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Future Fund: 5 megatrends are changing everything

It’s always useful to study the asset allocation of Australia’s sovereign wealth fund, the Future Fund, as it takes an unusual approach to investing. Whereas most institutional superannuation funds hold at least 25% of their assets in Australian equities, the Future Fund’s allocation at 30 September 2017 included only 6% to Australian equities. The main categories where it is overweight versus the industry are private equity at 12% and alternative assets at 15%. Cash is a healthy 19%. That’s nearly half its $134 billion in assets in these three categories, two of which barely move the needle for most SMSFs.

The main reason for this structure is the desire to protect capital. Its investment mandate is to achieve CPI plus 4% to 5% “with an acceptable but not excessive level of risk”. In its investment beliefs, it shows why assets such as private equity and alternatives figure highly:

“Markets can be inefficient, albeit that the degree of inefficiency varies across markets and over time. Skillful management can add value after fees, and such added value can be uncorrelated to market returns over time and can therefore be highly beneficial to the total portfolio investment characteristics. Capturing skill-based returns requires an appropriately resourced and disciplined process.” (my bolding)

Their beliefs drive them towards long term, illiquid and uncorrelated assets to extract returns for risk.

Five insights from the 2017 Sohn Conference

The Future Fund’s Chief Investment Officer, Dr Raphael Arndt, spoke at the recent Sohn Hearts and Minds Investment Leaders Conference. He identified five megatrends changing the world of investing:

  1. The end of the leverage tailwind means asset prices are not supported by as much debt, making price growth less sustainable.

  1. Declining population growth will reduce economic growth, with the United Nations forecasting global population growth will fall from the current level of around 1.5% to 0.25% by the turn of the century.

  1. Changes in the workforce and consumer preferences mean the best future investments will differ from the past, because younger generations consume and work differently. He included this chart showing that by 2025, baby boomers will comprise only 8% of the Australian workforce, while both millennials (Gen Y) and Gen Z (roughly, those born after 2000) will each be about one-third.

Changes in the Australian workforce, today and 2025

Source: Future Fund, Mark McCrindle

  1. Income inequality is increasing populism and populist policies, with many people in developed countries receiving little growth in wages in the last 20 years. The rich have become richer through asset price growth but populist policies will reduce economic growth.

  1. Technology is changing how society interacts, with new platforms achieving adoption faster than at any time in history.

Investments can become worthless quickly in the face of disruption by new technologies or competitors, and the past should not be taken as a guide to the future. This is one reason why the Future Fund holds so much cash. He emphasised the Fund’s desire to find returns which are uncorrelated to the equity markets and companies adversely hit by these trends, which explains the alternatives (or hedge fund) allocation.

Over the last seven years, the 9.9% return delivered by the Future Fund comfortably exceeds the CPI+ target of 6.5%.

 

Graham Hand is Managing Editor of Cuffelinks.

17 Comments
Warren Bird
December 16, 2017

And PS, if you opened the FF up to other investors and they had to provide liquidity, they would have to change their investment strategy.

Warren Bird
December 16, 2017

Most super funds already have options that are similar to, or at least not far off, the sort of profile that the FF has taken, allowing for the fact that they have to offer daily liquidity and the ability for investors to redeem units when they like. The FF can do things that super funds can't because they know that their only investor isn't going to take any money out without heaps of warning.

If there was sufficient investor demand from people who were willing to say, "I won't touch my money for 5 years no matter what the returns look like at any point along the way" then super funds could do what the FF does as well. People are willing to do this by buying a property, where they lock their funds away for a long time, but don't seem willing to do it in a super fund that someone else manages. The aggressive options at super funds don't seem to be the most popular choices for some reason.

Graham Hand
December 15, 2017

Hi Alex, I don't see a problem in making the Future Fund available to external investors as one of a wide range of options. Of course, dealing with hundreds of thousands of retail investors is quite another matter to having one client with one goal, but let's confine this comment to asset allocation.

However, I don't agree it should be a 'national default' option into which everyone goes unless they select an alternative. Australia has a superannuation sector of industry and retail funds which serves its clients well.

