The Future Fund has begun to take "modest amounts" of risk out of its portfolio in anticipation of rising interest rates, says managing director David Neal.
Speaking at an Australia British Chamber of Commerce lunch in Melbourne yesterday, Future Fund managing director David Neal said there has been "unprecedented" action by central banks and governments since 2008.
The world's largest economies have employed policies such as quantitative easing to "defend" economic growth, which has driven yields down and asset prices up, Mr Neal said.
"For investors this has boosted returns over recent years, but has done so essentially by bringing forward returns from the future.
"Our portfolio has generated a 52 per cent cumulative return in less than three years since June 2012. These levels of return are not sustainable indefinitely," Mr Neal said.
Long-term bond yields are between two and three per cent in the US, the UK and Australia, he said, adding that recent data from JP Morgan calculated there was over US$1.5 trillion of bonds trading on a negative yield as at 1 June 2015.
"This creates a tough dilemma for all investors. Given these low returns, achieving long-term return objectives from here is going to be very difficult," Mr Neal said.
Many funds may have portfolios that they do not believe will meet their long-term return needs, he said.
"Funds could respond to this by moving out along the risk curve, taking more and more risk to stretch for higher returns.
"Indeed this is exactly what central banks want us to do. They believe this will help kick-start animal spirits and increase economic activity," he said.
But this could be "painful" for funds, given that market are likely to reprice assets when the "central bank music stops", Mr Neal said.
"The Federal Reserve is widely expected to begin raising rates in September this year. The Bank of England is expected to start mid next year. The question for investors then is whether the party is winding down," he said.
"For our part, we have begun taking modest amounts of risk out of the portfolio, although at this stage we are still well within what we would consider to be normal levels of risk.
"We are more inclined to reduce risk than to chase return, but we have to recognise the determination of global policymakers," he said.
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