Future Fund’s single
total portfolio

For the past five years David Neal has been integrating the vision of “one team, one portfolio” into the culture of the investment team at the $77-billion Future Fund. This has now been set in stone – well, porcelain – with coffee cups bearing the moniker used by staff throughout the organisation.

The slogan is not a frivolous mantra but a reality among the investment team, and an overriding philosophy driving the culture and the investment decision-making at the Future Fund.

The investment team is driven by nine principles that all feed into the complex, multi-layered and reciprocal process. And its internal team is deliberately small, and strategic, with assets managed by external managers.

David Neal, the fund’s chief investment officer since inception and an engineer by training, puts a lot of emphasis on documenting the process via a diagram that shows the multiple inputs into decision-making.


Size and culture matters

“When you are managing a large amount of money, there’s a tendency to just grow and grow because it’s always easy to justify an extra person. Being clear about how our beliefs, comparative advantages and required culture influence the right team size and process is therefore critical,”
says Neal.

The fact decisions are made by an interactive team, means that size is clearly something he takes very seriously. Not just size per se, but the impact it has on the fund’s culture. Adding extra functions and people comes at a cost, he says.

“Our right size is not much bigger than it is now,” he says. “It is not just about size and cost, but the point at which the culture could degrade more rapidly with extra people.”

The fund is trying to remain as small as possible internally while allowing its asset size to grow as large as possible.

And while the investment process is supported by investment models, there is a recognition of their limitations, and the emphasis on qualitative inputs into the portfolio construction. The teams get together frequently to discuss ideas and everyone feeds into decision-making. The managing director and chief investment officer have right of veto, but Neal rarely uses that right.

Communication discussion forums, including macro and market forums, and senior-investment and full-investment team meetings feed into the decision-making process, highlighting the benefits of a small team in such a process.

The Future Fund sits in a peer group that includes the $158-billion Canadian Pension Plan Investment Board (CPPIB) and $15-billion NZ Super, both of which approach the management of assets in a single total portfolio. However, the difference in the approach taken by these two funds highlights a view taken by Neal, that the right size is a function of the business strategy driving the fund.

The CPPIB, for example, hires more than 600 employees and manages all assets in house. This differs to NZ Super and the Future Fund, whose teams focus on strategy and outsource asset management.

“We look at our own comparative value add in each area, what does it mean for process, and what team structure do you need. What we require is strategic thinkers, as most of the money management is outsourced.”

“We look at our own comparative value add in each area, what does it mean for process, and what team structure do you need. What we require is strategic thinkers, as most of the money management is outsourced.”


Total management costs

Last financial year the fund paid about $444 million in total management costs, which includes all fund-management fees, core custody and portfolio administration, and the costs of the board and the agency. About $153 million of that was investment-manager base fees, with a further $218 million in performance fees paid to managers, highlighting an important bias in the investment thinking towards rewarding alpha.The internal investment staff were collectively paid $21 million, and have a performance bonus which is aligned to both the three-year rolling return of the investment and annual plans. (It pays its chair $182,530 and board members
receive $91,280).


The mechanics of decision-making

There is a global trend among large funds to bring asset management in house, ostensibly as a cost-saving exercise. But not only is the Future Fund required by law to keep an external manager between its agency and the money, Neal doesn’t necessarily believe it would be more effective to fulfilling the fund’s strategic aim.

“I’m sure we could put a business case together to manage money in house,” he says. “CPPIB is a very high quality organisation and they are working very hard to add value. If success is defined as beating the benchmark in each sector then added together to beat a portfolio benchmark, then this is rational. But for us, every person added makes it harder to create an efficient total portfolio targeted on our ultimate real return objective. It would be difficult to have seamless ideas and true competition for capital across sectors with 600 people, you feed teams like that with transactions. We have very different objectives.”

It makes sense for Neal to document the investment decision-making process in a detailed linear model, complicated by important feedback loops. The foundation inputs of beliefs and the mandate interpretation feed into portfolio construction from the top down. That also gets fed with scenario planning and macro environment analysis such as strategic themes and sector risk and opportunity analysis. Qualitative and quantitative risk-and-return assessment are also inputs.

What is clear at the Future Fund is that the culture and the process are interdependent.

“The process requires that we are checking on the strength of our culture,” he says. “And it is what I spend most of my time doing. The culture reinforces the process and vice versa.”


One team, one-portfolio

One of the key differences Neal highlights is the Future Fund’s one-portfolio approach. What this means is that everyone in the organisation has input into the portfolio as a whole, and in this way it is much more akin to the approach of NZ Super, which also has a small strategically based team.

It is no coincidence that the inaugural general manager of the Future Fund, Paul Costello, formerly worked at NZ Super.

The Future Fund does have a target allocation, or medium-term allocation, which in the 2010/11 annual report was 39 per cent in equities, 15 per cent in tangibles, 16 per cent in debt, 20 per cent in alternatives and 10 per cent in cash.

However, the actual allocation can vary a great deal from this target, which is different again to the long-term strategic asset allocation, which is not even really seen as a benchmark, more of a guide to the typical nature of the portfolio over time. This raises questions of how the performance of the team can be assessed if there is no benchmark to measure their active decisions against.
“We should be confident and competent enough to be evaluated without the use of a benchmark, we don’t need to curl up in bed sucking the corner of a benchmark,” Neal says.

