New growth and maturity

“I spent years constantly going to people saying, ‘This is a really good investment – why are we not doing twice as much?’ and people would look at me and go, ‘Are you joking?’. It was a $100 billion portfolio so you could afford to have a billion of anything.” 

One of those investments was a £210 million ($A392.63 million)27 one-third stake in the UK’s second biggest shopping centre, the Bullring, in September 2009. The opportunistic investment arose after original owner listed Land Securities was forced to de-lever its balance sheet in the wake of the GFC. 

The size of the investment dwarfed the Fund’s property portfolio and, in a traditional investing structure, would have represented a risk to the property team. 

“It was a real demonstration of what ‘whole portfolio’ investing was,” Arndt says. The Fund later booked a healthy profit, selling it for £307 million in 2013.

“It was a real demonstration of what ‘whole portfolio’ investing was,” Arndt says.

The Fund first sold 684.4 million Telstra shares for $2.37 billion in August 2009, less than a year after it was allowed to sell the shares to other investors.29 By March 2011, it had ceased to be a substantial Telstra shareholder, and achieved market weighting by August 2011.30 

Some of the Fund’s earliest infrastructure investments were in two UK water companies and Melbourne Airport.31 It later took a 17.2% holding in Britain’s second biggest airport at Gatwick, which would sit alongside its stake in Melbourne Airport.32 

These infrastructure assets would typically deliver reliable, inflation-linked cashflows as yields on sovereign bonds were being eroded by falling interest rates. Similarly, the Fund invested in timber assets such as OneFortyOne, which was established in 2012 after acquiring a long-term lease over 80,000 hectares of plantation assets from the South Australian Government. 

Another creative strategy the Fund employed around this time was to identify property assets it could improve. 

“You had to work hard, and you had to pay expensive managers to do expensive work through that period to add value,” Neal says. “We bought a building on Third Avenue in New York that was a bit out of favour and needed complete refurbishing and repositioning. We fixed it up and sold it as a ‘core property’, getting a really big uplift on it.” 

The Fund was posting strong annual returns, hitting double-digit levels for the first time in 2009–10 and 2010–11,33 as it entered a new era of transition. 

It had always been a small tight-knit organisation – so much so that it had averaged about one employee per billion dollars of funds under management, says Elizabeth McPherson, who spent several years as the Fund’s Chief Culture Officer. 

“The organisation had always taken the work seriously, but it was on a journey from a small start-up ‘family’ company to being a serious business with a serious amount of money to manage for the Government,” she says. 

Paul Costello, who had been pivotal in setting the Fund’s culture and purpose, left the Fund in December 2010. Murray appointed investment executive Mark Burgess to lead the Agency. 

“The Future Fund was almost on a sugar high, they’d done so well for so long,” Burgess says. “The staff engagement ratings were exceptional. I thought it was a fantastic challenge to help guide it through its next stage of growth.” 

It was no longer a start-up trying to get set in a falling market. It was a maturing organisation that was fully invested, without the prospect of material new inflows. The Budget surpluses of just a few years earlier had been replaced with huge deficits in the aftermath of the GFC.

“We needed to finish the investment program and get ready for what the future would be,” Burgess says. “The team hadn’t had to have an internal dispute before over who was going to invest, because they’d had plenty of money. So, our sales skills and our ability to debate when to sell, and then the ability to internally compete for capital was just beginning to emerge.”

The Fund could see the $100 billion mark in its near future, but with larger size comes greater complexity. It needed to determine its place in the world as it was maturing and re-evaluate its competitive advantages.

“It’s like a boat in the water. When you first sail, it sails fast, but if you leave it in the water all the time it gets barnacles – and funds do that.”

The Fund’s advantages now centred on its genuine long-term investing outlook, its sovereign-backed reputation, great access to high-calibre external partners and fund managers, and an ultra-clear purpose. Its final advantage – a total portfolio investing approach – was being put to the test more often now that the Fund was fully invested.

