Sovereign wealth fund to take on more risk

The Future Fund anticipates that it will need to take on increased market risk over the next decade to give it the best chance of continuing to achieve target returns, which to date it has well exceeded.

After completing the 2021 financial year investment strategy review – the most comprehensive since the sovereign wealth fund’s establishment, according to Chief Executive Dr Raphael Arndt – the fund had concluded that “in a low forward-looking return environment” it would need to position its portfolios to take more market risk, on average, than in the past.

“With additional resources available to enable the change, we also expect to deploy more capital to higher return-generating assets, while adding diversifying exposures to manage downside risk and retaining a degree of flexibility to respond to the changing environment,” the fund said in its review document released on 6 September.   

In response to the changed outlook, the fund had already reduced cash holdings and increased investments across the portfolio, the review said. This had included increasing the allocation to listed equities in regions that were offering more attractive long-term return prospects. These regions included Australia and emerging markets.

The overall size of the private equity allocation had increased over the year, driven by higher valuations and new investments, and despite a strong IPO market converting some investments into large cash inflows.

The fund had increased investments in property and infrastructure via listed avenues “to respond to compelling valuations following market dislocations, and via unlisted avenues carefully selecting the most attractive assets and opportunities for the total portfolio. With a strong portfolio return over the year, these allocations, as a proportion of the total portfolio, remained relatively stable”.

Debt exposures had been allowed to continue to fall as credit spreads remained tight and forward-looking returns remained low, particularly in more liquid markets.

Adhering to the fund’s total portfolio approach of searching for the best use of capital across asset classes and along the capital stack, investments had, however, been made in credit opportunities in property and alternatives (hedge funds). The fund also continued to add to alternative exposures that were most accretive to the portfolio, including high-return relative-value strategies and inflation-related tail hedging strategies.

The fund had also retained a basket of defensive positions including in foreign currency, fixed income, and some hedging strategies.

The review noted that the fund regarded the defensiveness of nominal bonds as increasingly questionable as inflation risk rose. The fund continued to hold the view that a “meaningful level” of foreign currency exposure to both developed and emerging markets countries could provide valuable diversification.

Chief investment officer Sue Brake said that in carrying out the review the fund’s team had considered four distinct “orders”:

• The World Order – the political and geopolitical landscape within which global commerce operates;
• The Economic Order – the strucutural macroeconomic and microeconomic landscape;
• The Policy Order – the global policy tools that are used to manage the economy from a cyclical perspective, and
• The Market Order – the financial system and how it drives asset pricing.

“We identified and examined 20 distinct potential paradigm shifts under these orders and generated assessments of each, covering: the drivers of the change, possible paths forward, top-down macroeconomic implications and bottom-up asset class or sectoral implications,” she said.

“We believe secular scenarios that describe how the world might evolve over a long (10-year) horizon are a practical way to explore how different orders and paradigms might change and what the investment implications may be. This informs long-term whole-of-portfolio construction.

Brake said there would be a focus on portfolio opportunities that added defensiveness, diversification and inflation protection. Domestic exposures would also receive more attention “as the fund added both new and granular levers for robustness and value-add opportunities”.