Future Generation Australia Limited (FGX) Earnings Call Transcript & Summary

Hello, everyone. Thank you for joining us. My name is Lee Hopperton. I'm the Chief Investment Officer of Future Generation. I'd like to start today by acknowledging the traditional owners of the land where we are, which is the Gadigal people of the Eora Nation and to pay my respects to elders past and present. I'd also like to introduce you to the 2 guests I have with me. We've got a very large audience for this webinar, and I suspect it's due to the quality of the guests who are sitting next to me. We have Jennifer Westacott. Jennifer is the Chair of Future Generation Global. She was formerly the CEO of the Business Council of Australia, a Director of Wesfarmers, and she's currently the Chancellor of the University of Western Sydney. She's also the Director of the Governance Board at the RBA. We've also got Phil Lowe, Dr. Phil Lowe, he is the Chair of Future Generation Australia. You probably know him as the former RBA Governor. He's on the Board of Barrenjoey and Victor Chang and he's on the ASX Advisory Group of Corporate Governance for the ASX. So this is a great opportunity to hear from both the chairs. We've had quite a lot of questions that have come through already, and I've tried to categorize them. But if you do have questions, please submit them as I can see many people are doing through the website, and we will try and get to those. Before we start, I would just draw your attention to the disclaimer, which is on the screen, which essentially says that anything that 3 of us say today is general advice, general in nature. It's not personal advice. For that, you would need to see a licensed financial professional. So maybe I'll just give a quick update on Future Generation. And as you know, the way that we operate is we operate fund of funds, have 2 listed investment companies, Future Generation Global and Future Generation Australia. They invest with what we think are the best fund managers we can find in Australia and from around the world. Those fund managers very generously work for us for free. And because they're working for free, we're able to save a significant amount of fees for our shareholders. We've saved $175 million so far. That means we've been able to donate 1% of assets each year to some great causes. We've donated $100 million so far. The difference between the saving and what we've donated, of course, remains within the listed investment companies. It's for the benefit of shareholders in terms of income and the capital growth that we achieve. If you look at the fund managers that we invest with, as I said, we think these are some of the best fund managers in Australia. They're also very diversified. What we're trying to achieve with Future Generation is great returns, but with much lower volatility than the market. And the way we do that is through diversification. So the managers on the screen, they are what we think are the best managers, but they're also highly diversified in the terms of the way that they invest. So we have long/short managers, long-only managers, systematic managers. And our first layer of diversification is by manager, and that helps us to achieve the lower volatility returns that we've been able to achieve. If you look underneath the hood to what those fund managers are investing in, you can see that the portfolio is very diversified. We have a slight bias in Future Generation Australia towards small- and medium-sized companies, but we're significantly underweight the larger companies in Australia. So the top 10 companies in Australia make up nearly half the value of the index. And the best way for us to achieve lower volatility returns is to diversify away from those. So you can see that we have a very nicely spread portfolio. For Future Generation Global, it's a similar story. Global markets have become increasingly concentrated. The top 10 companies in the MSCI made up about 10% of its value 10 years ago, now nearly 1/3, mostly tech companies. We are typically underweight those large tech companies. Our fund managers find opportunities elsewhere. So again, we're overweight at the small, medium-sized companies, and we have a bias a little bit less than the market in terms of our exposure to the U.S. We're a bit overweight Europe. And the stability that those investment portfolios create enables the Board to generate and announce a growing stream of fully franked dividends. So in the case of Future Generation Australia, dividends -- fully franked dividends have been increased every year for the last 10 years. The dividend yield, if you include franking credits for Future Generation Australia is over 7.5%. And we've got a strong profit reserve, which gives us confidence in the sustainability of that dividend. Future Generation Global, likewise, has been increasing its dividend steadily. We announced a special dividend, $0.03 per share fully franked earlier this year, which gets paid tomorrow. Again, a very strong dividend yield of over 9% and strong profits reserve, which gives us the confidence that, that dividend is sustainable as well. So our first objective to deliver low volatile -- low volatility returns to our shareholders and generate great income. We think we've been achieving that. But of course, our second objective is to make a significant contribution to society and in particular, to support young Australians. And last year, we cracked through $100 million that we had donated to those great causes. We're very proud of that number, and we're hoping that, that will continue to grow into the future. The not-for-profits that we support are very broad. There's more details on each of those on our website. Future Generation Australia supporting youth at risk or vulnerable children, Future Generation Global, particularly supporting mental health initiatives for young people. Final thing before we move on to the Q&A is that if you do decide to buy Future Generation shares and you do that through CommSec, they're good enough to rebate that brokerage, so it's a free transaction for you. So that's a quick update on Future Generation's investment portfolios.

