The timing of Brake’s departure isn’t helpful, but the Future Fund could barely have called this current turmoil much better.
It was in the fund’s report for the March quarter of 2021 that Arndt and Brake warned of the impacts of rising inflation and lower investment returns; a position paper published in September last year entitled A New Investment Order predicted much of what we’re seeing now.
“We actually took our own advice, and we started to move the portfolio around at that time and even earlier,” Arndt explains.
“We’ve actually made $30 billion worth of changes to the portfolio since 2020 to reposition it for this more inflationary, more volatile world.”
Many of those changes are about seeking out inflation hedges. The fund has added gold and other commodities to the portfolio, while the deals to take stakes in Telstra’s mobile phone towers and the Australian assets of Tilt Renewables came with inflation-linked contracts.
The fund has also reduced its exposure to certain currencies, to interest rates and, at least until recently, to bonds.
“This was all about starting to build inflation resilience into the portfolio. We’ve still got aspirations to continue to grow that,” Arndt says.
This includes a greater focus on managing liquidity in the fund and a desire to introduce a more dynamic approach to asset allocation in a bid to replicate the success it has had in moving its equity risk positioning up and down, which Arndt says has added between 1 per cent and 1.5 per cent per annum to the fund.
Another key move has been to increase the fund’s exposure to macro hedge funds, which Arndt says have delivered a return in the financial year to date of about 20 per cent because of their ability to take short equities and short rates positions.
The Future Fund has been explicit about its view that alpha (above market returns) will become more important in a low-return environment, and Arndt says it will continue to hone its strategies for finding the best investment managers it can.
While it is too early to provide performance numbers for the fund’s overall performance – hedge fund and private market returns for the year to June 30 will take a little longer to come in – Arndt believes the Future Fund is $4 billion better off than if it hadn’t started adjusting its portfolio in 2020.
“The fund will be down like every other fund will be down when your equity market finishes the year 20 per cent down. But it’s a lot less than it might have been,” he says.
“If we can defend the portfolio now and then reposition … then we’re in a really good position because the returns should be reasonable – cash rates will be better, and bond rates should be better.”
Arndt’s key message is that the fund needs to keep moving and innovating to keep fighting inflation. Stagflation is not the fund’s central case, “but it’s a real scenario to worry about, and it’s an incredibly bad scenario for long-term investors”.
“As an investment community, we can’t just assume we can keep doing what we’ve always done and that it will be successful. It will not be,” he says.
“The world has changed, and what’s happening now is healthy because we’re moving from emergency policy settings to more normal policy settings.”
Arndt says low unemployment, strong household and corporate budgets, and reasonable GDP growth support that normalisation.
“Financial markets just need to adjust to that, and that adjustment needs to include a realisation that this is not like the GFC or the start of the pandemic, when central banks flooded markets with liquidity.
“This is an entirely different situation and no one’s coming to the rescue this time. This is actually caused by normalisation of policy settings, which is just a normal business cycle. But people haven’t had one of those for more than a decade.”