Future Fund’s Peter Costello warns of Donald Trump fallout

Concerns about the trade and investment policies of Donald Trump have added to the Future Fund’s cautious outlook.

Future Fund chairman Peter Costello. Picture: David Geraghty.

Concerns about the trade and investment policies of US President Donald Trump have added to the Future Fund’s already cautious outlook, as the $127.7 billion retirement savings pool rode a December-quarter surge in financial markets to again beat its return target.

While shying away from criticising specific policies, Future Fund chairman Peter Costello said that anything that hindered the free flow of trade and investment would be bad for investors.

“The best kind of climate is one where there is free movement of capital flows because if you are looking to invest around the world — as we are — anything that hinders that type of investment doesn’t help your returns,’’ Mr Costello said. “We would say from every global investors’ point of view if there are restrictions on capital flows or restrictions on trade it is not going to help us.’’

Mr Costello said the fund remained cautious about the investment outlook with long-term bond rates continuing to signal low returns and investors being asked to take ever higher risks to achieve those returns.

“While global equity markets have strengthened over recent months, uncertainty regarding global monetary policy and a range of geopolitical factors remains. We maintain our long held view that we see a challenging investment environment ahead with elevated risks and lower prospective returns than in previous years,” he said.

Despite the cautious tone, the fund continued to beat its government-mandated long-term average return target of inflation plus 4.5-5.5 per cent as global markets surged following the election of Mr Trump in November.

Returns for the year to December totalled 7.8 per cent, eclipsing its 6 per cent target return mandate by nearly 2 percentage points.

Mr Costello had warned as recently as December that the fund was facing a “formidable” challenge to meet its mandated return above inflation as globally low interest rates made easy returns scarce. He urged the federal government to clarify its plans for drawing down on the fund, which will be crucial to meeting its budget surplus.

Mr Costello said the country would be stronger if the fund was allowed to continue to grow rather than run down to meet public service retirement liabilities from 2020. But drawdowns could also affect returns unless the fund was given advance warning of how much was needed and when.

Scott Morrison has included almost $4bn of Future Fund earnings in the 2020-21 budget to reach a $1.1bn surplus, but would have to find money from recurrent spending to meet those liabilities if it does not draw down from the fund.

“I would argue that taking money out of the fund will in fact reduce the income which is now going on budget and taking money out of the fund would also reduce the asset,’’ Mr Costello said.

“If you want to strengthen the commonwealth balance sheet, a fund that is earning well and is growing and is an asset on your balance sheet is very useful.

“If you want to wind it up and spend the money, I don’t think you will be a in a better position.’’

While overcoming concerns expressed in December that the fund faced a “formidable’’ challenge to meet its target rate — adding nearly $5bn to the value of the portfolio in the first six months of the financial year — Mr Costello repeated calls for the government to lower the return target.

“We think it was the proper mandate for the last 10 years but we think it needs revisiting for the next 10 years,” he said.

The Medical Research Fund, which was established in 2015 and is managed by the Future Fund, has a mandated return target of the Reserve Bank cash rate plus 1.5-2 per cent, net of investment fees, which would be 3-3.5 per cent or as little as half the Future Fund target.

The 7.8 per cent return followed a rollercoaster ride in fin­ancial markets over the period, but fell short of the total returns on Australian shares (share price movements plus dividends), which grew by 11.6 per cent over the same period. Global sharemarkets were up around an average of 10 per cent over the year.

The fund has $8.5bn, or 6.7 per cent of its total assets, in Australian shares, and $28.5bn, or 22.4 per cent, in international shares, including emerging markets.

Cash holdings, which are considered a relatively safe investment, still account for the greatest share of assets the fund has invested in, at 19.7 per cent of the fund’s assets, down from 20.6 per cent at the same time a year earlier due to the exchange rate.

Chief executive David Neal said the fund had increased investments in private equity — particularly venture capital — and alternative assets.

But it had also increased infrastructure investment due to its participation in the Queensland Investment Corporation-led consortium’s purchase of the Port of Melbourne from the Victorian government for $9.7bn.

It also contributed to a $2bn fund set up by AGL to invest in renewable energy.

“We don’t think that the market is offering particularly good risk-adjusted returns so we are looking for other ways to increase our returns,’’ Mr Neal said.

The December-quarter surge in equities drove a 2.4 per cent ­return for the fund — ahead of its 1.7 per cent target. But Mr Costello warned that markets had run ahead of any growth in the economy or corporate earnings.

“They are anticipating a lot of investment and construction. Let’s hope it happens but if it does happen it won’t happen tomorrow,’’ Mr Costello said.

“Markets have run on expectation there and as we look around the world there are still historically low interest rates.

“We do think on balance, looking forward it’s a low return and risky environment and, given the fact we have a mandate to avoid excessive risk, that is weighing on our minds considerably.”

The comments come ahead of the corporate reporting season that starts this week and that analysts say could reveal some weaknesses in the economy.

Mr Costello said high housing prices and pressure on incomes had led to pressure on consumption, but that a recovery in commodity prices had helped the economy.

“You do still have a lot of the Australian economy geared to the property cycle,” he said.

“But one of the strengthening things is that all of the investment that went into mining at the peak of the boom has turned into extra capacity and gives us a bit more strength in the economy as it flows into production and is flowing into production, and now at quite decent prices.’’