Future Fund’s allocation lessons for private investors

The Future Fund has a terrific fundamental objective that could be applicable to any investor.

Future Fund’s allocation lessons

The Future Fund pulled in another very strong set of investment results this week and usefully — for the private investor — this $117 billion operator also revealed both its asset allocations and its view of the future.

Using the Future Fund as a role model for the individual ­investor is flawed, because the fund operates in a different space to most investors — even most super funds — but allowing for these exceptions there are still highly valuable investment ­insights on offer here

The fund has a terrific fundamental objective that could be ­applicable to any investor: it promises to earn at least 4.5 per cent more than inflation every year (measured on a 10-year basis to iron out deviations). For the year to June the fund managed to double its target rate with earnings growth of 15.4 per cent.

As a fund that operates out of a Melbourne office tower, the Future Fund shows absolutely no bias towards its “home” economy — indeed Australian shares have slipped from 9.4 per cent to 6.8 per cent in the fund’s asset allocation (see table): since our market has waned faster and harder than Wall Street during this now extended correction, this hard-nosed rationalist position taken by the fund has paid off. Most investors would struggle to be as disciplined as a sovereign wealth fund — and indeed the seduction of franked dividends will always make local stocks relatively attractive, but the lesson is: you must move investments offshore to get a healthy diversification.

A window into the workings of the fund is the broader movements in allocation, particularly the movement in money flows over the year to June. There are three points of guidance here:

● The outstanding item to note is that the fund moved heavily into cash. It’s ironic that most Australian investors have been earbashed for three years about getting out of cash into risk assets for better returns. Indeed, there are signs this is happening: the savings rate has finally drifted down to less than 8 per cent, from 10 per cent in 2010. In other words, the new Future Fund figures show the value of keeping on top of not just markets, but sentiment in markets such as the ever changing attitude to cash levels.

Cash is now a very significant holding in the fund — certainly at the end of June when these ­figures were reported it had shot to 19.5 per cent up sharply from 11.2 per cent a year earlier.

Of course, “cash” for the ­Future Fund does not mean putting it into a local bank at 2 per cent — the fund holds its cash in a range of currencies: its US dollar cash holdings would have made a nice profit this year just be being in the right currency.

● A perennial message from the fund is that more than 30 per cent of its entire portfolio, represented by holdings in alternative assets, private equity, infrastructure and timberland, are not ­directly exposed to our securities markets. Indeed it is these “non-correlated” holdings that should act as the ballast for the fund during the challenging times we are having right now especially on the ASX and Wall Street.

As a private investor you will find yourself consistently excluded from these asset classes unless you qualify as a sophisticated investor with investable assets of $2.5 million or an annual income for the last two years north of $250,000. These “sophisticated” investments are seen as too complex and too risky for most investors (though since our bank stocks have plunged by 20 per cent plus in a matter of months risk is a relatively concept here). Slowly, more alternative and ­private equity products are emerging in the market for mainstream retail investors and the sooner the better.

● The fund has increased its holdings in property: its property holdings inched up from 5.4 to 6 per cent. This level of property exposure would probably be much less than the exposure of many individual investors.

This is a fascinating move, which is obviously in global property and would cross both commercial and residential property. It would have been very interesting to receive more explicit information on just what property investments are on the books but little detail has been offered, though we do know the fund has been active in residential property developments in the recovering US housing market.

Overall, the fund will be not getting any garlands from the ethical investor movement — with chairman Peter Costello waving away questions about coal and oil investments. All the same, it’s on the record that the fund has quit armaments and ­tobacco, which implicitly suggests over the longer term the fund will move with market consensus on whatever is deemed to be “ethical” as the notion evolves.

For ever investor, the outstanding takeaway from the Future Fund results is the comment of Costello that the market — and public servants lucky enough to be entitled to this fund — cannot expect these sort of 15 per cent returns to continue. Running at the double the target rate to return — in an era of low rates and low returns and in nervous markets — the fund has peeled back community expectations — it’s something the average investor will have to do as well.

James Kirby is managing editor of Eureka Report.