Is using the Future Fund for housing, energy and infrastructure “a raid on Australia’s savings”?

Australia has a very large stash. The Future Fund, our sovereign wealth fund created in 2006, now manages approximately $230 billion.

Specifically, its mission is to “invest for the benefit of future generations of Australians.” For a long time, this was interpreted as obtaining the maximum possible return on an investment without taking unacceptable risk.

Like several other smaller public wealth funds, it is managed independently of the government.

So this week the government ruffled feathers when it announced a new investment mandate that, for the first time, will require it to prioritize specific investments in Australia:

• increase in residential housing supply
• supporting the energy transition
• provision of improved infrastructure

These might all seem like reasonable priorities for Australia. But from those who saw the directive as a departure from the Future Fund’s fundamental goals, criticism came thick and fast.

Shadow Treasurer Angus Taylor accused the Labor Party of “plundering Australia’s savings” for its own “pet projects”.

Peter Costello, who founded the fund when he was treasurer, said it would undermine the fund’s independence and lead to lower returns.

It is possible, although not clear, that requiring a fund to prioritize certain types of investments will result in lower returns.

There is a more pressing question. Why can’t the government finance these priority projects through debt rather than by spending sovereign wealth funds?

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Read more: $230B Australian Future Fund calls for investment in housing, energy transition, infrastructure

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Foundation history

The original purpose of the Future Fund was actually to create a pool of assets that could cover government liabilities for future public sector pensions.

When it was created in 2006, the Australian economy was enjoying a golden era of budget surpluses and revenues generated by mining and the boom in China.

When the government debt was paid off, questions suddenly arose about the need for a market for government bonds (used to borrow money).

Australia has also wondered whether it should invest its wealth in a new sovereign wealth fund.

The idea behind the Future Fund was that Australia’s surplus would not last forever and the main liability the government would one day have to face would be public service defined benefit pensions.

The decision was made to create a sovereign wealth fund to finance these obligations and, accordingly, the decision was made to maintain the government bond market.

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Read more: Investors submitted bids to each other to buy Australia’s first green bonds. Here’s why it’s a great sign

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Repayment of public debt

As we now know in retrospect, the global financial crisis brought an end to the era of fiscal surpluses. This has created new questions about the role of the Future Fund.

Given the rise in government debt, it was not obvious that maintaining a separate giant asset such as the Future Fund continued to make sense. Why not just use it to pay off debt?

As always, these questions come down to basic financial engineering.

If, hypothetically, the government paid 5% interest on its debt but could receive 6% from the Future Fund, it would be better to maintain the Future Fund than to spend it on debt reduction.

The Future Fund currently manages approximately $230 billion in assets. Net government debt is projected to be over $880 billion in 2024-25 and is expected to continue to rise.

The government also used this week’s announcement to promise there would be no money from the fund until at least 2032-33, by which time it is expected to have grown to $380 billion.

However, this financial engineering equation will remain a key issue for the government.

Will the new mandate affect returns?

The current objective of the Future Fund is to maximize profits and create the largest possible pool to finance the government’s future obligations. Specifically, its mandate currently targets a return of 4–5% per annum above the rate of inflation.

Will limiting what a fund can invest in reduce its total return? It’s reasonable to assume that any restrictions on investment decisions could have some negative impact on returns – and critics certainly proved that to be the case this week.

The evidence is mixed on how mandates such as sustainability requirements impact investment returns. The analysis showed that carefully constructed portfolios can produce good results, but this is not always the case.

The key questions for the Future Fund are how much money will be allocated to these types of projects and how binding the mandates will be.

Sensible instructions to focus on investment in green energy, housing and similar alternative assets may make sense in a national sense, but from the perspective of the national debt and the aims of the Future Fund they muddy the waters.

Should the government simply borrow for projects instead?

An alternative to having the Future Fund allocate funding to the government’s preferred priorities would be for the government to simply borrow the money itself and keep the Future Fund assets separate.

If the government is going to support and finance these activities anyway, it doesn’t matter whether it does so through its debt or its assets. The government’s net asset position is the same.

Australia continues to have relatively low levels of public debt compared to OECD countries, and financing costs are low. As long as we maintain financial discipline, it will continue to be so.