Markets underpricing risk, warns Future Fund

Australia’s sovereign wealth fund has delivered a 6 per cent annual return in the year to 30 June 2023 and has positioned its portfolio slightly below neutral setting as it prepares for more volatile markets, geopolitical risk, and sticky inflation.

This return fell below the Future Fund’s one-year target of 10 per cent. However, it is “quite solid in the circumstances”, according to chief executive, Dr Raphael Arndt.

“The really favourable tailwinds that investors have had for some decades now have ended. Investment markets have undergone profound changes, which we’ve talked about extensively, and we feel that markets are underpricing those risks,” he said.

“As a result, the portfolio is positioned slightly below neutral risk setting but more importantly, we’ve been making quite significant changes to the configuration of the portfolio to prepare for more volatile markets, more geopolitical risk, and sustained and sticky inflation. That actually helps in turns of generating returns going forward once asset values have repriced.”

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He added that the $256.2 billion fund is also moving into attractively priced credit and fixed interest opportunities, which would generate much better returns moving forward. As of 30 June 2023, some 16.5 per cent of the fund’s asset allocation is in private equity, behind equities (21.8 per cent) and alternatives (17 per cent). 

“It’s a global mandate, so some of it might very well end up in Australia, but the mandate for the managers is very broad and gives them the flexibility to find parts of the system where credit is underviewed, and where we can get attractive returns,” Arndt explained. 

Since inception, the fund has delivered 7.7 per cent per annum against a target return of 7 per cent. Over the past decade, it has delivered an average annual return of 8.8 per cent per annum against a target of 6.9 per cent. 

As interest rate hikes took effect, the global and Australian economies slowed and new challenges emerged for long-term drivers of growth, noted Peter Costello AC, chair of the Future Fund Board of Guardians.

He added that inflation remains elevated and above the 2–3 per cent range targeted by the Reserve Bank of Australia.

“We are yet to see the full impact of higher rates work their way through developed economies and continue to see the risk of a recession in developed economies as central banks remain vigilant in bringing inflation down,” Costello said.

“Sharemarkets were surprisingly strong through the second half of the financial year as they appeared to be pricing in a ‘Goldilocks’ scenario. Whilst this would be a welcome outcome, we see risks on the downside.”

He reiterated the board is focused on maintaining a portfolio that is resilient to a range of scenarios while delivering attractive risk-adjusted returns. 

Arndt added the Future Fund has made significant changes to the portfolio over the past two years, which means its holdings and returns will “look increasingly different from those of other asset owners.”