Future Fund tops 2016 target as Costello warns of elevated risks

The $127bn fund has dodged market volatilty and “formidable” challenges to book a solid 7.8pc return.

Chairman of the Future Fund, Peter Costello arrives with Treasurer Scott Morrison to the 10th anniversary dinner of the Future Fund. (Aaron Francis/The Australian)

Australia’s sovereign wealth fund, the Future Fund, has overcome sharp financial volatility and market uncertainty to beat its target over the 2016 calendar year.

The Peter Costello-chaired fund booked a return of 7.8 per cent over the last 12 months, eclipsing its 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 4.5 to 5.5 per cent return above inflation as globally low interest rates make easy returns scarce.

“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,” Mr Costello said in a release announcing the fund’s performance today.

The fund has grown to $127 billion at the end of December, well above double its initial $60bn seed funding, which was established under the Howard Government in 2006.

The 7.8 per cent return over the calendar year is a solid result given the rollercoaster ride in financial markets over the period, but it falls short of the total returns on Australian shares (share prices 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’s performance is lower than the prior calendar year return of 8.4 per cent and also undershoots the fund’s five-year performance average of 11.8 per cent per annum, but is in line with its 10-year average return.

Mr Costello said the fund would not be taking unnecessary risks in the volatile environment. 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. This is down slightly from 20.6 per cent the same time a year earlier.

“While global equity markets have strengthened over recent months, uncertainty regarding global monetary policy and a range of geopolitical factors remains,” Mr Costello said.

“With our long-term objective front of mind, the board exercises patience and diligence in investing the assets of the fund, ensuring we do not expose the portfolio to undue risks for the sake of shirt-term gains,” he said.

The fund has also reduced its exposure to developed market equities, with assets dropping from 17.2 per cent of the fund’s allocation to 15 per cent over the year. Alternative assets, which include non-traditional investments such as real estate debt and private equity, now account for 14.2 per cent of the fund, up from 12.6 per cent a year ago. Australian shares account for 6.7 per cent of the fund’s assets.

“Over the quarter we deployed capital into our private equity program, primarily through co-investments in venture capital and growth,” Future Fund managing director David Neal said.

“Our cash allocation has reduced largely due to the fall in the Australian dollar against the US dollar over the period,” he said.

Financial markets swung wildly over the last calendar year amid a series of geopolitical tremors and events. Bank stocks were hammered at the start of 2016 amid concerns a stronger US dollar would spark an emerging debt crisis that could push some systemically important institutions into insolvency. The Brexit vote midway through the year took many investors by surprise, as did the November election of Donald Trump to the White House. Uncertainty over the US Federal Reserve’s interest rate hikes and a global explosion in government bond yields also stymied the plans of investors.

The Future Fund recently celebrated its 10th anniversary, having received its original seed capital from the proceeds of the sale of the last part of Telstra and federal government surpluses. The fund was set up to allow windfall economic gains to help fund the superannuation liabilities of the federal government from 2020.

The Future Fund itself also manages several other federal government funds, including the Medical Research Fund and the Health and Hospitals Fund, bringing its total funds under management to $145bn.