Australia’s Future Fund Investment Wizardry

When David Neal joined Australia’s Future fund as its inaugural chief investment officer in July 2007, he knew he was stepping into the role of a lifetime. Founded just seven years ago, Australia’s Future Fund has quickly become one of the world’s most innovative sovereign wealth funds.


WHEN DAVID NEAL JOINED AUSTRALIA’S FUTURE FUND AS its inaugural chief investment officer in July 2007, he knew he was stepping into the role of a lifetime. Neal, then 37, who had previously worked as head of investment consulting for Watson Wyatt (now Towers Watson) in Australia, had already advised the government on setting up the sovereign wealth fund. Designed to help meet the future costs of public sector pension liabilities by delivering a consistent rate of return above inflation, the fund had a mission but no clear investment strategy; as the new CIO, Neal was responsible for creating one. Luckily, he had no legacy issues to contend with, or even any immediate liabilities — just a blank piece of paper and A$52.32 billion (then $38.8 billion), mostly held in cash, though the fund also had a nascent listed equities portfolio.

Determined to make full use of the freedom he’d been given, Neal set out to design an innovative investment strategy. Having observed a range of structural pitfalls among mature pension funds — namely, a tendency to overengineer their portfolios and become rigid in their asset allocations — he aimed to find a smarter way of running long-term money. With the support of the Future Fund’s then general manager, Paul Costello, who had been founding chief executive of the New Zealand Superannuation Fund (NZSF), Neal devised an integrated investment process that relied on the ingenuity and hard work of the fund’s sector specialists to help drive asset allocation.

“We brought in this idea of having one team, one portfolio — which is now written on all of our office mugs,” says Neal, whose holistic approach to investing has come to define the Future Fund’s strategy. His approach hasn’t changed, even as the fund’s assets have grown to A$82.4 billion ($84.7 billion). “Practically speaking, we simply allocate capital to the best ideas,” he explains. “We do think a lot about our strategy and manage it dynamically, but it is not fixed or set. We’re just looking to combine good ideas and achieve an appropriate risk-adjusted return.”

As simple and elegant as it sounds, the Future Fund’s total-portfolio approach is unusual, even among the largest and most sophisticated sovereign wealth funds. Although 30 or so such funds have been created since 1999, very few have moved to diversify as swiftly as the Future Fund has, according to Institutional Investor’s new Sovereign Wealth Center, which specializes in sovereign wealth fund research. Many of the funds launched over the past decade or so, including Chile’s Pension Reserve Fund (PRF), Ireland’s National Pensions Reserve Fund (NPRF) and the NZSF, have moved cautiously into new asset classes, preferring to familiarize themselves first with core allocations like fixed income and listed equities. For practical reasons, their hesitation makes sense. Most new funds need time to establish internal procedures and recruit investment staff; they may also have to contend with an overriding political imperative not to lose money in their first few years of operation. Reserve assets that have been transferred from a central bank or set aside from a government budgetary surplus are often seen as core sovereign holdings, so capital preservation is paramount.

What Neal and his Melbourne-based investment team have built over the past seven years is more analogous to an independent multiasset manager than to a sovereign wealth fund or even a major state-owned pension fund. The similarities are no accident. When he set out to help develop the Future Fund’s integrated investment strategy, Neal looked for inspiration among hedge funds, foundations and endowments, including New York–based multistrategy firm Och-Ziff Capital Management Group, London-based foundation Wellcome Trust and New Haven, Connecticut–based  Yale University Investments Office. The key difference between the Future Fund and an independent investment firm or endowment fund is that it works exclusively with external managers to implement its portfolio strategy and does not manage any liquid assets in-house.

The requirement to outsource investment management, which was included in the fund’s founding legislation, was intended to mitigate possible conflicts of interest and prevent the Future Fund from competing directly with private sector investment managers. That stipulation may have made perfect sense in the context of the buoyant precrisis financial markets, but it constrains the way the fund is now able to operate. Unlike some of its largest, most innovative peers in the sovereign wealth fund community, such as China Investment Corp. (CIC), Government of Singapore Investment Corp. (GIC) and the Kuwait Investment Authority (KIA), the Future Fund cannot run money on its own behalf. That requirement puts pressure on its investment team to find innovative, cost-effective ways of deploying capital.

Mark Burgess, the Future Fund’s current chief, believes that the team’s core skills are sufficient to overcome any structural challenges arising from the legislation. “We have an ethos here of adding value,” says Burgess, 50, who succeeded Costello as general manager in March 2011 and has since been named managing director and president. For Burgess — formerly CEO of Sydney-based Treasury Group, a company that invests in and supports the development of small and medium-size asset management firms — adding value means contributing original thought to the investment process and knowing when to move on an opportunity, whether buying or selling. In a global market environment as tricky as this one, he says, every team member “has to think like an investor.”

