Go to top of page

Medical Research Future Fund

Mandate: Reserve Bank of Australia cash rate plus 1.5% to 2.0% per annum over rolling 10-year periods with an acceptable but not excessive level of risk.

Earnings for 2018-19: $0.5 billion

Return 2018-19: 5.2%

Earnings since inception: $1.1 billion

Return since inception: 4.5% per annum

Cash flow history at 30 June 2019:

Contributions

Earnings

Withdrawals

Balance

$9.0 billion

$1.1 billion

$0.3 billion

$9.8 billion

Asset allocation at 30 June 2019

Asset class

% of Fund

Australian equities

3%

Global equities

Developed markets

8%

Emerging markets

5%

Private equity

5%

Property

5%

Infrastructure & Timberland

3%

Debt securities

24%

Alternatives

17%

Cash

31%

Investments by geography at 30 June 2019

Region

% of Fund

Australia

37%

United States of America

29%

Europe (ex UK)

6%

United Kingdom

5%

Japan

6%

Developed (other)

7%

Emerging

11%

Cumulative returns at 30 June 2019Graph showing the Medical Research Future Fund cumulative returns at 30 June 2019, together with the target return, since inception. The X axis shows the date and the Y axis shows the cumulative return.

Interpreting the Investment Mandate

The Medical Research Future Fund’s Investment Mandate was issued to the Board by the responsible Ministers in November 2015 and is available at Appendix B and on our website.

The Mandate asks the Board to generate a return of 1.5% to 2.0% per annum above the Reserve Bank of Australia official cash rate over the long term while taking ‘acceptable but not excessive risk’. The Board must also determine a Maximum Annual Distribution Amount taking account of:

  • the principle that the nominal value of the credits to the Fund be preserved over the long term
  • the principle of moderating the volatility of the maximum annual distribution.

In the same manner as the Future Fund, the Board is also required to conduct itself in a manner that:

  • is consistent with international best practice for institutional investment
  • minimises the impact on the Australian financial markets
  • is unlikely to cause a diminution of the Australian Government’s reputation in financial markets.

In managing the Fund’s risk and return requirements and our role in declaring Maximum Annual Distribution Amounts, we try to:

  • ensure a high probability of achieving the minimum benchmark return over rolling 10-year periods
  • control the risk of losses, with a particular focus on
  • expected downside outcomes over rolling three-year periods, so as to help preserve the nominal value of contributions over the long term
  • determine a combined level of investment risk and an approach to distributions that facilitates relative predictability in distributions.

At times there may be a conflict between these competing objectives because of the so-called ‘endowment trilemma’, whereby:

  • higher expected returns and distributions tend to increase the risk of losses
  • for a given distribution policy increased investment risk increases the volatility of distributions
  • adjusting the distribution policy for a given investment strategy can either decrease the volatility of distributions or the risk that capital is impaired over time, but not both at the same time.

However, our investment policy framework has been designed to guide the resolution of issues like this by formalising our approach to investment risk management in portfolio construction. This framework, along with the broad investment process, are described in greater detail in the ‘How We Invest’ section of this report.

Risk positioning

Based on its interpretation of the Mandate, the Board has a moderate appetite for risk in the Medical Research Future Fund on average. In accordance with our investment process, we also aim to build a portfolio with a relatively high degree of resilience to the investment environment. We seek genuine diversification that achieves greater balance in portfolio construction while allocating risk in a flexible and dynamic manner.

One of the primary metrics we use to understand and manage the broad market risk exposure of the Medical Research Future Fund is Equivalent Equity Exposure (EEE).

EEE estimates the ‘look-through’ sensitivity of the portfolio to price movements in global equity markets.

Our expected EEE range for the Medical Research Future Fund is 20 to 35. The average EEE in 2018-19 was 27 and at 30 June 2019 the EEE stood at 28, which is the middle of the range.

Investment Reviews

Listed equities

Strategy

The objective of the Listed Equities portfolio is to provide a liquid exposure to equity markets that generates attractive risk-adjusted returns over the long term. The portfolio structure has been tailored to benefit the risk-return profile of the total Medical Research Future Fund
via an enhanced beta sleeve for harvesting risk premia and a complementary alpha sleeve for accessing active manager skill.

The enhanced beta sleeve systematically harvests equity risk premia through exposure to factors that compensate for undiversifiable risk. The alpha sleeve complements this approach by investing in a skill based (stock picking) portfolio, targeting uncorrelated returns from equities management.

The opportunity set for the Listed Equities portfolio includes:

  • Australian, developed and emerging markets
  • physical and synthetic equity-related investments.
Report

The Listed Equities portfolio was valued at $1.5 billion as at 30 June 2019, reflecting 15.2% of the Medical Research Future Fund.

