Objective of the Directions
As stated in the Future Fund Act 2006 (the Act), the Government has established the Future Fund (the Fund) to strengthen the Australian Government’s long-term financial position by making provision for unfunded superannuation liabilities that will become payable during a period when an ageing population is likely to place significant pressure on the Government’s finances.
The Government’s aim is to accumulate financial assets in the Fund to meet its unfunded superannuation liability (the unfunded liability) as defined in the Act by the year 2020. In achieving this aim the Government has the expectation that the Board will take a long-term outlook when setting the investment strategy for the Fund.
The Government will invest seed capital of $18 billion in the Fund in 2005-06. In addition, the Government will seek to make further transfers to the Fund of financial assets or from future realised budget surpluses. Investment returns on the initial seed capital are not expected to be sufficient to meet the Government’s objective of offsetting the unfunded liability by 2020.
Under the Act the Board is responsible for seeking to maximise returns on the Fund over the long term. This responsibility is subject to any restrictions placed on the Fund by the Act and to any directions given by the responsible Ministers under subsection 18(1) or clause 8 of Schedule 1 of the Act. Directions issued under subsection 18(1) of the Act are known collectively as the investment mandate.
Directions
In setting this investment mandate the Government has employed the principle that any restriction placed on the investment of the Fund will lead to some increased risk or lower return or some less favourable trade-off between the two. As such, restrictions are only imposed where there is a sound public policy or national interest reason to do so.
Benchmark return
For the purpose of this investment mandate, the Government has directed the Board to adopt, as the long-term benchmark for the performance of the Fund, an average return over the long term of at least the Consumer Price Index (CPI) + 4.5 per cent to + 5.5 per cent per annum.
Given the nature of the initial investments there will be a transition period where the Board is moving from the Government’s cash contributions to a long-term strategic asset allocation. During this initial transition period the Government accepts that the Fund may experience returns that are lower than the long-term benchmark.
The Government is conscious of the risks inherent in investing a large portfolio of financial assets and acknowledges that in practice this will involve some short-term volatility in the Fund’s returns, including the possibility of losses in some years. In targeting the long-term benchmark, the Board is directed to determine an acceptable but not excessive level of risk for the Fund. This level of risk should be measured in terms such as the probability of losses in a particular year.
The Government is committed to maximising the return to the Australian public by investing for the long term and therefore the investment mandate establishes long-term performance measures. The Government’s intention is that new directions will only be issued in light of material changes in the investment environment faced by the Fund or in the national interest.
Section 55 of the Act requires the Board to keep the Ministers informed of the operations of the Board and give the nominated Minister such information in relation to those operations as is appropriate. This could include information the Board considers to be relevant on any significant changing circumstances of the Fund or broader financial markets.
If the Fund is to grow at a rate sufficient to offset the benefit payments and keep pace with the growth in the unfunded superannuation liability, the Fund will require a relatively growth oriented investment strategy for the very long term. Any benchmarking of the Fund’s performance against other funds or institutional investors must take into account its specific and unique purpose.
Limits for holding of listed companies
The Act sets out a number of legislative restrictions in relation to the investment of the Fund. Sections 21 and 22 of the Act prohibit the Board from triggering the takeover provisions under the Corporations Act 2001 and restrict the Board from holding a stake of more than 20 per cent in any foreign publicly listed company.
To provide the Government with comfort that these legal restrictions will be met, the investment mandate directs that the Board must establish a practical working limit to prevent a breach.
Telstra Corporation
This investment mandate directs that the Board must not acquire a direct equity holding in Telstra. However, the Board may acquire an indirect equity holding in Telstra as a result of investment through a pooled investment vehicle. As a consequence of the indirect nature of the investment, it is expected that any Telstra shares so acquired would not be held directly in the name of the Board and the Board would not have a direct voting right in respect of those shares.
Under the Act the Government may transfer financial assets, such as Telstra shares, to the Board. If any Telstra shares are transferred to the Board, the nominated Minister will issue a separate Ministerial direction to the Board under clause 8 of Schedule 1 of the Act at that time, outlining any conditions governing the management of those shares. If a transfer of Telstra shares to the Board materially affects the Government’s expectations of Fund performance, the responsible Ministers will also issue further directions under subsection 18(1) of the Act to clarify their expectations.
The Board may also acquire a direct equity holding as a result of a gift of Telstra shares under clause 7 of Schedule 1 of the Act.
Board must consider impacts from its investment strategy
The Government has a broad obligation to the Australian community to make decisions that are economically and fiscally responsible. In establishing the Fund it is the expectation of the Government that the investments of the Fund should not disrupt the normal operation of domestic financial markets. The Board, in setting the investment strategy and in instructing the investment of the Fund, must act in a manner that minimises the potential to effect any abnormal change in the volatility or efficient operation of Australian financial markets.
The Board is also required to act in a manner that is unlikely to cause any diminution of the Government’s reputation in Australian and international financial markets.
The Government participates in a number of international organisations which pursue high standards of conduct in financial markets. The Government recognises that the Board will invest in international capital markets as part of a sound investment strategy involving diversification. In doing so, the Government expects that the Board will act in a manner that is unlikely to cause embarrassment to the Government.
Corporate governance
In undertaking its investment functions, the Board must act consistent with, and establish policies on matters relevant to, international best practice for institutional investment. In particular, the Government would expect the Board’s policies to include its approach to corporate governance principles, including voting its shares.