The Future Fund has gained recognition in the asset management community for its entrepreneurial approach to portfolio management, but it hasn’t been particularly well understood beyond it.  Although the fund is rightly known as one of the world’s most transparent, accountable and well-governed sovereign wealth funds, its senior managers haven’t publicly disclosed many details about what it does, in part because the organization was still building its portfolio. Now, however, the portfolio is almost fully invested and the team is opening up. In December, Burgess, Neal and six of the team’s sector heads agreed to speak extensively — and exclusively — to Institutional Investor about their total-portfolio investment style and the challenges the fund faces.


The Future Fund’s team has adapted to the task at hand by developing close, collaborative relationships with its managers and leveraging those connections to explore new opportunities. Determining which investment risks to take can be a laborious process, but the fund works with dozens of talented external managers who assist in that process, including Boston-based private equity firm Advent International Corp., New York–based fund-of-hedge-funds powerhouse Blackstone Alternative Asset Management, Philadelphia-based boutique equity firm Mondrian Investment Partners and Boston-based credit specialist Sankaty Advisors. Despite, or perhaps because of, Neal’s background as an investment consultant, he and his team tend to refrain from using consultants to help develop the fund’s strategy; they prefer to rely on their in-house talent to set the Future Fund’s course and conduct research. The best ideas that emerge from their work are reviewed laterally by representatives of the different asset classes before they are presented to the full investment committee. Thanks to the Future Fund’s inclusive approach, virtually all of the fund’s asset specialists have developed the ability to assess the comparative benefits of dissimilar opportunities.

“The Future Fund takes a remarkably agnostic approach to asset allocation,” says Schroder Investment Management Australia CEO Gregory Cooper, who has worked closely with domestic superannuation (pension) funds. “They really target asset classes that they believe will help them achieve their return objective, which is a very different way of looking at asset allocation, particularly in Australia, where the equity markets have historically been so strong.”

Although the Future Fund began investing during an incredibly difficult period, just as the financial crisis took hold, its total-return approach has yielded modestly positive results. Last year the fund’s assets under management rose by 12.8 percent. Over a three-year period, the fund has delivered annualized returns of 7.9 percent; since its inception in May 2006, it has achieved an annualized return of 5.4 percent. In sharp contrast to other Australian superannuation funds, the Future Fund doesn’t benchmark its performance against that of its domestic peers. The organization simply seeks to meet its annualized real-return goal of 4.5 percent or more above inflation when measured over rolling ten-year periods. Although the fund has not managed to deliver that margin of success since its inception (during which time inflation has averaged about 2.7 percent), its admittedly ambitious goal was set before the financial crisis, when Australia’s gross domestic product was growing by an average of about 3.5 percent a year. “Achieving that return is clearly harder than it was originally envisaged to be,” Neal says. “But we aim to keep on. We certainly think we’re finding opportunities now that will allow us to meet the mandate.”

“The mandate is really to seek to maximize returns subject to acceptable risk,” adds Stephen Gilmore, the Future Fund’s head of strategy, who leads a team of eight strategists and analysts who parse risk, perform scenario analysis and offer up key macroeconomic themes. “It’s not about targeting returns but simply looking for the best opportunities in a given environment.”

The Future Fund’s founding chairman, David Murray, who served from April 2006 through March 2012, was outspoken about the importance of protecting the fund’s autonomy and ability to pursue commercial investment opportunities. As leader of the fund’s lyrically named board of guardians, Murray had no patience with the threat of political meddling. But his activism and engagement with the broader sovereign wealth fund community made him hard to replace, and the government struggled to find a successor. Although Deputy Prime Minister and  Treasurer  Wayne Swan and Minister for Finance and Deregulation Penny Wong — the ministers who jointly share responsibility for the Future Fund — finally settled on a new chairman, Sydney-based businessman David Gonski, the appointment process was protracted and controversial.

As sturdy as the Future Fund’s investment model has been, the fund’s activities still attract political attention. Last year the Australian Greens party brought pressure to bear on the fund to divest from tobacco-producing companies; the board eventually agreed to do so in March. Additional divestment requests by the Greens are highly likely. Meanwhile, fund allocations have dried up. Recurring budget surpluses now seem to belong to another era, as some analysts predict that the mining investment boom that has driven much of Australia’s growth over the past decade will peak in 2013 and then start to decline. GDP growth this year is expected to be just 2.5 percent, somewhat below trend for the Australian economy.