Our portfolio remains concentrated in developed markets while we continue to hold meaningful exposures to Australia and emerging markets. For cost efficiency and flexibility as the Fund has grown, we have maintained exposure to market beta in domestic and offshore markets using both physical assets and futures.

During the year, this was diversified via the implementation of an enhanced beta sleeve to capture a more robust balance of long-term equity factor premia and risk within the portfolio. We believe it is important that risk premia are captured and implemented efficiently and continue to work closely with select partners to help ensure the desired risk premia exposure for the total Medical Research Future Fund is achieved.

The exposure to alpha via long/short active equity strategies remained steady over the year.

Sector exposure at 30 June 2019

Strategy

Exposure

Energy

5%

Materials

9%

Industrials

10%

Consumer discretionary

11%

Consumer staple

6%

Health care

9%

Real estate

5%

Financials

21%

Information technology

14%

Communication services

7%

Utilities

3%

Region exposure at 30 June 2019

Region

Exposure

Australia

21%

United States of America

34%

Europe (ex UK)

5%

United Kingdom

3%

Japan

3%

Developed (other)

4%

Emerging

29%

Alternatives

Strategy

The opportunity set includes:

  • a broad variety of specialised active management strategies within traditional asset classes
  • exposure to ‘alternative’ or non-traditional risk premia such as momentum, volatility and insurance
  • other managers or mandates which do not align well with the principal sector strategies.

These strategies increase the Fund’s exposure to diversifying active management return. The Medical Research Future Fund’s Alternatives portfolio has a similar profile to the Future Fund and is made up of a subset of the same managers. Differences in the portfolios exist due to the different establishment date of the two funds, as well as the size and specific portfolio objectives of the funds.

We recognise that active manager skill is scarce, but also valuable as the ability to capture skill helps maximise the risk-adjusted performance of the total Fund. We take a value based approach to evaluating the costs of acquisition of such return streams–that is, management and performance fees. Our activity is centred on finding the right balance between identifying and accessing managers, strategies and organisations who can persistently add value while testing the market for more economic access points to the same or similar pattern of returns.

Report

The Alternatives portfolio was valued at $1.6 billion as at 30 June 2019, representing 16.8% of the Medical Research Future Fund.

The Alternatives allocation in the Medical Research Future Fund fulfils a similar role to that of the Future Fund, which is the provision of a positive return stream which offers a diversification benefit at the total Fund level. The weightings to sub-sectors and the allocations within those subsectors will be slightly different due to the sequencing of investments as well as the different risk profiles of the two funds.

2018-19 saw limited investment activity, primarily concentrated on opportunities in the alternative risk premia subsector. Following a significant cash flow in July 2019, we expect significant investment activity in 2019-20. The increased scale will allow us to bring the expected profile closer to the more mature portfolio held by the Future Fund.

Strategy exposure at 30 June 2019

Strategy

Exposure

Multi-strategy/Relative value

21%

Macro-directional

44%

Alternative risk premia

35%

Region exposure at 30 June 2019

Region

Exposure

Australia

5%

United States of America

45%

Europe (ex UK)

20%

United Kingdom

7%

Japan

6%

Developed (other)

4%

Emerging

14%

Debt

Strategy

The Debt opportunity set is global and includes all credit-oriented investment products and strategies including:

  • corporate credit
  • securitised credit
  • private debt, including corporate and mortgage loans
  • emerging markets debt, denominated in both ‘hard’ and local currencies
  • distressed and special situations credit.

The breadth and complexity of credit sub-sectors calls for our strategy to be, with few exceptions, implemented through discretionary mandates.

Debt mandates and manager skillsets may be broad and multi-sector in nature or focused on specific themes, regions or sectors. Our portfolio has multiple levers through which we can dynamically access attractive opportunities as market conditions fluctuate.

Interest rate positioning is managed at the total fund level and is thus not a key component of Debt portfolio construction. Instead, the Debt portfolio’s primary role is return generation, with a core of interest income ideally augmented by capital gains over time. We aim to deliver strong risk-adjusted returns with more downside protection than equity-orientated investments.

Report

As at 30 June 2019 the Debt portfolio was valued at $2.4 billion, representing 24.3% of the Medical Research Future Fund.

The Fund’s mandate has a lower risk profile than the Future Fund. As a result, we have built a debt portfolio which contains many, but not all, of the same sub-sectors as the Future Fund, but with a heavier tilt toward investment grade credit.

The Debt portfolio generated modest returns in 2018- 19, with gains coming across all sub- sectors. A fairly sanguine risk environment, especially in the second half of the fiscal year, provided meaningful tailwinds for credit markets.