There are some questions that we've had through, which I'll address in due course. But the bulk of the questions that we've had are focused around productivity. And I read back over the last time you both did these webinars a couple of years ago, Jennifer, you made the comment that you feared Australia might sleep walk into lower living standards, which is I thought was a great comment. Before maybe we get an update from you on how you think about that. Phil, would you mind talking to us about productivity, why it's important and your perspective on where we are?

Thanks, Lee, and it's great to be with you. Productivity is the amount that on average, we produce per hour of work in the country. So it's a pretty fundamental concept. And advances in productivity are the key to advances in living standards. Since around 2018, we've had no advance in productivity in Australia. So the amount on average that's produced per hour of work today is the same as it was in 2018. Since 2018, living standards in Australia have stagnated. Average real income per head is the same as it was back in 2018. And that's because we've had zero productivity growth. That follows a period of 25 years where productivity growth was almost 1.5% a year. So if we had, say, 1% or 1.5% productivity growth since 2018, the economic pie in Australia would be 10% bigger than it is. That means people's real wages would be 10% bigger, profits would be 10% bigger, government revenue will be 10% bigger. Everything would be 10% bigger. And everything -- if everything was 10% bigger, we wouldn't be talking about a cost of living crisis. We'll be talking about how to manage prosperity as we were for much of the previous few decades. So the fact that we're not getting any productivity growth today means our living stands have stagnated. And unless we can turn this around, we're going to continue to have a high standard of living in Australia, but it's not going to advance and we're stagnating. And really, this is why people are talking about productivity growth. We've entered into a world of stagnation in living standards and we're on a path for that stagnation to continue. I don't think we're going to go backwards, but we're not going to go forward.

Pretty worrying and....

Incredibly -- yes, incredibly important.

Yes. And so Jennifer, I feel suggests that we haven't yet woken up. Your perspective as well.

I think so. I think we might even be going a bit faster than sleep walking. You think the last decade has been the lowest rate in the last 6 decades of GDP per capita growth. So that tells you our living standards are falling away. And we talk about a cost of living crisis where we're heading into a standard of living problem. And to Phil's point, it's not that we're going to go backwards. It's just that we're not going to go forward. And we're certainly not going to travel at the same pace as countries like the U.S., which is, I think, on average, about 4x more productive than we are. And so I think what we've got to remember is what does it mean? A lot of people, I think, want to misrepresent productivity as a claim by business to work harder for less versus we want to get more value out of the inputs we produce, and that's about technology, machinery, skills, training, energy input costs and so on. But it ultimately results in higher wages and a bigger pie. And that means more money for government to spend on things that people need, more money in people's pockets. And that's the best way of really alleviating the cost of living crisis over time is to actually kind of make those structural changes that make us more productive and actually put sustainable long-term money into people's pockets.

So maybe just to sort of follow on from that point, what is that? What sort of reforms do you think would be the obvious ones to achieve that?

Well, I mean, you've got to be on all fronts, but like everything really matters. So if I think about we've got to really take the skilling of Australians more seriously. We've got to get our skills system up to date. Energy costs which have really increased over the years is a major kind of contributor to a declining productivity. But if I had to pick one, Lee, I would pick tax reform because productivity is a creature of investment and incentives. And we do not have that climate in Australia at the moment. One of the highest corporate tax rates in the world, very high income tax rates, taxes like stamp duty, which I think I've not seen any economist that says stamp duty isn't anything other than the worst tax in Australia from a productivity point of view. So I would always nominate comprehensive tax reform, not piecemeal tax reform. And nobody is naive enough to say that's easy to do. And we've had economic opportunities where it would have been easier to do than now. But nevertheless, unless we're willing to confront the fact that our tax system is neither going to produce the revenues that we need, and we can see that coming out of the commentary on the budget. But more importantly, it's not going to create the incentives for businesses to invest in those. It's equipment and skilling and technology that allows them to be more productive, expand and grow and pay people more, then I just don't believe we can actually kind of turn the corner in the way that Phil is suggesting.