The Future Fund’s total assets may still fall far short of the estimated A$140 billion the government initially said it would need for public sector pension liabilities come 2020 (the earliest the fund is subject to withdrawals at its current funding level), but new appropriations are probably out of the question. According to some macroeconomic research firms, the government may face a budget deficit of at least A$8 billion in the current fiscal year, which ends June 30, and next year’s deficit is expected to rise to nearly A$10 billion. Prime Minister Julia Gillard, whose leadership style has proved divisive, is preparing for the fight of her political career as her Labor Party trails the opposition Liberal-National coalition in preelection polls — and speculation about a leadership challenge from within her party persists.

In this gritty economic context, the Future Fund still shines brightly. But the pressure is now on to deliver consistent robust returns, as official estimates of Australia’s public sector pension liabilities continue to rise. Paradoxically, the greatest threat to the fund’s innovative model may ultimately stem from its success:   The more money it accrues and the larger its pool of assets, the more staff it may need to recruit — and the harder it may be for Neal and his team to retain their cohesive one-team, one-portfolio approach.

CREATING THE FUTURE FUND REQUIRED AN ACT OF political will — and the power to innovate. Peter Costello, former treasurer of the commonwealth, had both. Surveying the history of the Future Fund requires nothing more than a stroll around the perimeter of a swank conference room in the Melbourne offices of ECG Financial, a boutique corporate advisory firm where Costello serves as chairman, and reading the 12 front pages of the Australian that line the walls.

Costello, the longest-serving federal treasurer in Australian history, is obviously proud of his past. Starting in 1996, the year Costello was appointed treasurer, and continuing through 2007, the newspaper front pages blast the results of the government’s annual budget statements. Nine of the pages brightly proclaim budget surpluses, reflecting Costello’s successful efforts to bring down the government’s net debt, which stood at A$96 billion when he took office.

By 2004, Costello realized that, based on budget projections, the government would soon be in a position to retire all of Australia’s outstanding national debt. Astonishing as it now sounds, the government had no need to raise new funds by issuing bonds; as budget surpluses accrued, Costello actually began thinking about redeeming all of the country’s sovereign debt. “We got to the point where we could have just gone debt-free,” says Costello, 55, a frank, sun-roughened former lawyer. “But it caused a lot of consternation in the financial markets because bankers like trading sovereigns — particularly triple-A sovereigns.”

In those heady days before the financial crisis, triple-A sovereigns still had credibility, and bankers urged Costello to recognize that rating agencies needed Australia’s government bonds to benchmark corporate credit. Eventually, he backed down. But the government was left with an outstanding debt position that it didn’t need, he says, and he felt he had an obligation to offset it.

“Our thinking was that we ought to balance out the debt position with an asset position,” he explains. “That’s when we started thinking about setting up a sovereign wealth fund.”

The financial rationale for creating a sovereign wealth fund was perfectly clear to Costello and his peers at the Treasury in 2004. Australia was in the midst of a commodities boom. Tax revenue from mining was running high. China, in the midst of its own state-funded infrastructure expansion, seemed to have an insatiable appetite for building materials, and Costello knew that those flows couldn’t last forever. Like so many other resource-rich countries, including Chile, Norway, Qatar and Russia, Australia had an opportunity to safeguard some of its growing commodities wealth.

But Costello and his team at    Treasury knew they needed a compelling political justification to create the Future Fund — otherwise, he says, the government would have come under pressure to simply cut taxes or increase services. So they looked around for a reason. Most sovereign funds, especially those created in resource-rich countries, tend to be used for fiscal stabilization, economic development or future savings. Australia had little need for economic stabilization or development, but it did have a demographic weakness common to all developed countries in the   West: an aging population. Costello decided that he could make a compelling argument for creating a fund to partly offset the future public sector pension liabilities.

In March 2006, after a parliamentary vote and receipt of royal assent, the Future Fund Act became law. Key parts of the act came into force on April 3, establishing the fund, its board of guardians and its management agency, the investment office. The chairman of the board, who was also designated CEO of the agency, reported on investment performance to the minister for Finance and Deregulation; the treasurer shared responsibility with the Finance minister in making any board appointments or changes to the mandate. Day-to-day operating oversight was conducted by the agency’s general manager (now managing director). From the outset the Future Fund was recognized for the clarity of its governance structure, which was designed to protect the fund from political interference. The board of guardians, an independent body of seasoned business experts selected for their expertise in investment management and corporate governance, “were called guardians for a reason,” Costello says. “They are there to be guardians against the government.”

“I think we did a good job of explaining why we were there — and why we were independent,” says former chairman Murray. “We certainly followed through on providing transparency and accountability. To be independent yet remain closed would certainly not work in Australia.”

