Future Fund lost its invitation to the equity market’s party

Future Fund chairman Peter Costello continually emphasises that not having fresh top-ups from inflows can put it at a performance disadvantage.

(He notes that two new funds that the Future Fund has recently been given to manage – the Future Drought Fund and the Emergency Response Fund – performed very well this year).

Meanwhile, super funds often whinge about the Future Fund being in a superior position because it doesn’t need to deal with outflows.

Perhaps the more jarring element of the Future Fund’s stance is its regular reference to taking a risk-neutral position on its portfolio while highlighting its extreme caution about the future.

The major takeaway from Costello and Future Fund chief executive Raphael Arndt is that the good times that equity markets are currently experiencing can’t last.

And its positioning its portfolio for the hangover.

Arndt says that markets “are expensive by their own history – there is no doubt about that”.

But to justify these elevated valuations in equity markets, Arndt suggests that you would need to believe that monetary policy would stay very easy and that there aren’t significant new risk events that will occur that require further stimulus. Additionally, he says, “you would have to believe that the fiscal policy that is totally unprecedented and responsible for most of the economic growth over the period, continues and continues in the size that it has been”.

This, he says, requires political consensus around the world and whether this is likely is an open question.

And that’s not all. Arndt says the virus has to be manageable and the efficacy of the vaccines would need to be sufficiently robust to protect people against all possible mutations.

And, of course, inflation needs to stay low.

That’s a lot of belief and a lot of ifs.

In the meantime, the Future Fund has bolstered its cash levels and increased liquidity in readiness for the opportunities that will arise when markets eventually fall to earth.

This seems prudent enough. There are many investment prophets warning that markets are dangerously hot.

But in the meantime, the markets keep running. And while the Future Fund will benefit from its current exposure to equities, its returns will compare unfavourably to investors that are less risk averse.

Costello used the Future Fund results forum to launch an attack on the technology stocks that have performed so strongly this year – singling out the US tech-heavy Nasdaq index and its record highs.

Tech, more than any other sector, has been the beneficiary of cheap money and asset inflation, according to Costello.

He says tech stocks have “unbelievable valuations”, noting that some don’t make profits.

One can only presume that the likes of Tesla, Uber and perhaps Afterpay were on his mind.

“You have to ask whether that is sustainable in the long term. I think a professional investor will ask that.”

He describes tech as the sector du jour, whose investors believe in unlimited growth potential, that profit doesn’t matter and that the only thing that matters is market share.

“If you are in the middle of the frenzy it’s very good.”

Costello doesn’t claim to be an accurate clairvoyant – he doesn’t know when it will come to an end only that prices will correct at some point.

Nor does Costello mention the fact that many of the large (and small) tech stocks that have outperformed in 2020 are making substantial profits and have benefited from the turbocharged pace of disruption that has taken place because of COVID-19.

Indeed, rather than explain away the Future Fund’s target return miss, it would be useful to explain that its investment principles have seen it overshoot its target return over three-, five-, seven- and ten-year periods.