The Australian
NSW has decided to put its property stamp duty windfall in infrastructure.
Cashed-up Canadian pension funds have been very active in Australia of late, with a strong focus on agriculture, and so has Norway’s $1 trillion sovereign wealth fund.
It’s no coincidence that these resource-rich countries have been extending their global investment reach as both of them have a strategy of building up foreign currency assets, which in turn acts as a natural hedge against falling mineral prices.
And as commodity prices have cooled, both Norway and Canada have become richer. That’s right: the massive foreign currency investments of both countries mean that the downturn in mineral prices increases the value of their overseas investments when converted back into local currency.
In the space of one year, Canada’s net foreign assets have increased by a staggering $C500 billion ($498bn), transforming the country from being a modest net debtor to one that can boast $C265bn in net foreign assets.
Over a longer period, oil-rich Norway has almost doubled its net foreign assets from around 90 per cent of GDP in 2010, to 185 per cent in 2016. Norway’s position today is the equivalent of Australia having amassed a $3 trillion fortune, but the reality for Australia is far less impressive.
Norway’s future fund, GPFG, has acquired stakes of 4 per cent or more in GrainCorp, Beach Energy, AWE, Orica and Cleanaway, to name a few. Likewise, the Canadian Public Sector Pension Investment Board has been buying cattle properties, while the Ontario Teachers’ Pension Plan Board has been buying almond properties in Victoria.
In stark contrast, the mining boom has left Australia with a sharp increase in net foreign liabilities, which have more than doubled over the past decade to top the $1 trillion mark this year.
While government debt is partly to blame, Australia’s super funds have failed to seize overseas opportunities, which has left the vast majority of Australia’s retirement savings invested in local assets.
When compared to other advanced economies that are tied to the commodity cycle, Australia has missed a golden opportunity to profit handsomely from predictable swings in the Australian dollar. This is not a case of being clever with hindsight.
As a result, it can be argued that Australia’s future retirees may have been denied hundreds of billions of dollars in increased wealth because the super industry failed to take advantage of the sustained rise in the dollar over a four-year period.
Higher commodity prices buoyed the dollar well above its US70c long run average over the 4½ years to August 2014. It averaged US98.33c, which should have sent a signal to fund managers that this level presented perfect buying opportunities.
A portfolio of the emerging blue chips in the US, such as Apple, Microsoft and Google, would have increased by 250 per cent in value, and this portfolio would be even more valuable now that the dollar has fallen in step with lower mineral prices.
But six years later, only 30 per cent of Australia’s $1.3 trillion in superannuation assets is invested in foreign currency assets, according to APRA figures.
At the tail end of Australia’s biggest resources boom since the 1850s gold rush, the nation is mired in debt and deficit. Instead of having accumulated financial wealth, Australia has now racked up more than $1 trillion in net foreign liabilities, a 2.5 times nominal increase since the start of the boom. This debt burden is now worth more than 60 per cent of annual GDP.
There are two big lessons that can be learned from contrasting Australia’s record with that of these two resource rich nations.
Norway and Canada have both built up massive stores of foreign currency assets, demonstrating how commodity-based economies can profit from the inevitable swings in their currencies. Their fund managers acquired tens of billions of dollars of foreign assets when their currencies were strong, and these assets have become more valuable now that the commodity cycle has turned down.
While Norway has done this in spectacular style through government-led investment in a sovereign wealth fund, Canada’s portfolio investors have underpinned this drive into foreign assets by amassing around $4 trillion in gross foreign assets.
Some of Canada’s biggest pension funds have been buying into cattle and dairy businesses of late as well as tollroad projects.
By contrast, Australia’s public sector failed to put any of the windfall revenue aside from the mining boom. Nor did portfolio investors in the private sector take advantage of the cheaper cost of foreign assets as the dollar surged towards parity and above with the greenback. The dollar spent 16 months above parity during 2011 and 2012, according to RBA monthly data.
This pattern is being repeated with the property boom. NSW’s so-called impressive budget position is built primarily on a surge in stamp duty revenue that won’t be sustained. State Treasurer Gladys Berejiklian confirmed that all of the additional revenue would be spent. “Windfall tax revenue already goes straight into infrastructure in NSW,” a spokeswoman told The Weekend Australian.
APRA data shows that despite the opportunity presented by the strong dollar, only 30 per cent of Australia’s $1.3 trillion in superannuation savings is invested offshore. The super industry, which gets a guaranteed income stream thanks to government policy, is focused on the domestic market.
Pauline Vamos, chief executive of the Association of Superannuation Funds of Australia, says superannuation is a long-term investment and the asset allocation has to reflect this. She says changes in the exchange rate are just one of many factors that super funds take into account and use to manage risk.