The Future Fund has done a good job and is well-respected, but its portfolio with heavy allocations to cash, private equity and alternatives would not appeal to everyone. Consider two points:

1. On my reading of the FF 2016/2017 Annual Report, the management cost is 1.61%, made up of 0.3% direct and 1.31% look-through. The growth of ETFs and index investing, where asset management is available at very low costs, shows many people wan to minimise their fees. Private equity and alternatives do not come cheap.

2. One estimate I have seen (which I have not verified) is that FF has a 42% allocation to 'bond-sensitive' assets that would be adversely affected by rising interest rates.

The FF may well suit you, and it is set up for lower volatility by holding unlisted assets, but I believe public policy is better served by a wider choice.

Alex
December 15, 2017

Hi Graham,

Good point on current volatility levels, the Future Fund and non-market correlated assets.

What do you think of the idea of having a publicly accesible version of the Future Fund, that we regular citizens could sign up to, as a default super fund for example.

BTW I am loving the new Livewire x Cuffelinks podcast.

Kind regards,

Alex

Philip Carman
December 12, 2017

There's the problem - TLA's! * They're everywhere and they do nothing but confuse. No one knows what everyone is talking about and it's just a mix of laziness, stupidity and a collegiate arrogance that fails to understand the value of brands and the cost of marketing...
I once attended a Total Quality Management seminar, back in the early '90s and the keynote speaker went on about "TQM this..." and "TQM that.."and then I put up my hand and said this:" If you can't be bothered even saying Total Quality Management, why on earth would you expect anyone of us to embrace the concept?" - and then sat down. He stuttered a bit and then stopped and thought a bit and then said: "You're right. I'm sorry. From now on it will be Total Quality Management rather than TQM - because those three words DO mean far more and they are our brand. Thank you."

* TLA's are of course, Three Letter Acronyms. They are the dumbest thing that anyone in business can use for the above-stated reasons. Is it no wonder that people get confused when even the owners of the business are too lazy/stupid to use their own brand name??

Graham Hand
December 12, 2017

Hi Philip, fair enough, too many acronyms and abbreviations in this industry, but which in this article bothered you? It looks reasonably jargon-free to me, other than descriptions of generations.

Andrew Fairweather
December 08, 2017

Hi Graham Hand - you are correct, we do not distribute Aspect (although we used to when I was the CEO of Select; I assisted in the transition to CBA).

Hopefully all cleared up now!

Graeme
December 08, 2017

Don't know CFM and don't know what comprises the Future Fund's alts allocation. All I know is that going into the GFC I used fund of funds to obtain a spread of alts for a 6% allocation. I was lucky in that one mob did so poorly before the GFC that they closed the fund before the real damage was done. The others, from what I could work out (they weren't very forthcoming) managed to lose between 30 and 50% in illiquid 'securities' that required redemptions to be suspended. One then closed their fund at pretty close to the bottom, one became moribund and the other traded on and has (just) managed to beat the return on cash over 10 years. Not quite their projected returns of 20% pa, nor even the 7% that I hoped for. Lesson learnt!

Troy
December 10, 2017

This is why it is so important to understand what goes into those alts allocations - people have been caught out with unexpected results.

I think alts can be useful if you view traditional bonds as less of a cushion than they used to be, but to make any difference you have to allocate say 25% to them (what bonds used to be in a 70/30 fund allocation).

If you don't want to do that, then perhaps holding cash is a better result, and reducing some of the equities position instead.

SMSF Trustee
December 08, 2017

In that case, my apology stands, though you can see why it was confusing.

And also in that case, it would seem the issue is not getting planners interested in advising their clients, but in getting onto platforms. The platform I use has 13 funds listed as Alternatives, though most of them are more like absolute return target funds than managed derivatives funds. Aspect is on my platform, but at a base fee of 254 basis points. Tell them they're dreaming! If something with a credible process, team, track record etc were available on my platform for 1% or even less (like your Class A product, Andrew) I may be interested.

The point I made about these products giving up upside also stands. Going to the link you've provided, Andrew, the last two years from your fund has delivered zero return, not far off my Winton fund outcome.

