Speech by David Neal, Chief Executive Officer, at the 11th CBA Sovereign Wealth Fund and Central Bank Debt Conference, Melbourne Victoria
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Good morning and thank you for the opportunity to speak to you today.
I’d like to take some time to introduce the Future Fund to you and to explain why we do what we do and how we do it.
I’ll then set that in the context of the current low rate environment and make some comments on how we, as Australia’s sovereign wealth fund, think about the prospective investment environment.
Why the Future Fund was set up
The Future Fund is Australia’s sovereign wealth fund. It was set up in 2006 and received its initial and only contributions from government of $60.5bn between 2006 and 2008.
Contributions to the Fund came out of Budget surpluses and a small slice of the proceeds of privatisation of the telecommunications company, Telstra.
This $60.5bn has grown to just under $166bn today. That is, the Future Fund has made the Government $105bn from investment earnings, representing investment returns since inception of 8.1% pa.
At the heart of the success of the Future Fund is its clarity of purpose and mandate and I want to talk about why these have been so important.
Let me start by setting out some context.
The Future Fund was established in response to the then government’s assessment that Australia faced emerging costs associated with an ageing population. This would place pressure on the budget in years to come.
The government recognised that it also had large unfunded public sector superannuation liabilities which were – and still are – paid out of consolidated revenue. Putting these points together the government decided that, having all but paid off government debt, it could begin to set aside and grow money in the Future Fund which could, in time, meet those liabilities.
Doing so would therefore ease pressure on the budget over decades to come and strengthen the Commonwealth’s long-term financial position.
So while the Government could have spent the money, the idea was to save it for future generations.
The government created an intergenerational fund putting away savings from the taxpayers of 2006 for Australians in decades to come.
Under the legislation the money is to be locked up until 2020. There can be withdrawals from then if the Government wishes to use the Fund to help meet defined benefit pension payments.
But in 2017 the Government decided to defer drawing down the Fund until 2026-27. This will allow the Fund to grow further before it is drawn.
An important observation from this is that the money in the Future Fund is not owned by any individual. Individuals do not contribute into the Fund. They cannot draw from it.
The Future Fund is genuinely an intergenerational sovereign wealth fund and in no sense a superannuation or pension fund.
Since the Future Fund was set up, successive governments have entrusted our Board with the investment of additional public asset portfolios.
Today we manage five of these additional portfolios, the Medical Research Future Fund, the Aboriginal and Torres Strait Islander Land and Sea Future Fund, the Future Drought Fund, the Disability Care Australia Fund and the Education Investment Fund which is soon to be closed and its assets transferred to a new Emergency Response Fund.
Each of these funds is set up by its own legislation and is managed according to its specific objectives but taken together these five funds add $44bn to the value of the funds we manage, taking the total value of the portfolios we invest to $210bn.
The six funds under the Board’s management have each been given a very clear objective enshrined in legislation and reflected in the Investment Mandate Directions issued by government. They range from seeking relatively high long term real returns, and an associated higher level of risk tolerance, through moderate risk and return levels and the provision of a stable income stream, down to low risk focused on capital protection and high levels of liquidity.
The Future Fund’s mandate, for example, requires us to target a long-term return of Australian inflation plus 4 to 5% pa, while taking an acceptable but not excessive level of risk. Importantly the Investment Mandate and the legislation are clear that we are not charged with any policy objectives other than the generation of strong long-term risk adjusted returns. Sovereign wealth funds in other jurisdictions are often used for other purposes, such as economic development or macroeconomic stability. The Future Fund is solely about long term real returns.
From an investment perspective this clarity is enormously important.
What’s more, the governance arrangements under which we operate have established our investment activities at arm’s length from government. Our Board is not drawn from government. We are funded from the assets of the funds, not through the government budget process.
This independence ensures that we are able to design and implement investment strategies to achieve the financial objectives we have been set and to do so without interference.
An important feature of the history and context of our organisation is the powerful sense of purpose that is engrained within it. Our people come to work each day knowing that their work is delivering financial returns that will:
- strengthen Australia’s long-term financial position
- support medical research and innovation
- assist Indigenous Australians acquire and manage land, water and water-related rights
- support a better life for Australians with a significant and permanent disability and their carers;
- support initiatives that will enhance drought resilience, and
- support areas of the country affected by natural events, such as floods, bushfires and cyclones.