In 2018-19 we committed modest amounts of capital to distressed and middle market private corporate credit funds, and we intend to add at least one more commitment to a distressed-debt fund in 2019-20 as we continue to diversify the Fund’s range of mandates.

Strategy exposure at 30 June 2019

Strategy

Exposure

Private debt

8%

Investment grade corporate

26%

Sub-investment grade corporate

15%

Mortgage backed securities

10%

Other securitised

17%

Emerging markets debt

14%

Cash and other

10%

Region exposure at 30 June 2019

Region

Exposure

Australia

29%

United States of America

31%

Europe (ex UK)

3%

United Kingdom

9%

Japan

3%

Developed (other)

12%

Emerging

14%

Infrastructure

Strategy

The infrastructure strategy is designed to assist the Medical Research Future Fund in meeting its Investment Mandate, by providing inflation protection and diversification from the broader equities market.

We have commenced building a globally diversified exposure to unlisted infrastructure, initially leveraging existing manager relationships to access attractive risk adjusted returns.

We also invest in listed infrastructure, which we expect to provide similar characteristics to unlisted infrastructure over the longer term. Our listed infrastructure strategy provides an opportunity to access liquid exposures based on pricing relativities. This strategy is also used to provide proxy exposure while we build our unlisted infrastructure portfolio.

Report

As at 30 June 2019 we had $302 million of capital invested in infrastructure, representing 3.1% of the Medical Research Future Fund.

We have made three commitments to unlisted infrastructure funds. These funds focus on global opportunistic strategies, consistent with our view that opportunistic infrastructure will provide attractive risk adjusted returns in a competitive, low interest rate environment.

We expect the unlisted Infrastructure portfolio to grow over time. We continue to monitor the market for access to Australian and core exposures and will consider these selectively based on relative value.

During the year we initiated a passive global listed Infrastructure portfolio. While we expect to continue to have a listed infrastructure exposure over the longer term, it is likely to reduce gradually as we build our unlisted infrastructure exposure.

Sector exposure at 30 June 2019

Sector

Exposure

Airports

5%

Electricity, oil & gas

58%

Transport

20%

Water

4%

Communications

13%

Region exposure at 30 June 2019

Region

Exposure

Australia

6%

United States of America

54%

Europe (ex UK)

14%

United Kingdom

3%

Japan

7%

Developed (other)

16%

Property

Strategy

Our strategy in direct property for the Medical Research Future Fund involves a concentrated build out of our highest conviction ideas. This focuses on mandates where returns are supported by favourable thematics and where our global managers can assess relative value across markets, ultimately providing superior risk-adjusted returns.

We also invest in listed property. Our listed exposure seeks to provide a diversified, global listed property exposure that is liquid. The risk and returns are expected to be in line with the broad market over the long term.

Report

​​As at 30 June 2019 we had $474 million of capital invested in property, representing 4.9% of the ​​Medical Research Future Fund.​​

The Fund’s Property portfolio build continued during the year. We made an investment alongside one of our highest conviction managers in the US.

We also initiated a passive global listed property portfolio during the year. While we expect to continue to have a listed property exposure, it is partly being used as a proxy while we build our unlisted property exposure.

Sector exposure at 30 June 2019

Sector

Exposure

Retail

17%

Office

19%

Industrial

6%

Residential

17%

Diversified

21%

Healthcare

5%

Hospitality

4%

Other

11%

Region exposure at 30 June 2019

Region

Exposure

Australia

3%

United States of America

64%

Europe (ex UK)

8%

United Kingdom

4%

Japan

7%

Developed (other)

11%

Emerging

2%

Private Equity

Strategy

We are continuing to build a portfolio of private equity exposure for Medical Research Future Fund, the majority of which will come from existing manager relationships.

Report

As at 30 June 2019 we had $458 million of capital invested in private equity, representing 4.7% of the Medical Research Future Fund.

The heavy competition for assets and increasing volumes of capital, across both debt and equity, into the market since 2014 has had the effect of increasing asset prices to all-time highs.

Given this backdrop, our core areas of focus remain the funding of innovation, disruptive business models and small company growth across both developed and emerging markets. We continue to look for highly disciplined managers with (among other attributes) experience in generating strong returns in volatile economic environments and who provide good access to co-investment opportunities but in doing so are focused on alternative, more innovative and less crowded means of getting capital to work in private companies.

We continue to believe that many segments of the market are not offering sufficient return for the risks we are expected to take, which is leading us to look for more idiosyncratic return opportunities.

