Future Fund cashed and staffed up – now to put money to work

Cerulli Associates, Global Edge, February 2008

Australia’s Future Fund is cashed up and staffed up. 2008 should be the year when it really starts putting its money to work.

As of November, the fund had A$61.5 billion under management: nothing to compare with the bigger sovereign funds of the Middle East or Asia, but certainly substantial. It appears that what it’s got today is all it’s going to get in terms of seed capital, and it now has to turn it into A$140 billion – the projected government superannuation shortfall it was set up to offset – by 2020.

To do so, it has been busy hiring for its investment team, including two new hires in December: Raphael Arndt, formerly an investment director at successful infrastructure manager Hastings Funds Management, who joined as investment director for private markets, with a focus on building infrastructure and timberland investments; and Mitchell Stack, who becomes investment director for fixed interest and alternatives. Stack was previously head of investments at the Melborune-based fund manager Western Asset Management.

The investment team is now considerable. Marshalled by chief investment officer David Neal, previously the head of investment consulting at Watson Wyatt, it also includes head of private markets Gary Gabriel, ex-Unisuper; head of strategy Tony Day, who was chief strategist at Queensland’s powerful QIC; Elspeth Lumsden, investment director for equities, who used to run international equities at the Victorian Funds Management Corporation; and Craig Thorburn, an investment analyst who worked for the Commonwealth Treasury. All come under Paul Costello, the fund’s general manager, selected for his experience running New Zealand’s own sovereign super fund.

So it has the money and the people; what’s it doing with these riches? The fund set an objective of starting its investment program by June 30 2007, and achieved it, putting $1.85 billion into Australian equities and $2 billion into international equities by then, with the remainder and vast majority invested with the Reserve Bank of Australia. (The Australian equities figure does not include the 2.1 billion shares the Future Fund inherited in Telstra in February 2007 – see box). What it has done since then has not been disclosed.

It is tempting to find significance in this early preference for international over domestic equities, but the fund’s first annual report (released in October) specifically counsels against doing this, saying “it is important not to draw too much from this picture” and “the split between the Australian and international equity markets should not be seen as indicative of our policy” but reflective of opportunistic buying at the time. In addition, unlisted asset classes are clearly going to play a more important role in future, reflected by Arndt’s appointment.

Watson Wyatt was the asset consultant who helped put the Future Fund’s investment strategy together, but it is difficult to draw conclusions about what sort of allocation it has suggested for the fund. According to data from superannuation researcher SuperRatings, allocations at funds it advises range from fairly conservative (35% fixed income, 17.5% apiece local and international shares, 8% property, 4% cash and 16% alternatives at Auscoal Super’s balanced option) to the more aggressive (35% local shares, 33% international shares, 17% fixed interest, 7% property and 8% alternatives at the comparable option for LUCRF Super). Some in the industry expect it to have a relatively high allocation to alternatives like infrastructure – which mesh very nicely with the fund’s long term objectives – but otherwise to look much like any other super fund in terms of asset class split.

Generally speaking, the fund’s mandate requires it to get an average return of at least the consumer price index plus 4.5% to 5.5% over the long term as its benchmark; in practice at the moment that means around 6.6 to 7.6% (although it is not required to do so in the first year of investment as its portfolio is built). Doing so will involve considerable external mandates, but of the investments that had been made by June 30, all were passive. It’s really in the year ahead that most external mandates are expected to be up for grabs, and Australia’s major fund managers have been jostling for attention.

The Telstra holding is an irksome distortion both to the fund’s portfolio balance and its returns. What happens to that holding when the escrow period expires in the 2008-9 financial year is a subject of great contention in Australia, particularly since its sale in one hit would dilute the most politically sensitive stock in the country (it is held by over a million ordinary Australian retail investors).

The other interesting issue about the fund is just what the new government will do with it. The Future Fund was developed, launched and championed by a Liberal government; the new Labor government may well have different ideas for it, and has already suggested it will tap the fund for over $2 billion in order to help build a national broadband network, a suggestion strongly opposed by departing treasurer Peter Costello.

The fund is a fascinating enterprise because there’s really nothing else like it. There are plenty of sovereign funds but they tend to exist for much broader and vaguer principles of the public good rather than something as specific (and dull) as unfunded federal government pension debts. That said, there are plenty of countries that need to do something urgently about their pension liabilities but are in no position to do so; Australia has only been able to because of the economic windfall of the commodities boom, giving it repeated and bountiful public surpluses.

BOX:

The Future Fund was launched as a response to the Australian government’s unfunded superannuation liability. This liability, which by May 2007 stood at A$103 billion, has so far been funded on a pay as you go basis from the federal budget, at a cost of about $4.5 billion a year; the government realised that if this was to continue then in future the figure would become unmanageable at just the point when Australia’s ageing population starts putting greater strain on national finances.

So in the 2005-6 budget, the government pledged to set aside budget surpluses for a fund mandated to accumulate enough assets by 2020 to offset the unfunded liability – predicted to be around A$140 billion by then. The fund received its first $18 billion of seed capital in May 2006, with a number of further contributions through 2007; it has also received 2.1 billion shares in Telstra following the third and final tranche of the privatisation of that company, with a combined value of just under $9 billion at the time of transfer in February 2007.

The fund is supervised by a Board of Guardians chaired by David Murray, formerly the head of the Commonwealth Bank of Australia. The Future Fund team also oversees a separate entity, the Higher Education Endowment Fund, designed to support capital expenditure and research facilities in Australian universities; as of November 2007 this had $3 billion under management.