And Phil, would you agree tax reform would be the most prominent lever to pull for.

Well, it's certainly kind of one of the very important ones. There's no single thing that we can do here. But to my mind, what we've got to do is to make Australia a great place to invest, expand, innovate and hire people. And that should be our mindset. At the moment, too much political discourse is focused on how we cut the pie rather than grow the pie. And we grow the pie by investing, innovating, building new businesses and hiring people with good skills. So if that's your mindset, then the approach should be to kind of tackle everything that feeds into that. So that would be industrial relations, I think, taxation. We tax innovation and entrepreneurship too heavily and consumption too lightly. And the way we tax land is all screwed up, as Jennifer said. It's too hard to establish new businesses. There's too much kind of regulation. The cost of energy is too high and our university system isn't working to the full advantage of the people. So -- we've got to make Australia a great place to invest, innovate, expand and hire people. That would be my overarching thing. And if that's your frame of reference, then a lot of things fall into it, and we've covered some of those. And if we don't do that, then we're stagnating. And it's good. I mean the standard of living is good here. On average, Australians are lucky enough to enjoy one of the highest standards of living in the world. In a way, it's fantastic. But we've stagnated, and I think we've rested on our laurels for too long. And we need to take some hard choices. Otherwise, our kids will not have a better standard of living with us because the future generation funds are very focused on our kids. And unless we do something on the economic front, our kids are not going to have a better standard of living with us and possibly worse. And as apparent, it's challenging.

And just -- we'll come back to some of those topics. I mean, the sort of more recent news on the budget and a few other things. But AI is obviously -- there's a lot of questions that have come through on AI, and I'll talk about the portfolio in a second. But is AI a kind of silver bullet that could support productivity growth and maybe be a competitive advantage for Australia to ease that problem, either of you?

Well, possibly. I mean, we don't know.

Yes.

So it's a huge advance in technology with unpredictable effects. I think we all know of examples where tasks are being made more effective.

Yes, exactly.

Coding software, writing reports, preparing slide decks. Those tasks are being made much more effective. And that's going to help, but that's not going to shift the dial. I think what could shift the dial is whole new business models that we can even dream about at the moment. And one of the benefits of AI is it's reducing barriers to entry. You no longer need a kind of a big [ speak ] hardware and software stack, you can kind of use the AI tools. So barriers to entry are lower. And we know when barriers to entry are lower and you've got the fundamentals right, new businesses emerge. So I'm hopeful, I don't know what they are, but new business models will emerge that will help with productivity. But we -- there are some downsides as well. I worry a lot about the use of AI by bad actors and we've seen the anthropic and kind of this -- kind of discussion recently. So we're going to have to invest more in cybersecurity, and that's a deadweight loss. And I also worry about the income distribution effects of AI and the erosion of our tax base. So there are positives, but there are negatives, and it's unpredictable. But we do know through the broad sweep of time that advances in technology make more things possible and human ingenuity takes advantage of those possibilities and builds new businesses.

Yes. Positive on that -- the corporate Australia kind of view you have the adoption.