“You have to have people who don’t live through the size of their assets and they don’t live through the ego of that. I think the Fund had chosen the heads of those asset classes well and I think that goes back to Paul Costello and Dave Neal and their selection of individuals.”

Less than a year after Burgess started, inaugural Chair David Murray also called time on his tenure at the Fund. The Government would choose one of the country’s most experienced directors, David Gonski, as its next Chair. Open and approachable, with extensive experience across a wide range of sectors, he brought a different sensibility to the organisation.

“I started a thing akin to the soup du jour, which we had every meeting,” Gonski says. “Management and myself would pick an issue at each meeting where we would spend some time, argue it in depth, and I loved that the most.”

Gonski honed the Board’s structure by adding three new committees covering Risk, Governance, and Conflicts to the pre-existing Audit and Remuneration committees. They allowed potentially controversial decisions to be debated before being brought to the Board, elevating its focus.

Burgess also began lifting the Fund’s transparency and engagement with media, instituting quarterly portfolio updates, and educating the market about its investment profile. The Fund had posted several years of strong returns but its relatively low exposure to listed equities meant it would also likely underperform at certain times. 

“We did a lot of work on preparatory understanding by all the stakeholders, including the public sector in Canberra, about how the Fund will behave through a cycle,” Burgess says.

Gonski’s biggest concern was that some unforeseen issue – whether it be a period of poor returns or another negative event – would prompt the government of the day to raid the Fund for some short-term purpose.

“But what I also knew is, if the returns were good, and if we could explain what we were aiming to do, it’s very hard to take that money away. Australians are not stupid. So we had to give them an excuse to actually take it away, and I don’t think that excuse has ever arisen.”

The returns were good and not just because of traditional investment decisions such as asset allocation. The Fund recognised early on that environmental, social and governance (ESG) factors also played a strong role, particularly for long-term investors.

The Fund had been exercising all of its voting rights over Australian listed companies since appointing a Head of ESG in 2009. Consistent with international treaties the Australian Government had ratified, the Fund had banned investments in areas such as cluster bombs.34

But it was a letter Gonski received in 2013 that spurred a broader discussion about the Fund’s investments in tobacco manufacturers. The letter pointed out that Gonski was from medical stock – his father was a brain surgeon and his wife a doctor.

“The letter very politely said how could I preside over a body that invests monies into companies that manufacture cigarettes, which create cancer and sadness?”

Gonski raised the issue with Burgess and they agreed to take it to the Guardians, where it was debated through the Governance Committee. They noted that while tobacco was a legal product, it had addictive properties and there is no safe level of consumption. 

The Fund took its next major step towards embedding ESG into its investment decisions, divesting $222 million invested across 14 companies involved in tobacco manufacturing.35

“The Board unanimously determined that this was the right thing to do,” Gonski says. “We represent Australia, whose medical costs from cancer are enormous. I spoke to some of the members of staff, and they all agreed.”

The discussion sparked a broader one – where should the Fund draw the line? It was not ready to rule out other holdings – full divestment often just passed more complex issues onto other investors who may have a shorter-term view that ignores sustainability questions.

Gonski’s tenure would be relatively short, ending in January 2014. The third chair would bring the organisation full circle: former Treasurer Peter Costello. 

He had established the Fund, and first joined its Board in 2009 after retiring from politics. It’s unlikely that any other former politician could have joined the Board. Peter Costello’s intention in joining it was to isolate it from political interference.

“I thought the best way I could contribute to the maturing organisation was by becoming a Guardian of the Fund and using my experience to chop off any attempts to put it under political pressure,” he says.

“I thought the best way I could contribute to the maturing organisation was by becoming a Guardian of the Fund and using my experience to chop off any attempts to put it under political pressure,” he says.

His standing as one of the most successful Treasurers in Australian history allowed him to tackle two looming issues involving the Government that came to a head in 2017.