One of the most important legislative controls put in place was a requirement that the fund could invest only in financial assets. Obvious as that stipulation may sound, Costello says, it was intended to safeguard the fund from political directives, such as providing capital infusions to state-owned infrastructure projects. Australia, with its vast land mass and small population, is still developing its infrastructure, and Costello didn’t want legislators telling the fund to build a new bridge, for example. But by working with external asset managers and setting up joint ventures or managed accounts, the Future Fund can take direct ownership stakes in various assets, including private companies, as long as those stakes are not large enough to impact the commonwealth’s balance sheet.

The timing of the Future Fund’s launch, on the eve of the global financial crisis, now seems almost prescient. In May 2006 the government made its first transfer of seed capital, worth A$18 billion, to the newly established sovereign wealth fund. Over the following financial year, the fund received additional inflows of A$22.28 billion in cash and 2.1 billion shares of state-owned telecommunications company Telstra Corp., valued at A$8.97 billion at the time of transfer in February 2007.

The Future Fund had billions in its coffers before it even had an investment team, but it had a powerful board of guardians from the outset, led by Murray, a former chief executive of Commonwealth Bank of Australia. Having spent 39 years of his career with Commonwealth, including 13 years as its CEO, Murray had a broad knowledge of the financial markets and corporate governance. When the fund launched, his first priority was to start hiring.

Paul Costello (no relation to Peter Costello) joined the Future Fund in November 2006 as general manager and employee No. 1. Working closely with Murray and the board, he spent his first six months establishing an operational infrastructure — the Future Fund had no back office, recordkeeping functionality, investment controls or investment strategy. But it did have a mandate.

Costello and the new team set to work defining the Future Fund’s mission more closely in the context of its legislative directives. The stated goal was very clear. The fund was supposed to achieve returns at least equivalent to the consumer price index plus 4.5 to 5.5 percent a year over the long term, but the definition of “long term” was decidedly open-ended. The team decided that measuring the portfolio’s success over rolling ten-year periods would make the most sense.

The definition of risk presented an even thornier challenge. The Future Fund’s founding legislation simply states that the fund should engage in “an acceptable but not excessive” level of risk-taking to achieve its real-return mandate. Although the Future Fund didn’t have any immediate liabilities — the government cannot tap into the fund until 2020 unless its value exceeds its future liabilities, which appears extremely unlikely — the team recommended that the board seek to constrain the probability of a loss over any three-year period to less than 5 percent. “We wanted to run an investment program where we would always try and keep the risk of a material draw-down small,” says Costello, who is now nonexecutive chairman of Blackstone Group’s business in Australia and New Zealand, among other nonexecutive roles. “You can only try and control what you don’t want to have happen on your watch, and I think it provided a useful framework for the discussion around risk and return.”

Even without a CIO in place, the Future Fund began investing in equities in June 2007. By then, Costello says, the team had developed a very broad investment strategy and understood that listed equities would form a part of it. By the time Neal started work in July 2007, the Future Fund had invested A$1.85 billion in Australian equities and A$2 billion in international equities, beyond its core holding in Telstra.

From the outset Neal sought to establish a total-portfolio investment culture, says Tony Day, who joined the Future Fund in September 2007 as its first head of strategy. “That was really Dave Neal’s vision,” Day says. “He did not want to run an organization in which the heads of different asset classes started empire-building, carving out their own areas of power. He was very clear on that point from day one.”

Defining the Future Fund’s total-portfolio philosophy may have been fairly simple, but engineering it at a practical level took some work. Costello, Neal and Day sought to marry a quantitative view with a more qualitative, fundamental approach to asset allocation, allowing the team to incorporate macroeconomic perspectives. Factor modeling was essential to that process. To compare opportunities across asset classes, Day had to break down the return drivers behind different investments. “Part of my job was providing a translation service across the different asset-class divisions,” he says.

The key risk that Day perceived was the likelihood that the fund would continue to ramp up its equity allocation, as the preliminary target was about 50 to 60 percent. Among Australian superannuation funds — a powerful industry that currently manages A$1.5 trillion in total assets — high equity allocations are commonplace. Australian equities still make up, on average, 25.3 percent of all corporate, industry and government pension funds’ asset allocations; international equities make up an additional 20.6 percent, according to Sydney-based market research firm Rainmaker Group. By late 2007 the markets had begun to turn. The Future Fund had slightly less than 25 percent of its assets invested in equities, and the new team felt that percentage was high enough.

“We all had a strong conviction that something unprecedented was happening in the world and we shouldn’t go above that 25 percent,” Day says.

The Future Fund wasn’t the only new sovereign wealth fund to profit from its reluctance to diversify more swiftly as the global financial crisis took hold. Chile’s two new sovereign funds, the PRF and the Economic and Social Stabilization Fund, which were also legislated and funded in 2006, weathered the crisis remarkably well — and made money in 2007 and 2008 — because they were largely invested in sovereign bonds, corporate debt, inflation-linked bonds and money market funds.

