Euroweek Australia report: the Future Fund

Euroweek, August 2013

Standfirst: Australia’s Future Fund stands apart among sovereign wealth funds for its devotion to alternative asset classes, and for a mandate far more specifically expressed than at its peers around the world. Its focus on infrastructure, timber and other long-term assets could have ramifications for the country’s funding and investment models. By Chris Wright.

Australia’s Future Fund is one of the world’s newest and most distinctive sovereign wealth vehicles. Established by the Future Fund Act in 2006, and beginning its investment programme from the following June, from the outset it stood out from other sovereign funds.

First, there was the exceptional clarity of the mandate, unusual in sovereign wealth funds. Funds like the Abu Dhabi Investment Authority or Kuwait Investment Authority have a very broad mandate to diversify hydrocarbon wealth in order to provide stable income when the oil runs out; Asia Pacific funds like Singapore’s Temasek and GIC, or the China Investment Corporation, have a still more nebulous ‘for a rainy day’-type mandate, with no liabilities, no target date, and no obvious directive beyond the national future good.

The Future Fund, by contrast, was set up specifically to make provision for unfunded Commonwealth pension liabilities – that is, civil servants in Australian federal public service. The government had identified a coming problem when an ageing population was likely to place pressure on Australian government finances, and so transferred $18 billion in seed capital to the fund on May 5 2006 (in total it would receive $51.3 billion in funding by June 2008). The fund’s trustees and managers were given a provisional target date (2020) and a target total to hit by that date ($140 billion). There has almost certainly never been such a tightly defined sovereign vehicle.

It stood out for two other reasons, too. First, like it or not, it received 2.1 billion shares of Telstra worth A$8.9 billion in February 2007, proceeds from the third and final stage of the national telecommunications company’s privatisation. This holding would skew allocations dramatically and would take years to be digested by gradual sales into the market. And secondly, it became clear very quickly from the Future Fund’s hiring decisions that it was not going to look much like other funds in terms of target allocations either. After the various operational and strategic posts had been filled, the first hires seemed to have little to do with debt and equity and more with alternatives: first Gary Gabriel as head of private markets, from superannuation fund UniSuper in October 2007; then Steve Byrom from the New Zealand Superannuation fund the next month to run private equity; then Mitchell Stack from Western Australian Management to run fixed interest and alternatives, including hedge funds, macro and currency strategies; Raphael Arndt, from Hastings Funds Management, to build infrastructure and timber capabilities; and in early 2008 Barry Brakey, founder of the Pinnacle Property Group, to run real estate. Equities scarcely got a look in.

Five years on, the fruits of these unusual hires can be seen in the fund’s allocation. On March 31, private equity accounted for 6.8% of the A$85.166 billion portfolio, property 6.4%, infrastructure and timberland 6.5%, and “alternatives” – a definition which in many funds would include all of the above allocations – 15.3%, considerably more on its own than the 11.6% of the fund in Australian equities. Alternatives, in the Future Fund parlance, mainly means hedge funds and similar strategies. In fact, that’s an underweight: according to its most recent annual report, its target allocation at June 30 this year is 17.5% to alternatives, 16.5% to ‘tangibles’ (infrastructure, timberland and property), and 8% to private equity. That’s 42% of the fund in assets which, in most allocation definitions, would be considered alternative.

This is dramatically different to how most sovereign wealth funds look. Government Pension Fund Global, the sovereign wealth fund of Norway, has 60% of its assets in equities, 35 to 40% in fixed income, and up to 5% in real estate, for example. Temasek in Singapore is almost 100% equities. ADIA, considered visionary on alternatives, can nevertheless go up to 67% in listed equities – double the Future Fund target – and as low as 13% on combined alternatives, real estate, private equity and infrastructure (though it could theoretically go up to 33% too).

The Future Fund approach is interesting because it may reflect a way that more and more sovereign and pension funds invest. Most of the asset classes in which it has built internal expertise, particularly infrastructure and timber, pay off over the long, long term, and along the way pay predictable and stable income streams. In this respect, they have gradually been joined by many of the country’s bigger superannuation (pension) funds, a theme discussed in greater detail in other chapters. This, in turn, has created a greater pool of capital for the funding of infrastructure development in Australia, and a greater need for long-dated assets.

Like many sovereign funds, the Future Fund appoints external investment managers: 98 separate mandates were listed in the 2011-12 report. But it is perhaps the fund’s willingness to go direct into unlisted assets that provides a marker for the way it, and the broader pension industry in Australia, may develop in future. “There is a an emerging trend amongst the industry super funds, and the Future Fund, in looking to be more directly involved in investment decision making, including in relation to debt,” notes Paul Donnelly, global head of equity capital markets and debt capital markets for Macquarie Capital. “Where this may be of particular interest is in relation to debt for infrastructure assets. Long duration funds are natural investors in long duration debt, in contrast to the bank market where longer maturities are problematic.”

It’s also a model that has worked well in performance terms. The fund returned 10.6% in the nine months up to March 2013; over three and five year periods it is up an annualised 8.1% and 6.4% per year respectively. Managing director Mark Burgess says at every results announcement that the fund is committed to a medium to long-term return model with an emphasis on diversification; with seven years to go until the fund’s originally mandated target date, it’s hard to argue against the approach.