Official interest rates had more than halved since the Future Fund was established36, eroding the risk-free rate of return. There were more cuts to come, but they would prove to have little impact on the economy’s stubbornly low inflation and unemployment rates.

The Fund now needed to take on more risk to achieve the same return as when it was founded more than a decade ago. But it was bound to take on ‘acceptable but not excessive risk’ under its Investment Mandate.

Meanwhile, the Government could also begin drawing down on the Fund from 2020 to start paying for unfunded pension liabilities.

The Fund held significant illiquid investments such as airports and timberland, which would take time to sell. If it became a forced seller or markets crashed, the value of those investments would be devastated. Regardless, it had to hold more cash, which would depress returns.

These two issues were squeezing the Fund from opposite directions.

Peter Costello had the standing to raise these issues with the Coalition Government, which had been returned to power in 2013. But he also brought some unique baggage: he was the one to set the initial investment target. Now, as Chair, he was asking for it to be lowered. 

“I had to say it was right then, but it’s not right now,” he says. “That’s a more complicated argument. It was nuanced.”

The argument was based on facts. The 2020 drawdown date was predicated on ongoing contributions to the Future Fund, which never materialised. Without any new capital injection, withdrawals would send the Fund into terminal decline – it would be exhausted by around 2046, notwithstanding the unfunded pension liabilities which would continue to balloon to $275 billion.37 

Deferring withdrawals for another six years until 2027–28 would allow the Fund to grow to around $300 billion, easily covering all unfunded liabilities and cementing the Future Fund as a true self-sustaining intergenerational fund.

The former and current Treasurers (the latter being Scott Morrison who would later become Prime Minister) came to an agreement. The Government delayed the date of its earliest withdrawals and, shortly after, lowered the investment target to inflation plus 4%–5% in mid-2017.

“On the drawdown, the person who was very helpful – who I think understood the point – was Scott Morrison, who was Treasurer at the time,” Peter Costello says.

“On the drawdown, the person who was very helpful – who I think understood the point – was Scott Morrison, who was Treasurer at the time,” Peter Costello says.

Arndt, who took part in the discussions with Government, says the decision was less political than intellectual. “It was a very pure intellectual thought-through based-on-advice decision,” says Arndt.

David Neal had now been leading the institution as CEO for three years after the departure of Mark Burgess in 2014, with Arndt taking on the CIO role. The Fund had grown fast but retained its ultra-lean ethos – a feature of its much smaller beginnings.

With the drawdown issue resolved, Neal thought it was time to reinvest in the organisation and bolster its investment technology.

“You could see this portfolio growing, you could see the complexity of what we were dealing with. I’d started to form a really strong view that data was just incredibly important – the more we knew about the portfolio at greater depths, then the better decisions we were going to make. We didn’t need to save very many basis points on $100 billion to pay for it.”

The Fund needed to know its portfolio at a granular level – that data could be turned into more effective insights. Listed company data was transparent and instantaneous to amalgamate. Incorporating information about other asset classes such as private credit, unlisted infrastructure or private equity, had more of a time lag and was often described completely differently. 

“If you’re trying to make a decision about whether to buy that piece of real estate, or put a bit more into equities, you need to have a really good understanding of the nature of your real estate portfolio relative to the nature of your equities portfolio – that’s the data challenge.”

But, true to its emphasis on challenging the status quo, the Fund would not serve up a pre-prepared solution. Instead, it worked with external vendors to co-build a customised platform where each sector team could analyse and view the portfolio in their own way, Leong says.

“We were essentially sourcing data as a service through co-designing what we specifically needed,” she says. “We now have a more complete system that gives deeper data insights and is built for the longer term.” 

The new data system enabled the Agency to feed its new risk platform, allowing each team to analyse the portfolio through real-time dashboards according to a variety of criteria such as risk, probability of achieving its target, and asset allocation.

The multi-year project was launched in phases with a major release introduced and embedded just as the Fund stood on the precipice of another market crisis that would push its new technology to its limits.