The Future Fund lost money on its equity holdings during the worst of the crisis in 2008, and the value of its assets dropped by 8.49 percent that calendar year, but the fund held on to approximately two thirds of its cash and pivoted swiftly toward credit opportunities. With growing confidence, Neal and his team began putting money to work, diversifying the fund’s risk exposures and — if they couldn’t find what they wanted — partnering with external managers to create customized investment vehicles.

“One of the things that I wanted to make sure we did from the start was leverage our manager relationships very strongly,” Neal says. “We run an outsourced business, so we decided to focus on developing a relatively small number of relatively big relationships — not just to improve the flow of intellectual capital but to allow us to move more quickly when we identify an opportunity.”

TO THE UNTRAINED EYE THE Future Fund’s collaborative investing style is largely invisible. No one would know by looking at its list of 83 managers, for example, that the fund co-invests with several of its private equity partners and owns an equity stake in one of its debt specialists. But the connections between the fund and its external managers run deep. Even as some of the largest sovereign wealth funds in the world, including the Abu Dhabi Investment Authority, CIC and KIA, have sought to hire more staff, bulk up their investment teams and build their in-house asset management capabilities in the aftermath of the financial crisis, the Future Fund has worked to align its efforts more closely with its external managers and share intellectual capital.

The directive to outsource management was part of the fund’s founding legislation, so it cannot be ignored, but the team has adapted to it with entrepreneurial flair. Of the Future Fund’s 92 employees, 44 are investment experts, most of them sector specialists. Neal knew from the outset that he would never be able to employ hundreds of people to run assets in-house, so he gave his small staff intellectual freedom. Idea generation is prized. Collaborative work is too. But benchmarking is not. None of the sector teams are constrained by the need to create balanced, diversified asset-class portfolios or measure their performance against some external metric. Nor do they seek external managers who live and die by tracking error.

“We try to be as benchmark-unaware as possible,” says Elspeth (Elly) Lumsden, head of equities, with a wry laugh. “Our biggest challenge is trying to find managers who don’t focus on benchmarks either.”

The team ignores benchmarks only because it’s aiming to achieve an absolute-return target in global markets that are still beset with glaring financial and economic risks. The fund’s ability to dial up opportunistic risks and run a fairly concentrated, high-conviction portfolio is unusual in the context of Australian superannuation funds and derives largely from its emphasis on combining factor-based and fundamental analysis. Although asset-class diversification still counts at the total-fund level, Neal discourages sector managers from trying to create balanced portfolios. He just wants the teams to channel their best ideas, however scarce or plentiful, up to the total portfolio. Often, Neal says, he’ll encourage his sector teams to add more of a particular investment or security — even more than they’d be comfortable adding on their own to asset-specific portfolios — because those specific concentrations may help mitigate risk and drive returns across the entire fund.

“If you were to look at most of our sector portfolios on an individual basis, they’d look quite peculiar,” Neal says. “If you were to benchmark our property portfolio against a normal, diversified property portfolio, for example, it would look very different indeed, as would our equity portfolio, our private equity portfolio, even our infrastructure portfolio. I’m sure each of them would look more risky, even though we think they’re considerably less risky.”

The freedom that approach affords individual sector heads can’t be overestimated. Barry Brakey, head of property, says the Future Fund is unlike any other firm he’s worked for because the focus remains squarely on the potential of his best investment ideas to contribute to the overall portfolio. On the flip side, if he can’t find a compelling investment in a particular region, he’s under no compunction to deploy capital. “Unlike a traditional property portfolio, we don’t have any geographic or sector-specific targets or allocations,” he says. “We’re free to roam the markets and bring back only our best ideas. We’re not filling buckets.”

At the total-portfolio level, of course, those asset-class-specific anomalies don’t show. The Future Fund’s diverse allocations most closely resemble those of a major endowment fund or foundation. Five years after the financial crisis, the fund still has a sizable allocation to listed equities, including long-short hedge fund strategies, where it has invested 23.4 percent in international equities (18.1 percent in developed markets and 5.3 percent in emerging markets) and a further 11.1 percent in Australian equities. The fund’s second-largest allocation is to debt securities, at 19.1 percent, followed by alternative assets, which it narrowly defines as debtlike strategies, including commodities, credit and global macro, at 16.3 percent. Cash accounts for a mere 10.3 percent; private equity (which the fund does not consider an alternative asset class) represents 6.8 percent, property 6.6 percent and infrastructure and timberland a combined 6.4 percent.