Instead there is a concentration on meeting long-term goals via a commitment to teamwork and the nine investment principles, and a focus on the cultural values of integrity, innovation and “joined-upness”.

Long-term Strategic Asset Allocation Target asset allocation
(as of June 30, 2012)



Current asset allocation
(as of March 31, 2012)


The team functions by focusing on collaboration, looking for better ways to ways to communicate, which includes “being candid without getting personal”.

The fund has had some recent high-profile leadership changes but Neal takes this in his stride.

“With the CEO and chair changes, we have had a strong alignment. With all of the flavours of the board we’ve had, our overall investment beliefs, principles and strategy implementation, have consistently been bought into. There really hasn’t been a change. Personally, I don’t worry about it,” he says.


Continuous communication, continual development

While there is a one-portfolio approach, the investment team is still structured into the specialist sector teams of listed equities, private equity, property, infrastructure, debt and alternatives, strategy and environmental, social and corporate governance (ESG).

There is a focus on continuous communication and continual development so the entire team is brought along for the ride, whatever that might be. And while the “annual” portfolio reviews are conducted almost monthly the team, particularly the strategy team, is cognisant of focusing on the long-term – even as the short-term noise gets louder.

Neal says there is a lot of peer review in the investment team, stressing that the joined-up process only works if the specialists inform other specialists and vice versa.

He says the sector teams do their own analysis, guided by the strategy teamwork, and then filter up their ideas through their own research.

Those ideas arrive at a review committee, either a manager-review committee or an asset-review committee, consisting of about nine senior people.

That committee pulls apart the idea, tests its consistency with the strategic direction and whether in itself it is an opportunity. Passing that test, it then goes to the investment committee, which includes the sector heads, the managing director, the chief investment officer and head of strategy, whose job it is to build the portfolio and approve the investments.


Responding to change

While it seems like a reasonably bureaucratic process, Neal says it doesn’t necessarily take a long time to make a decision.

“We are open to the fact that things change, and so the portfolio and views change. It would be a very unusual world in which forward-looking risk and returns don’t change. But the things that populate the portfolio – the building blocks – don’t necessarily need to change when markets change quickly.”

The close relationship that the fund has with managers is also a lever to move the portfolio rapidly if it is appropriate.

“We have a close relationship with managers and I hope if the world changes, we have them already in place to be opportunistic either in the existing mandate or a new one. The committee owns that decision, the strategic decision, so we can do that rapidly at short notice,” he says.

Neal points to an example when the US credit rating was downgraded, and the fund took the view that the market had not sufficiently priced the likelihood that the US government was running out of fiscal stimulus bullets.

“We gathered the investment committee quickly, within a day of the strategy team forming the view, and made a decision to decrease our equity weight a few percent. We weren’t trying to make money from short-term trades, but it was a medium-term-outlook decision,” Neal says.

The investment committee has been granted decision-making approval within a range of plus or minus 3 per cent around the big headline allocations and within a sector have full discretion if the decision is to use an approved manger.

“For example, when the bank-loans market sold off in the credit crisis, we appointed a range of credit managers to build a substantial exposure for us. As the crisis developed, we had the discretion to move quickly and efficiently by expanding the mandates of those existing managers, for example, into securitised debt as it looked cheap.”

Neal describes the way that manager relationships are handled as “very deep and frequent”. Where the fund had 15 managers in June 2008, it now has 87.
“They’re important eyes and ears on the market, and they contribute to where the strategy should evolve. We have a bias to use an existing manager.”

“They’re important eyes and ears on the market, and they contribute to where the strategy should evolve. We have a bias to use an existing manager.”

The fund rarely uses consulting services, and Neal says the services they purchase are more about research and narrowing the field.

“It is a pretty small part of the overall approach.”

Neal says there is a trend to increase allocations to infrastructure, property and private equity, but it takes time to build and at some point will slow.

“It is taking us much longer to buy than we thought,” he says. “Three years ago we thought we’d be further along the line.”

The debt component of the fund also sets the portfolio apart, demonstrating that there is diversification as well as diversity. There is an overweight to high yield, which gives diversity to the corporate risk alongside its listed-equity and private-equity allocations.

This is a perfect example of the benefits of the one-portfolio approach. While the overall equity-like risk allocation has not altered, there is a recognition of the multi-dimensional nature of risk, and so where the risk is coming from, or being allocated to, has altered.

Future Fund principles of investment philosophy
Principle 1: Our portfolio management is focused on the specific objectives and risk definitions of the fund

Principle 2: We manage a single, total portfolio

Principle 3: We act as a single team, running an integrated process

Principle 4: We manage our portfolio dynamically

Principle 5: We aim to construct a diversified portfolio that is, as far as possible, robust to an uncertain future

Principle 6: We seek a relatively small number of relatively large relationships

Principle 7: We value flexibility and nimble decision-making

Principle 8: We manage for a net of costs return

Principle 9: While growing our investment team as large as necessary, we aim to keep it as small as possible