Passive management has received a ringing endorsement from Australia's $148.8 billion Future Fund, which tipped a large portion of its funds into lower cost, index-tracking investment vehicles. 

The Future Fund's annual report last week revealed it saved more than $80 million in fees in the 2017-18 financial year. It reduced investment management and advisory fees by $26.4 million to $106 million, and cut investment management performance fees by $54.4 million, to $3.2 million.

The Future Fund is an independently managed sovereign wealth fund, founded by then-treasurer Peter Costello in 2006 to help fund the pension entitlements of retired federal public servants.

Its shift to a more passive investment approach – particularly with the domestic equity portfolio – was highlighted as the primary reason for the funds falling costs, according to the Future Fund's annual report released last week.

"In asset classes where manager skill is less evident (such as listed equities), we have been transitioning the portfolio to a cheaper, more passive approach," the report said.

However, the Future Fund board says it is willing to throw further support behind active management where they are confident managers can "reliably add value net of fee" – such as private equity or hedge funds.

Morningstar data shows why portfolio managers are embracing the newer model of low-cost, passive investing and turning away from high-cost active funds. Large cap Australian equities managers have on average, almost mirrored the returns of the S&P/ASX 200 after fees since August 2008, with a slight divergence occurring since 2017.

Active underperformance has occurred even as fees across the industry have come down.

10 year history of large and small caps investing

10 years of large cap Australian equity management chart

Source: Morningstar Direct

The annual report shows the Future Fund handed its entire $9.7 billion Australian equities portfolio to Macquarie Investment Management last year, dropping Henderson Global Investors – which later merged with Janus Capital to become Janus Henderson Investors. 

Australian equities comprise the smallest part of the portfolio, accounting for only 6.5 per cent, while more than 25 per cent of the fund's assets are held in global equities - 18 per cent in developed markets and 7.3 per cent in emerging markets.

Around 15 per cent of the total balance is invested in alternative assets, and 14.8 per cent in private equity.

The fund's cash allocation has dipped from highs of 21 per cent in June 2017, to 14.4 per cent today.

Future Fund asset allocation, 2017-18

Future fund asset allocation 2017 v 2018

Source: Future Fund portfolio update at 30 September 2017, 30 September 2018

 The Future Fund's change of investment tack follows a global trend toward passive listed investments and index funds, which offer investors access to average market returns and substantially lower fees than traditional active management. 

Australia's ETF sector surpassed $40 billion in August 2018 to reach another new record of $41.5 billion. Just six years ago, the local ETF sector held just under $5 billion in funds under management, according to Morningstar data.

In August 2018, Fidelity Investments in the US launched two index funds with zero fees, signalling a new chapter in the passive investing price war.

In 2017-18, the Future Fund, overseen by chief executive David Neal, returned 9.3 per cent, exceeding its target return of 6.1 per cent. Over the past 10 years, it returned an average of 7.9 per cent per annum.

Looking ahead, fund chair Peter Costello says while the short-term outlook remains "reasonably positive", he remains cautious about the long-term prospects, including the impact of geopolitical and trade tensions, and the potential for market shocks.

 

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Emma Rapaport is a reporter with Morningstar Australia, based in Sydney.

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