Sector heads bear tremendous responsibility for large and growing pools of assets. Steve Byrom, who oversees A$5.6 billion with a team of just six investment specialists, has accelerated his research efforts as his team’s assets have expanded, traveling extensively to meet with potential new managers in far-flung locations. Since 2011, for example, Byrom and his team have traveled to India five times and interviewed dozens of managers, local advisers and regulators. On average, Byrom says, the private equity team schedules about 220 such meetings a year.

“We don’t actually want to have a lot of managers spread across the entire fund,” he says, “but what we are trying to do is build a strong portfolio of idiosyncratic risks.”

Generating ideas and weighting them for different asset classes require a keen understanding of the macroeconomic risks lurking in global markets, which Gilmore and his team provide. Gilmore, who took over as head of strategy in 2010 after Day’s departure, develops a range of scenarios against which the sector teams can test their portfolios. Working closely with Neal, he also sets out specific macroeconomic themes to explore. At the moment, the Future Fund is focused on six: debt and deleveraging, the interaction of policy and politics around the deleveraging process, demographics in developed and emerging markets, globalization (including emerging wealth), resource scarcity and inflation.

By focusing on the interplay between macroeconomic forces and the markets, the strategy team uncovers areas of interest. Those inputs are used by the sector teams, which conduct their own fundamental, qualitative research to source opportunities. In 2009 the Future Fund’s debt and alternatives team, then led by Mitchell Stack, decided it wanted to explore private lending to small and midsize companies in Europe as the banks pulled away from credit provision, creating a noticeable void. At the same time, Byrom’s private equity team was looking at ways to use equity to exploit dislocation in the European banking sector, including a possible co-investment with London-based TowerBrook Capital Partners. TowerBrook, which had been conducting research on market opportunities, was already in the process of setting up an independent specialist finance company to provide lending facilities to European companies. “We found it too hard to evaluate the balance sheets of existing companies,” says Ramez Sousou, co-founder and co-CEO of TowerBrook. “And we really didn’t want to have to deal with any legacy issues.”

In 2010 the Future Fund’s team decided to get involved alongside TowerBrook as an equity investor in London-based Haymarket Financial, TowerBrook’s boutique lending firm. At the same time, the Future Fund’s debt and alternatives team gave Haymarket a separate mandate.

“We wanted to step into where the banks had been, so we had to get a bit innovative,” says David George, who succeeded Stack as head of the debt and alternatives team. “We decided to look at opportunities with early-stage boutiques that could help us do that, and Haymarket was one of them.”

Three years after its inception, Haymarket oversees $4 billion in assets from a diverse group of institutions, including the Future Fund. Sousou, who was closely involved in setting up Haymarket, doesn’t see an end to the market opportunity for corporate lending because the banks are still holding back. Even the appearance of powerhouse investment firms like Blackstone Group, KKR & Co. and Oak Hill Capital Partners has not significantly reduced Haymarket’s opportunities, he says. “By having more people in the market, there are more participants who can help grow it,” he explains.

Beyond its focus on opportunities arising from debt and deleveraging in developed markets, the Future Fund is keenly interested in the theme of emerging wealth as millions of people in developing countries join an increasingly global consumer class. Sovereign funds, especially those in commodity-rich emerging markets, appear to be particularly attuned to that trend, not least because their very existence often reflects greater economic stabilization and security, which can presage a rising consumer class.

In typical Future Fund fashion, the equities team, run by Lumsden, began working on the idea of emerging wealth in-house in 2010 and then set out to find ways to implement it. At the core of the team’s investment thesis was the sense that the ramifications of this massive demographic shift had not been fully understood or priced into the markets. Lumsden believed that as a long-term investor the Future Fund could benefit from playing the trend for years to come.

But finding a pure way to access it was tough. Lumsden didn’t want to invest in it passively because she wanted exposure only to companies that were well positioned to profit directly from socioeconomic change in emerging markets. So she and her team searched for active managers who would be willing to work alongside them to develop criteria they could use to populate a portfolio — based on a given company’s percentage of sales, earnings growth or revenue that was directly attributable to growth in emerging markets. Lumsden says she was indifferent to the industry sector or domicile of any given prospect; even developed-market companies were worth consideration if they met the fund’s criteria.

The Future Fund made its first investment to a dedicated emerging-wealth strategy in March 2011, giving a mandate to New York–based Trilogy Global Advisors. In December 2012 the fund gave a second emerging-wealth mandate to Mondrian Investment Partners. Although the fund’s equity allocation to emerging wealth is still modest — only about 6 percent of the total listed equities portfolio is invested in dedicated emerging-wealth strategies — it is a theme Lumsden expects to pursue more aggressively.

