Australia’s Future Fund building inflation ‘arsenal’ as PE portfolio soars

Private equity accounted for 17.5% of the Future Fund portfolio as of 30 June, up from 14.6% just three months prior.

Australia’s Future Fund is bracing for a higher inflationary environment after reporting the institution’s best-ever annual results.

At a press briefing following a Thursday portfolio update, deputy chief investment officer Wendy Norris said inflation had become an increasing focus of the A$196.8 billion ($143 billion; €121.4 billion) sovereign wealth fund over the past year.

“There’s no easy kind of way to protect your portfolio against every possible inflation outcome but I’d say that we’re conscious that there is a secular change in the direction of inflation pressures,” she said. “So, that makes us very thoughtful about the asset allocation across our whole portfolio.”

Rising inflation has been identified as a major risk by some of the world’s largest private equity managers, as Private Equity International reported in June. This month, PEI sat down with Nicholas Brooks, head of economic and investment research at ICG, to discuss whether private equity is well-positioned to weather the storm.

Norris added: “We think that asset classes like real assets can help defensiveness in the increasingly inflationary environment over the long term… rather than trying to respond to a short-term view on inflation.

“And certainly, investing in asset classes that are less correlated to the economic cycle, where you’ve seen strong growth that’s driven by innovation and different drivers of the economy… play into the overall diversification that we’re trying to seek in our portfolio. So, certainly, private equity is part of that picture but we’re trying to build an arsenal of different responses to inflation across the whole portfolio.”

Future Fund posted a 22.1 percent return for the 12 months to 30 June against a 7.8 percent target. It attributed this year’s strong performance in part to significant exposure to private equity, which grew 32 percent to A$34.5 billion, or 17.5 percent of the overall portfolio, in the second quarter.

“Those strong results reflect the diversification in our portfolio and we saw strength across all asset classes, but particularly public and private equity,” Norris said. “We did kind of make some structural changes to the portfolio during the year reflecting our views of the changed market environment.”

Future Fund leaned into listed equities in the three months to 30 June at the expense of cash. Global equities grew 20 percent to A$53.8 billion, or 27.3 percent of the portfolio, over the quarter, and domestic equities climbed 33 percent to A$16.8 billion, or 8.5 percent of its holdings. Cash fell 22 percent to A$25.9 billion, or 13.2 percent of the portfolio.

“Over the medium term, returns are going to be harder to produce, particularly given the shifts in the investment environment created by the pandemic,” chief executive Raphael Arndt said in a Thursday statement.

“Given this, we believe that reducing some flexibility to move to a modestly higher level of risk is appropriate. We have adjusted the portfolio accordingly, initially through an increase in listed equity exposure. Over time, we will increase our focus on skill-based and less liquid opportunities where we and our investment managers can create value.”

Future Fund’s strong cash position was amassed by offloading around A$6 billion of private equity assets in the second quarter of 2020. “You have no idea what’s coming but you want to make sure you’re positioned well for whatever comes, so we made the decision to lighten our private equity portfolio [in late 2019] and create some more liquidity for the fund,” private equity head Alicia Gregory told PEI in October.

“We never would have predicted a covid but if there is any dislocation or wobbles in the market, that liquidity is always the important thing to have up your sleeve.”