“What is most important is having the right level of exposure to various asset classes and to never be a forced seller or buyer of those assets,” Vamos says.
“It is not possible over either the short or long term for investors, including superannuation fund trustees, to pick when the exchange rate has peaked or reached its lowest level or when prices for specific asset classes or specific assets have either peaked or reached a medium or long-term low.”
Many individuals even in APRA-regulated funds make their own investment choices, she says, adding that the proportion invested overseas is “at least” 32 per cent”.
But former Future Fund chairman David Murray says that while the domestic focus of super funds reflect the imperative of meeting dollar liabilities, there is a case for diversifying portfolios by investing in foreign currency assets. He warns there is a risk of super funds and portfolio managers over-investing in the larger Australian listed companies.
“The Future Fund adopted a dynamic asset allocation approach under which they form judgments about markets. A lot of the super money does not do that because funds copy the same asset allocation as others as they are concerned about differentiating their performance,” Murray says.
“The skew in concentrations on the ASX are very significant. Over-investing in Australia carries some higher risk than you might normally have in larger markets.”
In general, Murray says, it makes sense for portfolio investors to buy foreign currency assets when dollar is strong, but interest rate movements by other countries are less predictable.
“Commodity cycles are easier to observe, but monetary policy and associated currency movements in other countries are not easy to forecast, ” he says. While a 30 per cent foreign asset allocation for super funds is not bad, he says it is impossible to nominate an ideal level for this class of assets as it depends on members’ circumstances and interests.
During the six years in which Murray chaired the Future Fund, it began increasing its foreign asset substantially, up from a low of 18 per cent in 2008. In the wake of the GFC, the Future Fund took advantage of the bargain basement prices in global equity markets and dramatically lifted the share of foreign assets in its portfolio. Today, the Future Fund has invested around 70 per cent of its $117bn in offshore equites, bonds and other securities, a mirror image of the super industry with 70 per cent of its assets in domestic investments.
This strategy also makes sense because the Australian market represents only 2 per cent of global equites. In fact, it could be said the that the Future Fund is still over-invested in Australian assets, but the super industry is massively over-invested in these assets.
AMP Capital’s head of investment strategy Shane Oliver says Norway is a good role model for Australia because the country has a clearly developed plan to take advantage of its commodity-linked currency, the krone.
“They realised that when the oil runs out, or when the oil prices drops, that the currency will fall and the value of their foreign assets will rise. That is the reason behind their hefty foreign currency exposure. Norway is a net foreign creditor. It is in incredibly healthy shape. That gives them a buffer when the oil price turns down. In Australia we have not had the foresight to do that,” Oliver says.
Oliver says that while it makes sense for super funds to increase their foreign currency exposure when the dollar rises well above its average rate, managers would not want to deviate too much from their benchmarks because their liabilities are in dollars.
But this argument ignores the fact that the Future Fund also has dollar liabilities in the form of public sector pensions.
Oliver says it made more sense for the government to build up such a store of foreign wealth because it had a natural hedge.
“We can benefit massively from these swings in our exchange rate, but it is a question of whether you do it in individual super funds or with a sovereign wealth fund,” he says.
In the unlikely event of the dollar rising well above parity, for example, members of super funds would see their wealth slashed when converted back into local currency. Given this risk, it makes sense for the government to take on such a strategy that could massively reward the nation, notwithstanding the risk.
“If that goes wrong, it is only the government sector that bears the pain, and presumably they can manage that because as the oil prices goes up, you are getting more tax revenue anyway,” Oliver says.
“Individual investors won’t have that natural hedge. If the dollar surprises on the upside, individual members would question if the fund managers have taken on too much risk.”
Alex Pollak, chief executive of boutique investment manager Loftus Peak, says Australia’s domestic-focused investment managers are missing out on currency profits and capital growth by being so focused on the domestic sector.
He says investors should be looking at having a stake in the emerging giants like Apple, Microsoft and Google in the same way as they currently invest in the major banks.
Norway and Canada are two countries that Australian fund managers should closely examine in order to boost their long-term performance, Pollak says.
“The excessive domestic focus creates a case of too much money chasing too few assets”, with most of the investment flowing into the top 50 companies. With so much investment in the big companies, fund managers are able to justify poor performance by comparing their results to the index of major companies.
While super fund managers have clearly missed the boat, the dollar’s continued resilience presents opportunities to lift the share of foreign currency assets in any given fund. This will not only link the fund to growth opportunities not found on the ASX, it will also reduce the risk of over-investing in the Australian market.
Leave a Reply