Future Fund favours developed markets in the short term

Australia’s A$69 billion Future Fund aggressively moved into recession-struck developed world equities over the past financial year.

The fund’s 2009-10 Annual Report showed its holdings of these equities increased by A$5.6 billion, rising from 13.4% to 21.8% of the fund’s portfolio. At a time when many funds are pouring money into emerging markets fuelling fears there may be a bubble forming, the Future Fund’s emerging market equities holdings slightly decreased as a percentage of the fund’s portfolio from 3.2% to 3.1%.

The fund has also dramatically increased its alternatives allocation — a large portion of which is to ‘absolute return’ or hedge funds — from A$2.7 billion (5%) of its portfolio in 2008-09, to A$9.8 billion (15%) in 2010. This is targeted to rise to 20% of the portfolio in 2011.

“The hedge fund industry has had an impressive rebound from the fallout of 2008, benefiting from ongoing market volatility and the strength of the equity and credit market rallies,” the fund said.

“At the same time it continues to experience diminished competition for investment opportunities, driven mainly by the reduction of leverage and bank proprietary risk taking but also due to investor withdrawals.”

But it sounded a cautious note about emerging economies, saying that over the medium term these economies’ rising wealth especially in China, would provide opportunities for investors “if thoughtfully targeted”. The fund said it had “a meaningful weight” to emerging markets.

Its developed world equities approach was “relatively defensive”, the fund said, “reflected in a conscious bias towards high quality companies — those that are typically highly cash generative, have strong balance sheets and high and stable earnings patterns.”

Continuing global economic and investment uncertainty had determined the fund’s preference for shorter-horizon investment strategies, the annual report said.

“Weighing on markets are a number of structural issues including the need for debt deleverage throughout much of the world, global imbalances leading to potential disruptions to capital markets, the threat of one or more sovereign debt crises, and the social and political fallout from higher unemployment in some developed market economies.

“Where attractive risk premia are offered for longer horizon assets these will be considered but a more cautious approach to these opportunities than might have been taken in previous years is appropriate.”

The fund said its recent hedge fund activity had focused on multi-strategy hedge funds as well as macro-directional managers.

The fund achieved a strong return of 10.6% before inflation for FY 2009-10.

The fund’s allocation to property and infrastructure assets including plantation timber, also dramatically increased from 3.6% in 2008-09 to 9.5% of the portfolio in 2010, with a target of 14.5% for 2011.

“Financing pressures in the tangible assets sectors should provide opportunities to investors with sufficient ‘dry powder’,” the fund said, referring to cash holdings.

The fund’s target allocation for 2011 will see it further scale back its debt holdings from 21.9% of the portfolio in FY 2009-10 to 16%. Having benefited from earlier opportunistic buying of credit predominantly corporate bond assets, the fund is reducing its exposure.

“The more liquid credit markets rallied significantly during fiscal 2009/10 and we experienced very strong performance across the debt portfolio. This has provided some opportunity to sell into the market strength seen in early 2010,” the fund said.

“While this has resulted in a modest reduction in the size of the overall debt portfolio, we have actively rotated the exposures within the portfolio to focus on more idiosyncratic opportunities across global markets that have attracted limited capital flows to date.”

Three percent of the fund’s debt allocation went to emerging markets debt in 2009-10.

The Future Fund has A$69 billion of assets under management as well as another A$20 billion managed by the same Board of Guardians but which have less aggressive return targets. The fund’s mandated target is to give returns that are 4.5% to 5.5% above inflation measured by Australia’s consumer price index. Australia’s annualised CPI rate is currently 2.8%..

“The focus is on achieving absolute returns in line with those set by Government in the mandate,” the fund said.”It is this approach which led to the focus on opportunities in credit markets in the first years of the investment program and the increase in the weighting alternatives over the next stage.”