Given the poor returns of international shares for more than a decade, coupled with the generally worrying headlines from Europe and the US, many investors have given up on international shares as an investment class.

The Future Fund obviously keeps significant faith in this asset class to enhance the risk-adjusted returns for the overall portfolio. From the perspective of a smaller investor, the lure of franking credits from the dividends of Australian shares might see them as a bigger holding in a portfolio than international shares, with the lesson from the Future Fund being not to give up on international shares entirely.

The portfolio also has a high weighting to alternative assets, which would most commonly be described as hedge funds. The strategies the Future Fund uses include “fund of funds”, “distressed and event driven” and “commodity oriented”. Before smaller investors charge out and put 20% of their portfolios into hedge funds, it is worth remembering that these funds rely on skill. However, for retail investors the fees of these funds are often very high and, because they are skill-based trading funds, high levels of portfolio turnover often translate into high tax costs.

Private equity is an interesting asset class, accounting for more than 5% of the future fund portfolio. Private equity refers to companies that are privately owned rather than publicly listed on the ASX. Often the aim of a private equity investor is to buy a company then list it on a stock exchange at a premium.

There are managed funds that allow investors direct access to private equity – although they are often illiquid funds (long time frames until you can get your money back) with relatively high minimum investments. The ING Private Equity Access is a listed investment company (LIC) that invests in a number of different funds – and while costs are always a factor in “fund of funds” investments, the price of the LIC is currently below the value of its private equity portfolio.

One final note is that the Future Fund – so far at least – seems to be oblivious to the notion of ethical investing with investments in weapons manufacturers and tobacco companies. These investments have been controversial and subject to debate in parliament.


Like all investors, the Future Fund has struggled for returns over the past five-and-a-half years. To this point, with a 4.2% annualised return it has fallen short of its aim of a return of 4.5% pa above inflation. It is worth considering that Bruce Brammall in a recent piece (see How super were your returns?) pointed out that even the most conservative retail investor with a "secure" profile based on Vanguard data would have made 5.11% in the last financial year.

However, we must remember the Future Fund’s target is over rolling 10-year periods. It is interesting to look at the asset allocation of its portfolio and consider how it differs from the average investor’s portfolio with the high weighting to international shares, private equity investments and hedge funds providing food for thought as we think about how we build our own investment portfolios.

Scott Francis is an independent financial adviser based in Brisbane.

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