Australia’s Future Fund reported a negative return of 0.5% in Q3 with A$900 million wiped off the value of the sovereign wealth fund to A$205.2 billion (US$130 billion) – but its 12-month return was a positive 6.3% amid heightened volatility.

The fund continues to beat its long-term target return of 6.9% with its 10-year average annual return at 8.4%. However, the fund is now undershooting is benchmark with the one-year return and the three- and five-year averages undershooting by 1.0%, 1.2% and 3.1%, respectively.

The chair of the Future Fund’s board of guardians, Peter Costello, noted challenges in public equities and fixed income with further monetary tightening and geopolitical risk likely to weigh heavy on performance. He added, “Looking ahead the key issues remain the extent of further monetary policy tightening required to bring inflation back within central bank targets, how markets respond to those measures and whether the Israel-Gaza conflict turns into a wider regional war.”

The fund has made a strategic tilt by reducing cash holdings by A$4 billion while bumping up credit investments by A$2.8 billion to take advantage of rising global interest rates. Investment grade credit is reporting higher yields than equities at 7-9%, which Future Fund sees as attractive on a risk-adjusted basis. The Future Fund reported in August that it had doubled its exposure to domestic corporate debt to A$1 billion as returns soared. The strategy is likely to persist due to inflation and higher interest rates, as well as demographic trends.

This follows the trend seen among other institutional investors, including AustralianSuper, the nation’s largest super fund which now has 18% of its portfolio – totalling A$40 billion – in fixed income, after doubling its investment in the latest financial year. The super fund would like to go further and faster with investment in long-term corporate debt, but CEO Paul Schroder stated that the market needed to develop to allow increased allocations, with greater co-operation between banks, insurers, funds and companies.

In equities, the Future Fund is moving away from its reliance on passive index strategies – or “set and forget” – as it seeks to respond to be market volatility and higher persistent inflation. Over the past two years it has handed out mandates for developed and emerging market equities to external active managers, including UBS, State Street, Legal & General, Insight and Robeco. In Australian equities, it has appointed Macquarie, UBS and Maple-Brown Abbott. In 2017, the sovereign fund turned overwhelmingly to passive mandates to reduce costs, having concluded that the fees demanded by active managers were not justified, but its bearish outlook has prompted it to re-engage to seek opportunities in an uncertain market.

Additionally, the fund is utilizing specialist managers, including in risk assets such as venture capital where prices are cheaper and more competitive due to risk aversion.

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