Australia’s A$202.8 billion (US$135.8 billion) Future Fund notched up a 3.4% return in the first quarter, as it displayed resilience against stock market volatility and inflation, delivering a 1.1% return for the full financial year ending in March.
For the 2022 calendar year, the sovereign wealth fund posted a 3.7% loss, although it showed a 0.9% positive return in H2.
In Q1, the fund adjusted its asset allocation in favor of developed market equities (17.0% from 15.9%), while private equity fell from 16.9% to 16.4% and cash reduced from 11.8% to 10.6%. Alternatives allocations, including hedge funds, was 17.1%, down from 15.2% from Q1 2022. Meanwhile, the fund’s exposure to private equity fell 1 percentage point to 16.4%, while its property and debt securities allocations were down 0.2pp and 0.4pp and infrastructure and timberland were unchanged.
CEO Raphael Arndt said the fund was shifting “towards investments that rely on investor skill rather than market risk” given inflation and higher interest rate environment creating significant uncertainty, particularly over equity valuations. The Future Fund will focus investment on commodities and gold, which offer protection against stagflation.
The fund is also more sceptical about real assets than its peers, despite their traditional role as a shelter against inflation. The domestic unlisted real estate market, in which the fund has invested heavily, is witnessing downward pressure on asset values.
In his keynote address, Arndt said, “In today’s environment, where the role of beta is challenged, the role of Alpha in portfolio construction is more important than ever. In other words – just having capital is no longer enough to ensure decent returns.
“A previously considered safe investment like an office building or shopping centre is no longer safe. A large cap company can be split up, regulated or its markets disrupted. There are no set-and-forget investments any more.
“Beta returns will not be enough to ensure a comfortable retirement, or in the case of the Future Fund, to meet challenging investment mandates.”
Arndt told the Australian Financial Review that the fund was prepared to back stock pickers again, reversing a decision made in 2017 to move its public equity exposure to low-cost index tracking strategies.
Last year, the Future Fund warned it would struggle to meet its absolute return target of 4-5% above CPI, having seen a -1.2% return in FY2021/22. On the publication of the fund’s FY2021/22 annual report, Costello said, “We expect deglobalisation, geopolitical tensions, trade barriers and high inflation to be a feature of the investment climate going forward.”
On the CPI-linked returns target, Costello said, “This was probably written in the days when it was expected that inflation will be 2-3%. If you get an inflation rate of 6, 7 or 8, the CPI plus target will be extremely difficult to attain. In fact, in the current environment, you just won’t do it. That’s a big challenge. This target was not written for high inflation rate society. And hopefully inflation will be brought down, and we can continue to work to the target.”
Indeed, in Q1 the fund missed its 11.0% by nearly 10 percentage points. Of course, missing the returns targets in one year is unlikely to significantly affect multi-year performance. Targets are focused on medium- to long-term averages. The Future Fund is tracking well ahead of its target and by Q1 enjoyed a 7.7% annualised return since its inception in May 2006, above the 7.0% target, and adding A$134 billion to the federal government’s coffers.