Future Fund CIO on working with asset managers

AsianInvestor’s award for the best sovereign fund in this year's Institutional Excellence Awards, held on Wednesday in Singapore, reflects the maturing of Australia’s Future Fund over its first decade.

While the A$123 billion ($92.5 billion) fund is due to start being drawn down in 2020, it is set to continue investing for decades to come, noted chief investment officer Raphael Arndt.

For this reason, Arndt said the fund's executives and managers recognised the need not just to invest with a long-term objective, but to improve the conversation around how long-term pools of capital were managed.

Q  Will the government mandate for the fund be extended beyond 2020?

A   We are currently in discussion with the government about what their intentions are in regards to withdrawing funds from 2020. This is a matter for the government to consider.

In terms of the fund as a whole, factors including investment performance, how much money is taken each year to meet the liabilities and any additional flows into the Future Fund will influence how long the Fund lasts, but it is expected to continue to operate in much the same way as today for many decades to come.

Q  Is the fund likely to dial down the risk at that point?

A  Peter Costello [the fund's chairman] is on record saying that, irrespective of drawdowns, we feel that our mandate should be reviewed, given the current investment climate, and that’s an ongoing discussion with the government. Given our view of the world right now, we have reduced risk in the fund over the last two years [it currentlyhas more than 20% of the portfolio in cash].

Q  You have talked about taking a more active role with the aim of improving the conversation around how long-term pools of capital are managed. Can you explain more about that?

A  We thought that as the pool of long-term capital continues to grow, because of growth of savings and pensions, it would be beholden on us to drive the conversation forward. Through collaborative research with the Centre for International Finance and Regulation, we have contributed to a series of academic pieces in Australia on long-term investment.

We also want to exert some influence on the arrangements that exist between fund managers and asset owners, to drive the alignment of interests between us. There is a need for continued pressure to improve investing terms for asset owners, so we are active participants in industry networks such as the Hedge Fund Standards Board and the Institutional Limited Partners Association.

Obviously we’d like to pay lower fees, but it’s not as simple as that. It is the nature of the alignment that we not so satisfied with, so we need to get the message across on what we are prepared to pay for, and what we’re not prepared to pay for.

At a manager level, we do a lot of work analysing and talking to our managers around the quality and value they are providing.

Q  How has the fund's investment policy evolved given the current market environment?

A  One of the issues that is really a result of the market we are in is that all assets are expensive. There is more and more capital competing for every idea.

In order to continue to improve what we do and allocate capital to the best ideas, we needed an investment strategy that gave us control over the portfolio construction, the risks we were taking and at the same time allowed us to be nimble in how we are meeting the market in individual opportunities. For example, investing in more emerging and start-up managers that we think have an edge, but equally have spare capacity and an ability to deliver alpha.

Also, across most sectors, we undertake co-investments alongside our external managers. In our private equity portfolio in the last two years, we’ve made more than 20 co-investments. We can now assess an opportunity alongside our manager and be there to invest at the time of financial close, rather than accepting a syndication or a sell-down after the fact, requiring the manager or the fund to underwrite our position.

Q   So how do you develop an investment structure and decision-making process that is both able to allow you to have strong control over your portfolio at a central level but also be nimble?

A  That is a difficult question to answer. Most funds do one or the other. They either have a central investment committee, and that can be a slow process, where the papers need to be prepared well in advance and not all the people on that committee understand the issues of a particular asset class or transaction. Or they devolve decision-making to sector teams that can be very nimble, but you lose control over your central portfolio construction.

Some funds seem to address this through overlays – they don’t actually change the asset allocation, [rather] they shape the ultimate exposure through the use of overlays.

We decided to have a process where we had a strong central investment committee that would set the overall portfolio exposure and various risk budgets – for example, equity risk factoring, illiquidity, exposure to different macro economic scenarios, drawdown risk – and make decisions about moving the portfolio around dynamically.

At the same time, having made that decision about an individual idea or strategy, we devolve the ultimate responsibility for approving the investment to one of two other investment decision-making committees; either where the members are skilled in assessing managers (the manager review committee), or the transaction team, people who have done direct transactions in property and infrastructure (the asset review committee).

So that group of people can get much more into the technical aspects of manager due diligence and they can therefore be a bit more nimble in making decisions, but without compromising the overall portfolio construction.

The second thing is we talk about having a joined-up investment process. That means our top-down people – our macro economists and portfolio construction people – are talking to our sector teams, and they are not only informing each other, they are influencing each other.

So the top-down people might see that we’re observing that the trading of a particular airport or toll road is much better than we expected and maybe the economy is doing better than we planned and we might adjust our macroeconomic view. Alternatively the macroeconomist might be concerned about a particular economic risk profile, and the sector teams can respond to that in how they are building their portfolios.

Q  Are you continuing to build new relationships for co-investment?

A  We don’t see it growing much more – it’s already a significant part of our programme, at 20% of our private equity portfolio. We also do co-investments and direct investments under separate accounts, which are very similar, in property and infrastructure. We have also done co-investments alongside our hedge fund and credit managers. 

Doing co-investments allows us to better understand the manager and its due diligence process and expertise. It allows us to tailor our portfolio exposures, to better suit what we are looking for and to reduce the fee drag, because we typically pay low or no fees on co-investments.

The manager benefits from the capital injection, and our understanding of the manager is enhanced through the additional insight we gain through working alongside the manager on co-investments.

It also allows us greater control of liquidity on the portfolios. In a private equity-style drawdown fund, you can’t control when you might get a capital call, but when you are doing co-investments you certainly can.