Future Fund shifts to active approach in 'new investment order'

Dr Raphael Arndt, chief executive officer of Australia’s A$250 billion Future Fund is challenging asset owners to review and revise their investment approach, particularly to move away from their bias for passive management.

Speaking at a conference in Sydney last Thursday, Arndt said the benign conditions that have endured for many years are in the process of significant change, demanding that investors explore new ways to deliver sustainable, long-term returns.

“Every one of us should be talking about the new investment order,” he said.

“In today’s environment, where the role of beta is challenged, the role of alpha in portfolio construction is more important than ever. In other words, just having capital is no longer enough to ensure decent returns.”

“We are making continuing changes to the portfolio towards investments that rely on investor skill rather than market risk.

For the past decade or more, the Future Fund’s harnessing of alpha has largely come through skill-based strategies in its private markets and alternative investment programs. “We are now seeking alpha more broadly,” said Arndt.

Changing times

Six years ago the Future Fund pivoted its listed equities approach away from active managers. At that time markets were being driven by central bank policies and the view was that it was “nigh on impossible” for active equities managers to consistently add value over and above their fees, said Arndt.

“Conditions have changed. Economies are diverging and companies can better distinguish themselves in a more challenging environment. As a result, active alpha-seeking strategies in our $65 billion listed equities program are increasingly attractive, provided that we can be confident that returns are driven by skill and not luck.”

Notably, changes in domestic markets have made small cap equities attractive to the investment team “for the first time and we have commenced a new program to invest in them in recent months”.

External fund manager skill is rare and expensive, said Arndt, but “paying sometimes high fees to fund managers is necessary to access skill. In my view, investors should be questioning this trade-off again.”

He also questioned whether asset owners can they truly replicate best in class performance with internal investment teams. “That may be true for some investors in some strategies but surely cannot succeed for all investors across all strategies.

“Will they be more dynamic with portfolio construction as market conditions change? Will they invest meaningfully in technology to understand what is in their portfolios? These are the questions investors need to consider in these challenging times.”

Decarbonisation challenge

Arndt also addressed “the biggest capital expenditure program that we will see in our lifetimes” -  the global transition to reduce emissions, particularly in the energy sector.

He described the US Inflation Reduction Act as a game changer in pulling through new technologies to support the energy transition.

“Every asset will be impacted in some way by the low carbon transition. Either directly, through supply chains, or by changing consumer preferences. As physical risks emerge, this will add another layer of complexity that will disrupt our systems even further.

For its part, the Future Fund is investing into renewable energy, including as an owner of 40% of Tilt Renewables, Australia’s largest wind and solar generation business. It has a cross-sector working group which meets regularly to share insights around the risks and opportunities arising from climate change and the response to it.

This spans investment opportunities not just in infrastructure and utilities but also in property, private equity and hedge funds. The fund is also engaging with investee companies to understand their transition and resilience planning, while investing in technology solutions supporting decarbonisation through private equity investments.

The fund’s latest result to the end of March 2023 show a 1.1% return for the 12 months, including a 3.4% gain in the March quarter. To put that in context, the ASX 200 was flat (0.1% return, including dividends) for the 12 months ending March and the S&P500 was down 7.7%.

The fund’s chairman Peter Costello noted that since April last year the Fed Funds Rate has gone from almost zero to 5%. In Australia the cash rate has risen from 0.1% to 3.6% over the same period.

“The effects of higher rates are playing out in different ways across different markets around the world, making investing conditions unpredictable,” said Costello.