“We still have traditional emerging-market managers in the equities portfolio,” she says, “but this is a growing area for us.”

The Future Fund’s total-portfolio approach means that all of the sector teams, which interact on various internal committees, regularly meet and talk about what they’re seeing in the markets. When they decide to appoint a new manager, staffers who serve on the manager review committee — representing every asset class — come together to talk. Similarly, when the fund considers moving into a new asset class, members of the asset review committee gather to discuss the proposed investment’s risk and return parameters. The top-level investment committee (which is chaired by Neal and includes Burgess; Gilmore; Craig Thorburn, director of emerging markets; and every sector head) presides over all manager and asset-class recommendations and decides whether to advance them to the board. The combination of diverse perspectives, says Raphael Arndt, head of infrastructure and timberland, makes the fund nimble and responsive to potential risks and opportunities.

Arndt, who previously worked as an infrastructure portfolio manager at Melbourne-based Hastings Fund Management, says he wasn’t as viscerally aware of what was going on in other asset classes before he arrived at the Future Fund in February 2008. Now, he says, he is close to the action in other asset classes. Everyone works in an open-plan office on the same floor. In such close proximity, Arndt says, he learns about what is going on with equities, the pricing of credit and hedging strategies almost on a daily basis.

“I ran a fund at Hastings that grew quite a bit while I was there,” he says, “but I think having the opportunity to sit at a multiasset, return-seeking institution — and build something from scratch in the current environment — is quite different from being a traditional manager.”

INVESTMENT RISK IS COMPLEX but generally quantifiable. Political risk is not. Since its inception the Future Fund has focused its investment process on seeking desirable risk exposures, but the one risk it cannot mitigate entirely is the possibility of political interference. The issue is one that former chairman Murray, who worked tirelessly to promote good governance practices within the sovereign wealth fund community, cares about passionately. As the inaugural chairman — and current honorary chairman — of the first organization to bring together most of the world’s largest sovereign wealth funds, the International Forum of Sovereign Wealth Funds (formerly known as the International Working Group of Sovereign Wealth Funds), Murray argued for accountability, transparency and proper governance. In so doing, he raised the profile of the Future Fund, which subsequently garnered accolades for its own reporting structure and political independence.

Murray’s activism and international leadership inevitably meant that the government faced a challenge in replacing him. His initial five-year term as chairman was scheduled to end in April 2011, but he volunteered to stay on another year while the government organized the transition. During that interim year Prime Minister Gillard’s government began a formal search process for Murray’s replacement and invited David Gonski, a prominent Australian businessman, to serve as a special adviser. Gonski canvassed the Future Fund’s board members for their views on the qualities a chairman would need and their preferences for either an internal or external candidate. Gonski presented his report to the government in November 2011. According to an interview he subsequently gave to the Australian, Gonski relayed the board’s preference for an internal candidate; a majority supported current board member Peter Costello, the former Australian treasurer. Nothing happened. Several months later, in March, the government decided to appoint the messenger instead.

“I had nothing to do with it,” says Gonski, 59, a soft-spoken but exceptionally well-connected executive who is chairman of Investec Bank (Australia) and Coca-Cola Amatil. “My role was simply to communicate to the government what the board said, and I did that,” adds Gonski, who was named the next chairman of the Future Fund in March 2012. “I had no role in the decision making. I’m not in the business of appointing people.”

Four months had passed between Gonski’s submission of the report and the government’s invitation to him to take on the job, but the public outcry in the wake of the announcement was swift and stinging. Outgoing Future Fund board member Brian Watson blasted the government for failing to follow good business practice. Suddenly, the Future Fund looked more vulnerable to political gamesmanship than anyone had imagined — unsurprising, perhaps, given the increasingly partisan tone of Australian politics. The Labor Party, led by Gillard, reportedly balked at appointing Costello out of concern that the former treasurer, a member of the Liberal Party, might use the post to address — or worse, criticize — the government’s economic policy. Costello, a veteran of political turf battles, wasn’t surprised, even if he was disappointed. Having called the government’s handling of the appointment process “a schmozzle,” referring to the slang term for a minor altercation among players, he fretted that the controversy risked harming the Future Fund’s reputation.

“I still think schmozzle is the right word for it,” he says. “But the most important thing is that the fund is still there and still has more than A$80 billion in assets. I just would have liked it to have had more.”

