Continued improvements in technology has enabled Australia’s sovereign wealth fund, the Future Fund, to better assess what part of a fund manager’s performance is skill and what part is simply a style or factor tilt.
As a result, the A$130 billion fund has overhauled its approach to listed equities, implementing a global smart beta program and turning over some active managers it uses in its portfolio.
“The concern here is whether we are paying managers for their stock picking skill,” Future Fund Chief Investment Officer Raphael Arndt said at the Investment Innovation Institute’s [i3] Investment Strategy Forum in Torquay last week.
“If we want factor exposures, we can access factor indices much more cheaply without paying active management fees,” he said.
Arndt also pointed out it would pay more attention to positions taken by different managers that offset each other in the total portfolio.
“This is of no value to us, but results in us paying active fees for close to beta returns,” he said.
The review has resulted in a new model that enables the fund to construct a more targeted portfolio, underpinned by a refined investment philosophy.
The Future Fund has A$38 billion in listed equities and it will construct its portfolio based on the following objectives:
- Capturing equity market risk premium over the long term (beta) and being a tool to adjust total fund risk
- Harvesting long-term equity factor premia (alternative beta), which may vary through time
- Delivering good risk-adjusted, skill-based returns with low correlation to market returns over the long term (alpha)
- Allowing us to access desired exposures from a whole of Future Fund perspective.
Arndt said the portfolio has been split in five sub-strategies, including global beta, global alternative beta, Australian equities, emerging markets equities and global alpha.
Although the fund always had passive strategies in its portfolios, these strategies will receive increased attention under the new model and will include smart beta strategies instead of only market capitalisation-based strategies.
“We intend that [the global beta strategy] will be the most significant part of our listed equities program going forward,” Arndt said. “It will efficiently deliver equity market risk premia in a cost-effective way.”
“While the programme will certainly be passive, it will not necessarily be entirely market cap.
“What it will be is liquid, scalable, and aimed at delivering the equity risk premia sustainably over time. As I said, this is still a work in progress,” he said.
We won't pay active management fees for the delivery of market beta or factor exposures, which we can purchase for a few basis points.
Arndt also indicated that Australian equities will always remain an important avenue for the Future Fund to get exposure to the domestic economy, but he noted the concentration and lack of diversity in the ASX200 presented challenges for long only active managers.
“When assessing our desired weighting to Australian Equities we need to weigh up the benefits of a domestic exposure linked to our mandate, which we do not need to currency hedge, with the necessity to be properly diversified and, in an equities context, liquid,” he said.
As at 31 March 2017, the Future Fund’s exposure to Australian equities was A$8 billion, or 6.5 per cent of the Future Fund’s portfolio and 22 per cent of the fund’s listed equities portfolio.
Arndt emphasised that the Future Fund did not give up on active management and would continue to allocate to managers as part of its listed equities portfolio.
But he said the “hurdle for an active manager will always be the value-added net of fees compared with a passive implementation.”
“We have reshaped our Alpha program – with the intention that we have a small number of managers delivering attractive risk-adjusted returns,” he said.
“We are looking for true stock picking skill executed in a way where we are not paying for beta or for style or factor bets.”
“Importantly we won’t pay active management fees for the delivery of market beta or factor exposures, which we can purchase for a few basis points.”
“Many Australian and global equity fund managers have been given a free kick over recent years due to the rise in asset values, and hence their funds under management.
“They can thank central banks for the effects of quantitative easing which have allowed them to grow.
“This era is ending.”
For an exclusive interview with Raphael Arndt, Chief Investment Officer of The Future Fund, please keep an eye out for next week’s edition of [i3] Insights, which will be published on 18 May.