This sense of purpose is a vital part of why our people join our organisation and strive to build and manage great investment portfolios.
And it motivates each of one of us to continually improve and contribute to the organisation’s success. It drives us to try to address the misalignments and frictions that can grow in the investment value chain and to find ways to turn risk into return as efficiently as possible.
The extent to which we do this has direct impact on the wellbeing and prosperity of Australians for generations to come.
So having explained why we do what we do – both in terms of our organisation’s policy purpose and in terms of why our staff come to work and work hard - let me talk a little about how we approach our task and how we see the current environment.
How we approach our task
Our annual report and our website provide a wealth of information on how we go about investing and how we organise and structure ourselves.
I encourage you to explore this information, but I wanted to highlight three elements that I think will give you a good sense of what we do.
We place our long-term investment objectives at the heart of what we do. This may seem obvious but it is less common in institutional investment than perhaps it should be. More often than is desirable, institutions are distracted by short- and medium- term influences. This can be because of a combination of the kinds of performance metrics used, peer pressure and career risk.
Typically some sort of benchmark approach is developed to mitigate this risk, to reduce the impact of short term noise. The intent is that this provides a series of measures against which an institution can assess its return.
But of course in setting the benchmarks, the institution risks setting up a measure that becomes the primary focus of the investment team. The focus is no longer about the original objective, but about beating the benchmark.
To address this, our approach is to set up our governance processes so that we can have effective conversations about whether a decision is going to help us achieve our objective or not. Of course we use measures, benchmarks and metrics. But we work hard to set up our investment processes, our decision-making bodies and culture so that we remain focused on the long-term objective.
The second element I wanted to highlight is our commitment to dynamically managing the portfolio.
The investment environment is constantly changing. Setting a static position is likely to mean that over time you fail to adapt to a new context and miss new investment opportunities.
The approach I just outlined helps us to work collaboratively across the organisation to identify the best opportunities we can find, across all asset classes and all geographies. It helps us to compare and contrast those opportunities and to set them against how we see the investment environment today and in the future.
We adjust the portfolio to reflect where we see risk and reward. We are willing to increase risk where we believe it will be rewarded and to reduce risk where we see the reward as inadequate.
As you may imagine, this requires that we have confidence in our investment processes and the ability to work constructively across our investment team and organisation. Moreover, it can only be successful with a highly skilled Board that is aligned to and supportive of this approach.
The quality and experience of the Board and the skills and collaborative approach of our staff since inception have been central to what has been achieved.
The third element I wanted to draw to your attention, is our use of external investment managers.
I am often asked the question of whether we insource or outsource investment management. My answer is that we operate a hybrid model.
All our investments are made through external investment managers. Some of those arrangements, as you might expect, are quite straightforward. We establish a mandate, set the parameters and the manager takes it from there with our team maintaining oversight.
But in many situations, we work deeply and collaboratively with our external partners. We work with them to identify opportunities, test investment hypotheses and develop potential strategies.
This can help us to create and access niche opportunities that suit our particular requirements. It also helps us build a partnership arrangement through which we access broader insights that we can feed into our investment process.
We hope that through our partnership mindset we are also able to add value to our managers beyond the fees that we pay.
This approach allows us to use the scale, expertise and global network of managers to be able to identify and access a wider and deeper range of investment expertise than we could realistically build internally.
In effect we are able to access the very best investment minds in the world and bring those insights here to Melbourne where we can incorporate them into our total portfolio perspective.
Finally, by using external partners to execute on implementation our team can remain focused on the most important and impactful strategic issues.
These three elements, as well as other aspects of our approach, give our organisation a distinctive character.
We have to build and sustain a culture that prioritises collaboration.
We have to attract staff with deep expertise and also the passion and ability to maintain a broader perspective across the wider portfolio.
We have to be willing to challenge ourselves and each other to maintain a focus on what matters for the portfolio as a whole.
This is certainly not an easy model to follow, but it is one that we believe is enormously valuable. It has certainly added value over our first 12 years.
With those remarks on what we do let me talk a little about how we see the world today.
Current investment environment and implications for investors
The Future Fund has a broadly diversified portfolio across asset classes and geographies.