Compared with some of its peers, the Future Fund was lucky to have escaped the global financial crisis with its capital base intact. Not all sovereign wealth funds were so fortunate. Between 2009 and 2011, Ireland’s NPRF suffered enormous outflows after the government appropriated a total of €20.7 billion ($26.9 billion) of its assets to recapitalize Bank of Ireland and Allied Irish Banks. Chile’s Economic and Social Stabilization Fund, sister fund to the Pension Reserve Fund, contributed $9.3 billion in direct monetary stimulus to its country’s economy in 2009 — a purpose well matched to its original design. But Australia’s economy sustained remarkably little damage during the worst of the crisis. No major Australian bank failed; most of the country’s banks remained profitable and able to access capital markets, which allowed them to keep lending. Although business confidence ebbed, Australia suffered only one quarter of negative growth — the fourth quarter of 2008 — and never went into recession. Leery of being drawn into the meltdown, the Australian government lowered interest rates and opted for a heavy dose of fiscal stimulus.

The cost of supporting the economy during the downturn has contributed to the government’s current fiscal challenge. At the moment, with the Gillard administration expected to fail on its promise of delivering a budget surplus this year, the possibility of any additional appropriations to the Future Fund appears remote. If anything, the fund has drawn media attention as a source of potential capital as the government seeks to spur infrastructure investment. In a report issued in October 2012, Infrastructure Australia — a statutory body created in 2008 to advise the federal government, state governments and investors on Australia’s infrastructure needs — urged the government to consider selling off more than A$100 billion in commercial assets across the country, from roads and ports to freight rail lines and power stations. Some of those assets may be of interest to the Future Fund, but only if they make financial sense in the context of the fund’s total portfolio.

“From our point of view, we’re always looking for good deals,” Gonski says. “An infrastructure investment in Australian dollars is much easier for us than an overseas investment given the [foreign] currency risk, but it needs to pay well.”

Although the government may have handled Gonski’s appointment poorly, the new chairman has made several constructive changes to the Future Fund’s board structure, including adding several committees. One of his first moves at the fund’s management level was to delegate more authority to general manager Burgess and give him a greater role as a public spokesman for the fund.

In acknowledgment of that shift, the board changed Burgess’s title to managing director and president. Burgess, who has had decades of experience running investment teams, sees his role as complementary to Neal’s. As CIO, Neal keeps a sharp lookout for opportunities and sizes risk exposures; Burgess also watches for undue risk. Some of his concerns are specific to the investment portfolio, such as currency risk, but he also pays close attention to operational and reputational risks, which arise almost inevitably from doing business across multiple international markets.

Burgess is now closely involved in shaping the overall direction of the Future Fund: recruiting staff, managing the agency’s business, engaging with its stakeholders, working with peers and helping to ensure best practices. No longer merely a sovereign wealth fund start-up with a blank slate and billions in cash, the Future Fund is now a fully invested, powerful international asset manager. Keeping the organization keen and nimble is a complicated task. Burgess is also involved in helping the investment team refine its monitoring techniques and reallocate capital — a natural evolutionary phase but one that requires a new set of skills. Complexity, he believes, is often the enemy of efficiency when seeking to invest well, and Burgess has been busy imparting his knowledge of the discipline of selling down positions as the fund seeks to optimize its risk exposures in the face of changing economic circumstances.

“Selling is a very different discipline, psychologically, than buying,” he says. “In the Future Fund’s first five years, we didn’t sell that many assets; we just went around acquiring things. We’ve sharpened this up now, and we have methods to review and refresh the portfolio because we need to make sure that it’s kept fresh and alive at all times. We don’t want it collecting any barnacles.”

Keeping the culture of the Future Fund vibrant also requires hiring staff who believe in the model and want to become more knowledgeable about asset classes beyond their own areas of expertise. Those qualities are not exactly common. Many investment professionals are trained to focus closely on specific securities or strategies because they get paid on their own portfolio’s performance. The Future Fund has tied everyone’s compensation — to a greater or lesser degree, depending on their level of investing responsibility — to its total portfolio’s returns to reinforce the sense of shared purpose across the team. It’s an idealistic approach, and Neal is only too aware of the management challenge.

“We were lucky because we built it from scratch,” he says. “Everyone we hired bought into how we were going to do things. But there are still people externally who are puzzled by it, and occasionally we see some furrowed brows even within the team.”

As long as the fund has just a few dozen investment professionals, it is still possible to gather everyone on the same floor. Conversations flow easily. Arndt can still push his chair back a few feet and confer with Lumsden. Byrom can still walk around the corner and debate with George about the appropriate cost of capital. “All the teams are continually checking and counterchecking their views against the views of the other teams, but they still feel a sense of ownership about what they do,” says Burgess. The process isn’t easy, nor is it perfect, he concedes. But the paradox of the Future Fund’s total-portfolio model is that its continued success may ultimately place an even greater strain on the ability of the team to function as an integrated whole, depending on how quickly its assets rise. As bittersweet as such an outcome might be, it is one that Burgess and Neal would gladly embrace. • •