Peter Costello and the Future Fund Fiddle

The latest portfolio update from the Future Fund confirmed that the average annual return on its investments has been 7.7 percent since it was established in May 2006.

Former Treasurer Peter Costello, who is the Chair of the Future Fund Board of Guardians, judged this return to be good to the point where he claimed that it was successful in “exceeding the return objective”.

That is an expansive claim.

In the media release – that included details of the fund return up to June 30, 2016 – there was a table that showed the 7.7 percent annual return that Costello referred to. It also noted that the ‘target return’ or objective for the Future Fund since inception was 6.9 per cent, which no doubt leads Costello to his conclusion that the 7.7 percent was larger and had exceeded the objective.

Alas, that target return for the Future Fund in its own media release is misleading. According to the Future Fund Act 2006, the investment objective or target return is at “least the rate of inflation (measured by the change in the CPI) plus 4.5 to 5.5 percent”.

This return was designed to be achieved “over the long term” which is prudent and sensible given the inherent short-term volatility and variability in many market values.

With the Future Fund in operation for a decade, there is a reasonable long-term time-frame with which to judge its performance.

Based on the long-run target for annual in ation of 2.5 percent (set by the government and the RBA) this means that the Future Fund’s target return should be at least seven or eight percent. To ‘exceed’ its objective, the return delivered by the Future Fund would, quite obviously, need to be above eight percent per annum.

As a small aside, since the creation of the Future Fund, the average annual rise in the CPI has been 2.4 percent which suggests that target return over the decade of operation should be between 6.9 and 7.9 percent, with this slightly lower result due to the inflation rate being very low and below the RBA target in recent years.

At 7.7 per cent, the return has been around the middle of the target and no more. The Future Fund and Costello referred to the lower end of this band when claiming success rather than the legislated target which has an upper bound one percentage point higher than in the Future Fund’s own media release.

In some respects, the over-egging of its success by the Future Fund and Costello is not all that serious. The returns have been solid and within the minimum target range it established.

It is also interesting to note that the investment strategy of the Fund is unusual for an Australian fund manager, with just 6.3 percent of the overall portfolio in Australian stocks.

Interestingly and rather refreshingly, it has 22.5 percent in global stocks, over 10 percent in private equity and what appears to be a heavy weighting of 13.7 percent in ‘alternative assets’.

It is important to note that the Future Fund is managing taxpayers’ money and its main purpose is to cover the  nancial obligation of the superannuation and retirement costs of Commonwealth public servants. The $122 billion funds under management are set to achieve this objective, and if it can continue to achieve solid returns, it will have done a good job.

There is no need for it, or Costello, to exaggerate its success by fudging the target return and claiming success in beating it when it has done no such thing. The good news it that the Future Fund is close to achieving its aim. No more, no less.

Stephen Koukoulas is the General Manager of Market Economics