Australia's Future Fund heavy in cash

Australia's A$117 billion ($90.9 billion) Future Fund is holding more cash this year, as the hunt for value in global markets becomes increasingly challenging.

“We've always thought quite hard and quite deeply about the option value of cash,” concluding that cash doesn't have to be a “drag ... on your portfolio, provided you have a process in place and a governance in place” to deploy it when the time is right, David Neal, the Future Fund's managing director, said in an April 28 interview.

The topic is relevant to a central debate among asset owners over whether the deluge of central bank liquidity inflating market valuations now will succeed in returning the global economy to sustainable growth.

Earlier on April 28, Future Fund officials revealed that the Melbourne-based sovereign wealth fund's cash holdings surged almost A$4 billion during the quarter ended March 31, boosting cash to 15.2% of total assets from 12.8% at the end of the prior quarter. Six months before, 9.8% of the fund's portfolio had been in cash.

For the sovereign wealth fund, which started investing in May 2006, it was the highest allocation to cash since the fiscal year ended June 30, 2010, when the fund's continued deployment of A$60.5 billion in contributions received from the Australian government saw its cash holdings plunge to 13% of the portfolio from 41%.

“In a world where stocks, and especially bonds, are not cheap, holding a bit more cash in reserve now seems prudent,” said Aaron Costello, a Singapore-based managing director on the global research team of investment consultant Cambridge Associates Asia Pte. Ltd.

“That is what we're advising clients, and anecdotally that is what we see investors doing” now in the Asia-Pacific region,” he said.

Greenwich Associates' survey of roughly 200 institutional investors in Asia ex-Japan between January and March showed their volume-weighted allocation to cash and/or short-term investments such as money market instruments rising to 4.9% from 2.7% a year before, said Abhi Shroff, Singapore-based managing director, Asia-Pacific with the financial services industry research and advisory firm.

The asset allocation challenges of a low but rising interest rate environment is one factor behind that trend, noted Mr. Shroff.

Garry Hawker, partner with Mercer Investments in Singapore and director of strategic research, growth markets, said rather than actively selling risk assets to hold cash, asset owners might simply be finding it harder to identify attractive options in which to invest cash flows and/or private equity distributions.

For the Future Fund, however, the breadth of the latest incremental drop in risk asset exposure — with declines in allocations to debt securities, Australian equities, hedge funds, property, infrastructure and timberland — points to a more deliberate move.

Over the past six months, the investment team has trimmed the fund's exposure to risk assets to roughly 85% of the portfolio from a record 90%, leaving the portfolio today with what “we would regard (as) something like neutral or normal levels of risk,” said Mr. Neal.

Even with those changes, the fund reported a solid 7.1% gain for the latest quarter. That compared to a 7.3% return for the median “growth” pension fund in Australia with risk asset exposures of between 77% and 90%, according to Adam Gee, CEO of superannuation industry research firm SuperRatings Pty Ltd., Sydney. Those funds, with far higher allocations to Australian stocks than the Future Fund's 8.2% weighting, enjoyed a bigger lift from the 8.9% first-quarter gain posted by Australia's S&P/ASX benchmark index.

For the broader mix of Australia's superannuation funds, there's not much direct evidence of institutional money moving into cash, but “we are seeing a general acknowledgement that finding quality investments is getting harder given the cash flows of these funds and where we are in the economic cycle,” said Alex Dunnin, Sydney-based head of research for The Rainmaker Group, a research, publishing and consulting firm focused on Australia's financial services industry.

For the first three quarters of the fiscal year ending June 30, 2015, the Future Fund gained a healthy 15.1%, more than triple its target return of 4.5% for the nine-month period, and better than the roughly 13.6% gain for the median growth pension fund reporting to SuperRatings.

But with the rally in risk asset valuations since the global financial crisis growing long in the tooth, fund executives took pains to emphasize the negative. “Given the enormous monetary stimulus around the world, asset prices are generally fully priced and in some cases overpriced,” said Peter Costello, chairman of the Future Fund, in the announcement of the fund's latest results.

In the April 28 interview, Mr. Neal said the fund's cash level shouldn't be seen as proof “that we have a defensive portfolio,” as cash can be deployed to balance risks resulting from “other stuff that we have.”

For example, in contrast to a typical asset owner's highly liquid fixed-income allocations to sovereign bonds, the Future Fund's 9.9% allocation to debt securities is dominated by less liquid private lending. That, together with another illiquid investment — the fund's 9.6% allocation to private equity — requires “a higher cash weighting beside it ... to get to normal risk levels,” he said.

On balance, however, rising cash levels reflect “the opportunities that we're finding in the marketplace,” Mr. Neal said. If the increase in market valuations for the companies in which Future Fund invests continues to outpace the growth of their underlying cash flows, the portfolio's exposure to risk assets will continue to fall, he said.

“As the reward for risk declines, we will take less risk,” he said.

For long-term investors, the role cash can play in a portfolio is relevant to the central debate now about risk, said Mr. Neal: whether global policymakers can engineer a soft landing that grinds out modest market gains year after year, or instead an event occurs at some point that reprices risk premiums by knocking markets lower.

Asset owners are keenly aware that, in the second scenario, having cash on hand to make opportunistic investments can be highly advantageous — a lesson that Future Fund, with its 2006 launch, learned during the global financial crisis, said Jayne Bok, Hong Kong-based head of sovereign advisory in Asia with Towers Watson.

For now, however, the liquidity buoying capital markets is making it harder to capitalize on those more targeted, “idiosyncratic” investment opportunities, noted Mr. Neal.

With so much liquidity chasing every fleeting investment opportunity identified, “they're harder to find and they're harder to secure” — on favorable terms — “once you've found them,” said Mr. Neal. Money managers feel they're in a stronger position to dictate terms and conditions, effectively saying, “If you don't want to come in with us on this, we'll find someone else who will,” he said.

“When there is too much capital chasing limited deal flow, it becomes a seller's market,” agreed Ms. Bok.

But the bigger problem with setting aside cash for future opportunities “is that it's notoriously difficult to time such opportunities,” said Ms. Bok.

If it takes three or four years before the opportunity comes to get back in, “there's a point at which you've held cash for too long, and it wasn't a very good decision,” Mr. Neal said. “It's a tricky thing to do.”

Asked how well he'll be sleeping if economic policymakers succeed in keeping global growth on a slow, steady keel for the next two or three years, Mr. Neal said “I imagine the bed will get increasingly uncomfortable in a year or two's time.”

Already, “it's starting to get a little bit itchy,” he said. n