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Inside the Future Fund - Eureka Report article

October 6, 2008

Inside the Future Fund
By Scott Francis



PORTFOLIO POINT: Like SMSFs, the Future Fund is investing to provide retirement income. Unlike most SMSFs, a big slice of its portfolio is in global shares.

Suddenly portfolio management is crucial. As investment markets rapidly reshape in the wake of the global credit crisis, your portfolio structure, allocations and ongoing management will make a big difference to your returns this year.

In times likes this it is interesting to take a look at Australia's biggest investment portfolio, the $64 billion Future Fund. The fund is really doing what a lot of self-managed superannuation fund investors are doing but on a much grander scale: building an investment portfolio to provide retirement benefits. It has been admirably transparent in its investment deals, which means we can get a very clear picture of its activities to date.

In particular, the fund does a thorough job of documenting its investment philosophy and decisions, providing an example for self-managed super fund investors.

Investment strategy

The Investment Strategy is a key self-managed super fund document that trustees should understand, maintain and use to manage their fund's investment portfolio. The Future Fund maintains a Statement of Investment Policies, a 22-page document that provides a thorough overview of the thinking behind its investments.

Some interesting ideas from the Statement of Investment Philosophies include that:
  • The stated investment return aim is 4.5-5.5% a year above inflation. Assuming inflation at the top end of the Reserve Bank range of 3%, that implies a return of 7.5-8.5% a year. SMSF trustees who expect a return higher than this might have to think about what they know that the Future Fund managers do not.
  • Returns over the short term (one year) are not a particular target; the focus is on five-year returns.
  • A key focus on the organisation is "combining a wide variety of lowly correlated assets to reduce volatility". This is not dissimilar to the discussion on asset allocation mentioned by Doug Turek in his article last Wednesday.
  • The asset classes that the Future Fund will invest in are:

- Global equities.
- Australian equities.
- Global and Australian fixed interest that have debt ratings.
- Global and Australian property.
- Private equity.
- Commodity futures.

It is interesting to reflect on what investments are missing.

Here's what the Future Fund you have any of these investments in your portfolio?
1. Hedge funds.
2. Unsecured Notes.
3. Mortgage funds.

If we interpret the absence of these investments as a guide on what not to invest in, then private investors in products such as Basis Capital, Macquarie Fortress Notes, Westpoint, Fincorp and (potentially) City Pacific could have saved billions.

The Future Fund pays no income tax (fund documents do not indicate if it received a refund of franking credits that it received). In this respect, the fact it does not pay income tax makes it very similar to a self-managed super fund in pension phase.

Drilling further into the workings of the fund, it is interesting to look at a number of points.

The exposure to global shares

The Future Fund has posted a number of Portfolio Updates on its website. The use of global shares in the portfolio is interesting; the portfolio has a significantly higher exposure to global shares than to Australian shares. As at June 30, 2008, 17.6% of the portfolio was invested in global shares of developed countries and 2.1% in global shares of developing countries (or emerging markets), while 9.2% was in Australian shares.

I don't think it is a stretch to say that this is different from most Australian investors, who might use global shares as a point of diversification rather than the core equity holding.

I guess the question is: why this weighting to global shares? Do the investment minds at the Future Fund expect global shares to outperform? Is the Australian equity market too small to invest a large portion of the future fund?

I don't know the answer to these questions, but it has been a terrible 10-year period in global equity markets and that must change at some point. (Actually, for the three months to the end of September the sharp fall in the Australian dollar has seen a positive return from the global share index (MSCI) unhedged).

Clearly the future fund thinks that global equity exposure in a portfolio is justified.

Global real estate

The portfolio also has 1.4% of its assets held in global property. This hardly seems like a newsworthy statement, except that there is data showing that global listed property has a "low correlation" with traditional growth assets such as Australian shares. A "lowly correlated" combination of assets means they will tend to be performing differently from each other, reducing the overall volatility of the portfolio. As the Future Fund Investment Philosophy states, investing in lowly correlated assets is a strategy to reduce risk (portfolio volatility).

The following table from Vanguard (a manager of the Future Fund) shows the 17 year (to the end of June 2007) correlations of different asset classes. International listed property (0.3122) is the least correlated of the growth assets to Australian shares. This suggests that it provides the greatest diversification benefits.

* The sectors listed are the underlying indexes used for the range of Vanguard funds.
Source: Vanguard, Morningstar.

Slowly building the portfolio

In the six months to June 30, 2008, the Future Fund continued to build its exposure to growth assets. The global shares increased from 15.3% of the portfolio to 19.7%; Australian shares from 8.8% to 9.2%.

This suggests that the fund is less interested in trying to time the market, instead looking to build the portfolio over time.


The Future Fund website is well worth a look. SMSF trustees might find their own fund has a lot of similarities to the Future Fund: to provide retirement income. The Future Fund has a mass of resources at its disposal, so it might we worth having a peek at its work.