Future Fund lifts bets on stocks and private debt bets, sees inflation higher for longer

Australia’s sovereign wealth fund has been buying more domestic and overseas stocks, and adding to private debt bets, as it believes inflation will stay elevated in a strong global economy.

Future Fund CEO Raphael Arndt in Melbourne. Aaron Francis / The Australian

Australia’s sovereign wealth fund has been buying more domestic and overseas stocks, and adding to private debt bets, as it believes inflation could remain higher for longer in a stronger than expected global economy.

Posting a 10.1 per cent return for the year to the end of March that beat its government-mandated target return by 2.5 percentage points, the fund said financial markets have not fully accounted for the possibility that interest rates may not fall this year.

“The global economy is in good shape, better than expected this time last year, thanks to the strength of the US economy,” Future Fund chief executive Raphael Arndt said.

“Markets have priced in this economic resilience and expectations of several rate cuts in Australia and the US before year end. But as we have been saying for some time, inflation remains sticky and while it remains above central bank targets the risk is that rates will be held higher for longer.

“While markets have begun to price in this risk since the end of the quarter, investors have not yet fully adjusted to this view,” Dr Arndt added.

This week’s stronger-than-expected inflation data for March caused traders to reverse their bets on the Reserve Bank cutting interest rates this year. Economists also now expect interest rates to remain higher for longer.

Dr Arndt warned that conflicts in the Middle East and Ukraine have exacerbated geopolitical risks, which are expected to remain elevated “for some time”.

“Any increase in conflicts risks adding further to inflationary pressures. Investors need to be alert to these dangers and retain the flexibility to respond quickly,” he said.

The fund increased bets in developed market equities by $7.6bn, while investments in Australian stocks also rose $2bn. Australian equities now make up 10.1 per cent of the portfolio, while developed equities account for double that, at 20.3 per cent.

It trimmed its allocation to property by $823m to account for 15 per cent of the fund.

“We are conscious of the potential for a significant deterioration marked by conflict, geostrategic competition and supply issues,” chief investment officer Ben Samild said.

He added the allocations had been designed to provide “resilience” to the portfolio, which hit a record value of $223bn as of March 31, up from $212bn in December.

“Conditions for risk assets continued to be favourable through the quarter, with growth and inflation stronger than had been expected. Over the past year we increased our risk exposure to take advantage of those conditions,” Mr Samild said.

The fund also boosted private debt bets by $2bn over the March quarter, citing the attractive returns that this asset class can provide amid current conditions.

“We continued to add to credit investments as the persistence of higher growth and rates makes for attractive risk-adjusted long-term returns from this sector,” he said.

Credit investments accounted for 11 per cent of the portfolio at the end of March, up from 10.7 per cent in December.

The Future Fund also beat its return targets across the 10-year and seven-year investment horizons, but returns fell short of targets when measured over five and three-year periods. It has returned 7.8 per cent since inception, beating its target by 0.8 percentage points.