The Future Fund also maintains its faith in hedge funds, and while retirement industry peers balk at paying fees, Arndt says he’s looking for the best talent the investment world has to offer.
A hedge fund book of close to $35 billion, representing 17 percent of the portfolio, has performed when the fund needed it most, generating a 20 percent return and some managers achieving 40 percent after the fees.
Hedge funds’ strong run comes after a long period in which institutions questioned the role of alternative asset managers when stocks and bonds did all the heavy lifting.
While Future Fund isn’t specific about which strategies generated those stellar returns, Arndt confessed that macro hedge funds were among the best performers.
Broadly speaking, they can be divided into two camps, discretionary and systematic, which are somewhat like assets and liabilities.
Whether guided by top traders or clever models and trend-following strategies, hedge funds that could short stocks and bonds and long commodities benefited from the inflationary push.
Private club
The Future Fund has an equally large allocation of $34 billion for private equity and venture capital. But scanning the list of managers, the biggest names in the industry are absent. The fund is not a fan of buyout companies that use debt to acquire businesses and resell them in the medium term.
With the rising cost of debt, these strategies are even less attractive.
Instead, Future Fund prefers early-stage private equity investments that should be less sensitive to general movements in interest rates. Venture capital exposures, Arndt says, are mature and return capital faster than is being implemented. Either way, Arndt believes that purely new companies are not exposed to inflation.
Infrastructure is the mainstay of an inflation-fighting portfolio, and where the Future Fund and Australia’s largest superfunds have the most common ground.
The fund holds seven Australian infrastructure assets worth more than $1 billion in its $18.5 billion portfolio.
Property valuations have taken longer to adjust to the new environment than infrastructure, and he says some managers believe property debt rather than equity is the best bet.
In general, Future Fund is comfortable investing in corporate debt, primarily through private lending.
Arndt doesn’t foresee high defaults, but advocates paying credit analysts to manage that risk, and all exposures are floating rate anyway, meaning interest payments rise in line with base interest rates. .
special effects
The Future Fund has not gone totally alternative. While it has tended to avoid sovereign bonds and has reduced its duration exposure (ie sensitivity to interest rates), it is slowly increasing that as a hedge against an economic downturn.
Long-term bonds, the US dollar and the Japanese yen have tended to be reliable exposures for Australian investors in the face of crises. While the yen has detracted (as the Bank of Japan remains the last taxi out of the inflation-fighting range), the US dollar’s rally to 20-year highs has been a significant contributor.
In listed stocks, of which Future Fund owns $55 billion, biases toward value and quality stocks have worked.
The US stock market trading at 20 times trailing earnings requires a “strong view on earnings growth to sustain that multiple,” says Arndt, which is a view the Future Fund does not share.
European and Australian markets trading 13-14 times are not far from fair value levels.
Where the Future Fund has concerns is in emerging markets, which explains why it reduced its portfolio weight from 9% to 5%.
One source of concern is China, where Future Fund has previously signaled its intention to reduce exposure.
That economy is still struggling with lockdowns as tensions rise with its trading partners. Meanwhile, household leverage is higher than Australia’s, limiting lawmakers’ ability to raise interest rates, while lowering rates only further inflates the debt bubble.
It is an enigma for China. But it’s similar for the developed world, where leverage and politics mean rates won’t go up as much as they should, creating what Arndt believes is a future of persistent wealth-destroying inflation.
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