Should the Future Fund shut up shop?

On Monday, I penned a piece discussing the Future Fund's defensive pivot. It was mainly about the fund's asset allocation. But there's a much bigger story at play here, as the comments in my previous article make clear. One that renders this emperor absent their clothes.  

Any investment fund, be it private or one gallivanting as a sovereign wealth fund, should be judged on its performance. 

So let's talk about performance. 

The Future Fund's self-anointed "Guardians" generated 6% over the past year. The year has been highly volatile, to be sure. But let's put that 6% figure in perspective. 

The Guardians could've bought the S&P500 index, stayed in bed every other day, and returned almost 3x what they did in reality. 

But as this wire explains, 6% for the Future Fund is in many ways worse than 6% for a regular investment fund. 

This piece will explain why, and why the whole concept of the Future Fund is arguably flawed. It's a truncated version of an excellent critique from Dimitri Burshtein, published by The Centre for Independent Studies. 

What is it really for?

The Future Fund was created in 2006 to finance the obligations of Australia's public service superannuation schemes.

Back then, these obligations were funded on the go straight out of the Federal Budget. 

Founder and current chair Peter Costello said at the time that “The Future Fund will be invested with the aim of accumulating financial assets sufficient to offset the government’s unfunded superannuation liabilities by 2020.”

Its name might be a misnomer. Sovereign wealth funds invest for the future. The Future Fund invests for the retirement of past generations of public servants. 

"In an accounting sense, the Future Fund is more of a provision than an investment," says Burshtein.

"It is unlikely that the Future Fund’s public credibility would have the same currency were $200 billion of public resources allocated to something called the ‘Funding Retired Public Servants Pensions Fund.'"

Australia has changed

In 2006, the superannuation obligations of the public service were projected to be $140 billion by 2020.

It was a heady time for the Federal Government's balance sheet, which in 2007 sat at net debt of -$30 billion.

Today, net debt sits at $550 billion. 

In 2006, unfunded superannuation liabilities were forecast to be $140 billion by 2020.

According to the Australian National Audit Service, the government's unfunded super liability was $408 billion, and declined to $322 billion at 30 June 2022. 

"At the time of its establishment, it was estimated that the original Future Fund would have sufficient resources by 2020 to relieve the budget of the need to meet the cost of these unfunded superannuation obligations," says Burshtein.

"The balance of the original Future Fund was approximately $203 billion as at end March 2023, sufficient to meet the 2005 forecast, but nowhere near sufficient to meet the 2022 figure."

When 6% ain't a real 6%

The Future Fund targets CPI + 4% to 5% per annum.

That equates to a target return of 10% per annum for the year to June 30. It returned 6%, which is of course 4% below target. 

Most funds have periods of outperformance and underperformance. That's par for the course of running an investment fund. 

But the Future Fund gets special treatment. Treatment that, taken together, give it a unique advantage. And this makes the 6% figure it just generated less impressive still. 

"While it is correct that the financial performance of the Future Fund has been relatively strong compared to general investment funds, the Future Fund has three structural advantages," notes Burshtein. 

First, the Future Fund doesn't pay income tax, and benefits from sovereign tax immunity on most investments.

"Everything else equal, this gives the Future Fund an approximately 10 per cent performance advantage over other investment funds. This advantage will be further enhanced because the Albanese government intends to increase the tax rate on high balance superannuation accounts."

Second, the Future Fund isn't saddled with the same level of administration costs that typical funds are. The top 10 superannuation funds collectively have approximately 15 million accounts. The Future Fund has one - The Commonwealth.  

Third, because the fund has one client, The Commonwealth, it doesn't have to meet frequent withdrawals. Thus, it can enjoy a juicy liquidity premium. 

Burshtein also brings up another interesting point regarding performance. 

"If, in the event of emergency, Future Fund investments needed to be quickly converted to cash, a significant liquidation cost would be imposed. 

"Such an emergency event would likely be systemic, meaning that investments would need to be sold into falling markets further eroding value. Even notionally liquid assets, such as listed securities and bonds, could be subject to a significant liquidation cost given the size of the Future Funds’ holdings."

Conclusion

In sum, the vaunted status afforded the Future Fund seems a bit rich. At best, it's an average to low performing fund. At worst, it's a misallocation of taxpayer dollars. 

As Burshtein puts it: "If public finance was as simple as borrowing money, investing, and spending the profit above the cost of interest, the Commonwealth should just borrow $10 trillion, invest it, and eliminate all taxes."

"By closing the Future Fund and retiring debt, the Commonwealth will have a lower interest expense in the budget and Australian citizens will have a much clearer and transparent view as to where public spending is going and the state of the Commonwealth’s balance sheet."