Around 80% of the portfolio is invested overseas. We have an allocation of around 35% to listed equities while we also have an exposure of around 30% to generally more illiquid asset classes such as infrastructure, property and private equity.
Included within that infrastructure allocation are major assets here in Victoria, including meaningful holdings in the Port of Melbourne and in Melbourne Airport. These are important assets and attractive investments offering us exposure to growth in Victoria and beyond.
While we look globally for investment opportunities, domestic exposures such as these are attractive for several reasons. We know the assets and the market. They also provide a good match for our Australian inflation-based mandate.
The rest of our portfolio includes exposures in credit (around 9% of the portfolio) and what we call Alternatives (around 14%), a range of skill-based absolute return strategies and exposures to other risk premia that provide a diversity of return streams.
For some time we, along with many other institutions, have cautioned that the strong investment returns of recent years cannot continue.
These strong post financial crisis investment returns have been fuelled by easy monetary policy and stimulus measures which have helped to push up asset prices.
But the outlook for global economic growth is uncertain.
Traditionally central banks have had to juggle the twin challenges of supporting expansion while containing inflation. In recent years they have increasingly been wrestling with how to get inflation up to their targets and interest rates have fallen to extraordinary levels as they have fought this battle.
As a result there is now $17tn of negative yielding debt in the world.
Meanwhile a range of geopolitical events have the potential to place pressure on confidence both in the real economy and in financial markets.
Looking further ahead, global debt levels and demographic pressures will shape economies and markets over the medium to long-term.
For the Future Fund, given our view of the risks and the reward that we can see on offer for taking those risks, we are maintaining what I would call a ‘normal’ level of risk, sitting around the middle of the range of risk levels we regard as generally appropriate for our objective over time.
Whilst there are a wide range of risks evident, at the same time the risk premium on offer is reasonable relative to the ultra-low government yields.
What we are doing, however, is prioritising greater flexibility in the portfolio.
As we have said publicly before, we have taken a deliberate decision to sell around $5bn of illiquid assets across a breadth of asset classes with the proceeds allocated to more liquid strategies.
This is designed to ensure that we can adjust the portfolio quickly if needed so that we can withstand and potentially take advantage of any market dislocations that arise.
Of course it is also allowing us to take advantage of full valuations on assets where our investment thesis is complete, and down the track it creates the potential for us to re-enter illiquid markets when pricing is advantageous to us.
We are also working hard to maintain our focus on identifying and taking advantage of our managers’ skill so that we can add additional return or reduce risk. This includes our focus on strategies that have low correlation with risk assets such as hedge funds and venture capital.
As well as how the portfolio is currently positioned, we are working hard to ensure that our organisation is properly equipped to pursue our objective over the longer-term.
To do this we have been dedicating significant resources to upgrading our technology capabilities.
Improvements in technology are disrupting traditional investment models by creating new opportunities to generate returns and manage risks.
Over recent years we have been upgrading our investment data and analytics capabilities.
This work is focused on redesigning how we source, manage and deliver investment data and boosts the quality, scope and timeliness of the data we need to run our portfolios.
This allows our investment teams, for example, to more easily access and publish data sets for consumption across the organisation. This facilitates collaboration, increases efficiency and importantly means our team spends its time on higher value add activities, creating insights from the data rather than struggling to source and manage it.
We are now looking to the future, undertaking work to review our next generation technology and data strategy. We aim to build a roadmap for the next three years to help us make the right strategic technology decisions.
As well as looking at how we can use technology to further improve our investment processes themselves, we want to look at how technology can improve knowledge sharing and strengthen collaboration within our business and at how we can work alongside our technology partners to drive innovation in our overall approach.
So as well as looking at how we can be successful investors today in the current climate, we are working hard to make sure that our organisation and capabilities are suitable for the longer-term.
To draw this together, let me go back to where I started.
The Future Fund is an intergenerational Sovereign Wealth Fund.
We are sharply focused on our purpose of investing for the benefit of future generations of Australians.
The clarity of our purpose and our investment mandates give us a real sense of focus in our investment activity and a powerful motivation for our people to collaborate and innovate.
While markets have been strong and our model has helped us to deliver strong returns, we do expect prospective returns to be lower.
So we are working hard to ensure that we can be flexible to adapt to a changing environment and have an organisation that is in the best shape possible to sustain its success over decades to come.