The Future Fund adds some backbone

As it seeks to add some long-term stability to its overseas-dominated portfolio, the Future Fund is bulking up investment in domestic infrastructure – but only with proven assets at this stage.

Earlier this week the Future Fund was part of a consortium that agreed to buy the South Australia Government’s forestry plantations for more than $600 million. Today it announced it had entered a conditional arrangement to acquire all the assets of the Australian Infrastructure Fund for $2 billion.

Do two asset deals in a week constitute a pattern of behaviour or illuminate a strategy? Yes, although there’s nothing particularly novel or unexpected about what the Future Fund is doing.

If the proposal is followed through to a completed transaction, the Future Fund would acquire Australian Infrastructure Fund’s interests in a portfolio of airport assets, including Melbourne, Perth, Queensland regionals, the Northern Territory and a 40 per cent interest in Hochtief AirPort Capital, which itself has interests in Sydney Airport, Dusseldorf, Hamburg and Athens. The Future Fund itself has an existing 16.8 per cent interest in Melbourne Airport.

The deal is subject to due diligence and will almost inevitably change shape to some degree given that the Australian Infrastructure Fund (AIX) portfolio of investments will be riddled with pre-emptive rights held by third parties.

Assuming it proceeds, however, it would deliver the Future Fund a portfolio of investments in a range of Australian airports and roughly double the investment it has in infrastructure within its $77 billion portfolio. At the moment the fund groups infrastructure and timber together and they constitute $4.3 billion or 5.6 per cent of the portfolio.

They are two classes of what the fund terms its "tangible assets’’ program, which includes property investments approaching $5 billion, or about 6 per cent of the fund.

The fund had a stated objective of having 12 per cent of its portfolio within that program by June 30 this year, which appears to have been met, with a long-term goal of shifting 25 per cent of the portfolio into the program.

The appeal is obvious and is underscored by the volatility and risks within the current market environment.

The fund’s investment mandate is to achieve real, or CPI-plus, returns of 4.5 per cent to 5.5 per cent a year in the long-term. To achieve that, particularly in this post-crisis environment, it needs stable long-term income flows from assets that have either formal or effective inflation-plus returns.

Infrastructure is the most obvious source of those kinds of returns and airports have proven themselves to be attractive long-term propositions. Another element of AIX’s appeal would that the bulk of its assets are Australian and primarily domestic.

One of the issues for the fund, which has the bulk of its assets offshore, is managing the currency risk in a volatile environment. It hedges those exposures but, without any recurring injections of funds since Labor came into power, that forces it to retain a lot of liquidity.

That would make big slabs of low-volatility domestic assets – infrastructure, timber and property – particularly attractive. The fund potentially has a role to play in helping to fund sensible infrastructure development within this economy, although it appears so far to be more interested in a low-risk strategy of investing in mature and proven assets rather than greenfields projects.

The proposed purchase of AIX’s portfolio would be done at an asset rather than entity level – the fund would acquire AIX’s investments rather than AIX itself – because the fund’s mandate doesn’t allow it to make takeover bids. It’s probably also a cleaner route from the fund’s point of view.