Scott Morrison says ‘good debt’ to underwrite Future Fund

The Australian 12:00am September 1, 2017

Andrew White

Scott Morrison has defended a decision to increase commonwealth borrowings to pay public sector superannuation rather than drawing from the Future Fund, arguing that the sovereign wealth fund was delivering higher returns than the cost of borrowing.

As the Future Fund yesterday reported annual returns of 8.7 per cent — beating its benchmark by 1.8 per cent — chairman Peter Costello said a deal with the federal government to delay draw-downs of the fund by five years until 2026 would ensure that it could cover the full unfunded superannuation liability and carry on until the end of the century.

But Mr Costello warned that the fund was preparing for rising interest rates, which was likely to have a major impact on returns and asset values that have been inflated by years of easy money.

Unfunded super liabilities are projected to surge from $174 billion last financial year to $200bn by 2021, when the fund was originally due to start paying out.

But under a deal in May, the Treasurer agreed to delay the drawdown until 2026, meaning the commonwealth would have to fund liabilities from the budget and increase borrowings from $540bn this year to $606bn by the end of the four-year forward estimates.

Mr Morrison said yesterday that the increased borrowing was “good debt” that took advantage of historically low interest rates for government borrowing and ­allowed the Future Fund to print superior returns.

The Treasury on Monday auctioned $900 million of May 2028 bonds paying 2.25 per cent, with demand nearly three times the value offered.

“To be able to borrow at those rates means that we have made the decision not to draw down on the Future Fund which is earning at 6-8 per cent,” Mr Morrison told a business gathering in Sydney yesterday.

“Why would you draw down when it has that cost to your returns, when you can do it on this other level, maintain the Future Fund for another 10 years to ensure your unfunded superannuation liabilities are covered off.”

Mr Costello said the Future Fund was on course to pass $200bn by 2025-26 — from $133bn at the end of the last ­financial year, thanks to the government delaying the drawdown by five years.

“That gives the fund essentially another 10 years and we would expect it to grow in excess of $200bn, and if no withdrawals are made before 2026 the fund could cover all superannuation ­liabilities of the commonwealth and essentially would continue through the whole of this century,” he said.

Mr Costello said the liabilities lay in defined benefit schemes that had been closed for 20 years but which continued to accumulate liabilities from public servants still working under the scheme. Paying out those liabilities could run until 2085 depending on the lifespan of members.

Results for 2016-17 released yesterday show the $133bn fund returned 8.7 per cent, smashing its target of 6.4 per cent for the year.

Independent economist and vice-chancellor’s fellow at the University of Tasmania, Saul ­Eslake, said borrowing to fund the liabilities was a “reasonable trade-off” because fixed bond rates insured the government against future rate rises.

“In one sense they have borrowed to pay superannuation, but in another they are borrowing to invest in a higher-yielding asset, which is the Future Fund,’’ Mr Eslake said.

“I think it is a reasonable decision, particularly if they haven’t locked themselves into doing it even if circumstances change.”

The fund returned 2.9 per cent for the June quarter, more than double the 1.3 per cent target rate, and has averaged 7.8 per cent a year since May 2006 when it was set up with $60.5bn of federal budget surpluses and the proceeds from the sale of Telstra. Investment returns have added $73bn to the fund.

That compared with a target return of 6.9 per cent a year, made up of CPI plus 4.5 per cent. The government has since May changed the target to the consumer price index plus 4 per cent.

But it was well below the 12.4 per cent reported earlier this year for the country’s biggest superannuation fund, the $120bn AustralianSuper, and highlighted the conservative stance taken by the fund when record low interest rates have pushed investors to chase more risky investments.

Sharemarkets rallied through the end of 2016 and into this year on the back of optimism about US President Donald Trump’s agenda and a gathering global economic recovery.

Developed market equities — mainly the US — remain the fund’s second-biggest asset class at $19.8bn, or 14.9 per cent of ­assets. Australian equities represent 6 per cent, or $8bn.

Mr Costello said yesterday that low rates in place since the global financial crisis remained a major influence on the market but that the fund was preparing for rates to rise. “As the eye of the crisis moves past us you would expect the emergency responses would be normalised. You don’t stay in a state of emergency long after the eye of the storm has passed,” he said.

The benchmark returns were beaten despite the fund retaining a record balance of $28bn, or 21 per cent of the fund, in cash.

Future Fund chief executive David Neal said the large cash weighting was not a permanent feature but reflected the fund’s cautious view of investment markets, which he said were not offering returns in line with risks.

But he said the high cash weighting also masked higher risk investments being made in the fund.

The debt portfolio does not carry any sovereign bonds because they do not offer attractive returns and investments in asset classes such as private equity and infrastructure carried higher risk.

The allocation to private equity of 11.6 per cent, or $15.5bn, at year end had increased with a “fairly active co-investment program conducted with our best managers and their best ideas”.

The fund also increased its infrastructure exposure to 8 per cent, or $10.7bn, through its participation in a consortium with QIC to buy Port of Melbourne.