Strategy exposure at 30 June 2019

Strategy

Exposure

Buyout

13%

Secondaries

82%

Venture and growth

5%

Region exposure at 30 June 2019

Region

Exposure

Australia

6%

United States of America

61%

Europe (ex UK)

10%

United Kingdom

5%

Developed (other)

6%

Emerging

11%

Currency

As discussed on page 25, we explicitly manage the size and composition of the foreign currency exposures in the portfolio rather than allowing them to be shaped by our underlying investments.

At 30 June 2019, we held an exposure to foreign developed market currencies equivalent to 13.1% of the total Medical Research Future Fund. We expect our basket of developed market currencies to diversify the portfolio against broad market risk and generate liquidity in adverse conditions.

We also held an exposure of 6.2% of the Fund to emerging market currencies at 30 June 2019. We expect a diversified exposure to emerging market currencies to deliver a modest excess return through some combination of gradual (but incremental) real effective exchange rate appreciation and/or positive real interest rate differentials relative to the Australian dollar.

Performance

In 2018-19 the Medical Research Future Fund generated an investment return of 5.2%, exceeding its target benchmark of 3.0% per annum.

Since inception the Fund has delivered a return of 4.5% per annum, exceeding its target benchmark of 3.0% per annum.

The Fund received a contribution of $2.3 billion from the Australian Government on 10 July 2018, and at 30 June 2019 was valued at $9.8 billion.

Medical Research Future Fund returns and target benchmark

Period to 30 June 2019

Return (% pa)

Target return (% pa)

From inception

4.5

3.0

Three years

4.9

3.0

2018-19 financial year

5.2

3.0

Costs

Cost management

Our use of external investment managers, together with our commitment to a broadly diversified portfolio and breadth of investment classes, means that over time our costs will generally be higher than those investors with less complex portfolios.

The commitment to genuine diversification is an important facet of our investment strategy and has been beneficial to the Fund’s overall performance delivering strong returns net of costs while reducing volatility.

We continue to closely monitor costs in the asset classes in which we invest, reviewing the expected returns and costs of implementing the investment strategy on an ongoing basis. In negotiating terms, we focus on securing arrangements that offer value for money for the skills and resources applied, that are competitive relative to other managers in the sector and that provide for strong alignment between managers and our organisation.

Every decision we make in relation to the portfolio is considered having regard to the returns and risks net of all costs, and all returns we report are always net of all costs.

Direct costs

Direct costs, previously reported as management costs and transaction and operational costs, reflect all directly incurred costs associated with the management of the Medical Research Future Fund.

The Fund’s direct costs over the last three years are shown on the following page. This includes the direct cost ratio (direct costs divided by the average net assets for the financial year).

Changes in costs over the years reflect changes in the size of the Medical Research Future Fund, investment activity undertaken during the year, and the accrual and payment of performance fees.

We continued to build out and diversify the Fund’s portfolio during the year. The fund is now invested across all asset classes.

Look-through costs

In addition to direct costs, investment management and performance fee costs incurred indirectly through investment vehicles or where the fund is part of a comingled group of funds are reported as ‘look-through’ costs.

The look-through costs are identified by making additional enquiries of managers of non-consolidated investment vehicles to estimate the underlying management and performance fees of these entities.

In providing this additional information, we seek to provide a full and complete indication of investment management and performance fee costs.

We note that these additional cost disclosures are based on unaudited estimates and derived using a variety of methodologies, particularly with regard to performance fees which may become payable.

We employ a range of performance fee arrangements, which incorporate the use of high-water marks and claw-back provisions, to ensure as far as possible that performance fees reflect genuine outperformance over time.

It is important to note that the majority of accrued performance fees are only paid on realisation of an investment and therefore it is possible not all accrued fees will ultimately be paid.

The additional look-through costs over the last three years are shown below.

Summary of direct costs and direct cost ratio

2016-17

2017-18

2018-19

Direct costs

$10.1 million

$11.8 million

$14.0 million

Direct cost ratio

0.231%

0.168%

0.145%

Summary of look-through costs

2016-17

2017-18

2018-19

Look-through costs

0.56%

0.61%

0.46%

Cost disclosures under section 81 of the Future Fund Act 2006

Under its statutory arrangements the Board also reports costs in accordance with section 81
of the Future Fund Act 2006.

Purpose

Amount debited 2016-17

Amount debited 2017-18

Amount debited 2018-19

Contracts with investment managers

$7,532,456

$9,390,187

$9,805,622

Board remuneration and allowances

-

-

-

Agency remuneration and allowances

-

-

-

Consultants and advisers to the Board and Agency

-

-

-

Agency operations

$2,017,154

$2,271,251

$3,685,575

Note:

All costs reported under section 81 of the Future Fund Act 2006 are reported on a cash basis, whereas the direct costs in the above table include accruals.