Graham Hand
December 08, 2017

I think I can see the source of confusion here. It's NOT a misunderstanding in spelling of Winton versus Winston. SMSF Trustee read the CFM brochure as if it were a list of four funds distributed by one business (Andrew's). I made the same mistake on first read. What the brochure actually does is compare the CFM fund with three other funds that are managed/distributed elsewhere. What triggered the difference for me is that I arranged the Aspect deal at CFS which gave CFS exclusive distribution rights so Aspect could not be part of Andrew's stable. Right?

Andrew Fairweather
December 08, 2017

Not ours - we are Winston (and not Winton). CFM (which we distribute) is half the price of Winton for similar levels of volatility. http://cfmaltbeta.com.au/our-products/is-trends-trust/

SMSF Trustee
December 07, 2017

Isn't Winton Global Alpha one of yours? If not, then apologies, but this website seems to suggest otherwise:

http://winstoncapital.com.au/wp-content/uploads/2017/03/CFM-ISDiversified-v-Managed-Futures-March-2017.pdf

Andrew Fairweather
December 07, 2017

Hi SMSF trustee - CFM has no fund that is priced at 1.88% plus a performance fee. The CFM trend following strategy is less than half that amount but i wont use this forum to advertise what we offer but it might pay to check your facts. And I wasn't suggesting they (you) were ignorant - i was openly suggesting that advisers taking a deeper look.

Andrew Fairweather
December 07, 2017

Firstly let me declare my conflict - we represent CFM here in Australia who offer a low cost managed futures fund and a diversified alternative beta strategy; strategies that sit within the cited Future Fund's own alternatives allocation (they have Alt beta since inception) - but we really struggle to get cut through with financial advisers, even with very high ratings in place. The common objection to not using Alts are their complexity, lack of transparency and high fees, whilst others say they use cash as their 'alternative'. It's my view - and I'm not alone - that a typical retail advised balanced fund (with zero to low allocations to Alts) will do far worse in the next equity drawdown because the duration rally that provided the buffer last time around is simply not there anymore - during the GFC, the drawdown with most balanced funds was ~28%. Next time? So, my plea to advisers is to seek out more information in relation to Alts - most of the previous issues of high fees, opaque strategies and lack of liquidity have well and truly been dealt with. Not allocating more to Alts puts advisers at a distinct disadvantage to Industry Funds and the like, whose returns have been very good over long periods of time.

SMSF Trustee
December 07, 2017

Andrew, I do use alternatives in my SMSF, but fees are a huge issue. In fact I use one of your funds, and the fee is 1.88% per annum plus a performance fee. I've got a 5% allocation. It would be more, but not at that fee level. You're asking me to give up more than my cash return in the hope that the trend following strategies it implements will get lucky and then you want me to give you 20% of the upside.

The flipside of the claim that such investments won't draw down when the equity market takes a tumble is the experience I've had over the last couple of years. The fund has given me 1% total return over that time, compared with 15-25% for my equities and managed funds (which include fixed income) and 50% on my property funds. So you give up the upside in the good times as well as getting some protection when things aren't so good.

So across the cycle, I sometimes wonder what the point is. I'll hold onto my 5% for now because I do expect the next 2 years to be better. But it's not going to be more than that because, though equities might have a downturn, cash is my buffer for the most part because I know I'll earn the cash rate on that allocation.

The Future Fund can have 15% to alternatives because it negotiates fees down well below what the alternatives managers charge us ordinary investors. So they're not giving up their cash return to make a higher allocation. But note that they also have a very high cash allocation, presumably for similar reasons to mine.

So please don't try to make it sound like we SMSF managers (or our advisers) are lacking information or ignorant. Just accept the fact that our experience leads us to be sceptical of your claims at the fees you charge!

Pablo Berrutti
December 07, 2017

Interesting post thank you.

I wonder whether the manifold and compounding environmental crisis (climate change, mass extinction, resource constraints, and pollution) feature on Dr Arndt's longer list? Seems a strange omission to me.

It would be interesting to hear his thoughts on the combination of points 3 and 5 in terms of what AI and robotics will do the labour market.

 

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