The Future Fund, given its ‘investment mandate’ last week and a promise of an initial $18 billion in cash to invest, appears to have both the flexibility and fire power to achieve the target 4.5-5.5 per cent real return requested by the Government over the next 20 years.

Unfortunately for the board and, more importantly, the executive coming into the fund, criticism will abound over its decisions and performance in the short term. With last week’s announcement, harmless as it might seem, criticism has already begun. And the fund hasn’t even announced its chief investment officer yet. Generally, the target return was seen as too low. After all, the Australian equities market has averaged about 10 per cent real (after inflation) for the past 10 years. But for the previous 10 years (including the 1987 crash) it was only about 5 per cent and the 10 years before that was about 2 per cent. A big question, which critics need to assess, is what is the likely rate of return of equities markets over the next 20 years. But that is not the only question. The way institutional investment funds, such as the Future Fund but also such as some large super funds, handle their investments over the next 20 years is likely to be very different to the way they have handled them in the past. Asset consulting firm Watson Wyatt has been working with the Commonwealth Treasury on the development of the investment mandate for the Future Fund for several months. What has been announced and reported is a tiny part of the advice given by Watson Wyatt as to how the investments should be managed. Watson Wyatt has been at the forefront of developing new asset classes for super funds and at the forefront of presenting all funds with what is regarded as the brave new world of funds management for institutional investors. This is a world whereby funds will tend to invest in up to 13-15 asset classes or sub or alternative asset classes, with uncorrelated returns, and with the managers seeking and being paid for their alpha rather than beta returns. This world is already upon us. Super funds are undergoing, maybe a bit slowly, the transition to this new paradigm in investing. The old asset allocations are just that – the old asset allocations. This is not news for super funds, and it is not news for the Future Fund trustees (termed guardians). If Watson Wyatt is allowed to provide the guidance which has been requested of it (which also means that guidance needs to be given due credit), the Future Fund should be able to comfortably adapt to the brave new world of funds management. The two important appointments we have not yet been informed of are that of chief investment officer and second – or implementation – asset consultant. David Neal, the head of investment consulting for Watson Wyatt, was rumoured for the past couple of months as being in contention as the CIO of the Future Fund. This has been roundly denied, by Neal and others. For the second consultant, Mercer Investment Consulting has been considered the front-runner but the position has not yet been advertised. Either way, the Future Fund is unlikely to invest its billions over the next 20 years in a way which is at all similar to how big funds have invested their money over the last 20 years. Critics should bide their time until they have something concrete to criticise. According to the statement last week from Peter Costello, Treasurer, the investment mandate directs that the board: . Adopts a long-term benchmark of an average return of at least 4.5 to 5.5 per cent real per annum but recognises that the Fund may have returns lower than this while the Board develops and implements its investment strategy; . Determines an acceptable but not excessive level of risk for the Fund; . Establishes an internal limit on holdings of any listed company in order to ensure that it does not trigger the takeover provisions under the Corporations Act 2001 or hold a stake of more than 20 per cent in any foreign publicly listed company; . Only acquires a direct equity holding in Telstra if shares are transferred to the Fund by the Government or gifted to the Fund with the approval of the Government; . Acts in a manner that minimises the potential to cause any abnormal change in the volatility or efficient operation of Australian financial markets or adversely affect the Government’s reputation in these markets; and . Has regard to international best practice for institutional investment in determining its approach to corporate governance principles.

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