I think just to Phil's point, I think the task change thing is kind of like the first sweep of AI, and we're seeing that now. And there's no doubt that, that's going to have a productivity dividend. I think you've got to see AI alongside other technologies, robotics, digitization. I think the challenge is how do we give Australians agency in AI. Because if we don't do that, we won't get those business model changes. And how do we get the regulatory environment to allow that big innovation, particularly in that business model change in that whole kind of creating new forms of value. If we don't do that, we won't get the big dividend. But we will need some guardrails. The question is getting that balance right because my big nervousness is 2 things. One, that we haven't got enough equity in access to the skills to use it and that we're not getting the skill system aligned enough fast enough to give people those skills that they need to run, not just to survive in an AI world, but to take advantage of it. I mean this is all about critical thinking, computational analysis. Otherwise, AI just becomes potentially just on the process side. I do worry about AI combined with social media if those guardrails aren't there because of the extra territorial nature of those technologies and sort of this whole question of how people are going to get information uncurated. Where I see businesses going with this, I think most businesses are looking at it from 3 lenses. The first is everything around the customer. What can we do to improve our customer service to know more about our customers, to get more stickiness with our customers, to extend our value proposition to our customers to give them new services that create greater value. The second thing, though, that's the more complex bit, but actually the bit that you can create tremendous value is the business model. What are we thinking about in our business model? How does this allow us to kind of rethink our business model? And the third is process, which I think everyone is kind of very comfortable with start on process data, analytics, those repetitive tasks. But I think the bit that is harder is the customer bit because of all of the things people are concerned about, but that's where tremendous value will be created. My big nervousness, though, Lee, is I just don't think we're paying enough attention to pockets of the economy where people are not going to have the agency. So I'm very concerned about the SME sector. To assume everybody is going to have the same level of capability, I think, is naive. And I think government needs to kind of really think through with business, not on its own, some kind of sense in which what is the standard of agency that we want for all Australians or what are the particular pockets of agency like SMEs where we really need to make sure that people understand the technology are using the technology, are confident with the technology and are able to do it in a way that improves their value.

This might be a good point for me to head off. We've had a lot of questions coming in on the kind of portfolio aspect. Well, actually, Richard has asked, will Future Generation use AI models, which is -- we're a smallish business. So the answer is yes, we are using AI. We're trying to figure out the best ways of using it. At the moment, we're finding it's a great tool to do searches for us to aggregate information. We're not using it to -- for our investment decisions or -- but to create reports to aggregate information to search for investment opportunities, it's been great. And then several people, Pete, Casey, Paul, others have asked about essentially AI valuations, how invested the portfolios are in AI. And it's a really difficult question to answer. The sort of simple, but not very good answer is that we're underweight those very large AI-related technology companies because they have become a very expensive -- these decisions are all taken by our fund managers, I should say, not by the investment committee, but the fund managers we've selected are typically underweight those large names. And the reason is valuations are quite high for some of those. The markets are very concentrated, so it's becoming more difficult to add value. But that's a very simplistic answer because where AI starts and finishes is really difficult to measure. So many of the fund managers are involved -- are invested in the second derivatives. So for example, the data centers that are being built in Australia and elsewhere, the power transmission that's required, the adoption that is going through corporates around the world and then other opportunities that are coming up, like you may have heard about the Software-as-a-Service, the SaaS apocalypse that happened earlier in the year, presenting valuation opportunities as people figure out what the impact of AI is. So the answer to all of those questions is the fund managers who we speak to and are invested with are constantly looking at AI. I'd be very surprised if there's any conversation they're having with a company that doesn't involve a discussion about how they're using AI. And certainly, when we're talking to fund managers, we're interested in what kind of exposures they're getting, but it's a very broad question to answer that. Maybe now is a good time to come on to the sort of next step of productivity reform, the more immediate point around the budget. We've had a lot of questions on that as well. Matthew Cranston, who's a journalist at the Australian, very well regarded, has asked one for you, Phil. What does Dr. Lowe think about the major tax changes being legislated? Are they more likely to increase or decrease productivity, investment and housing supply or not?

Well, there's some good here and some bad. So let me start with the good. I support the changes to negative gearing and the capital gains tax treatment on residential property. And partly, I say that because when the value of a property goes up, it's largely because the value of the land goes up. And you as the owner of the property, normally don't do things to make the value of the land goes up. It goes up because of inflation or zoning or kind of growth in the city. So I could never understand why we taxed concession that increases in the value of land. So removing that discount there and removing negative gearing, I 100% support that. I think it's a mistake, though, to extend the changes, the capital gains tax to risk-bearing assets because as I said before, what we want to do is to make Australia a great place to invest, expand, innovate and hire people. And increasing capital gains taxes on assets whose value rises because of enterprise works against that. So I was disappointed that the government extended the capital gains tax treatment to nonresidential assets. And I think that will be to our detriment that they've done that. On the tax changes on housing, I don't think that's going to make a difference to supply, which is the fundamental issue. So they need to work simultaneously on increasing supply, which the governments right across the country have fallen way, way short of those targets they announced. So the first order of action, I think, is to achieve the targets they set out before. But from a tax design perspective, I think the change in the need of gearing and the cap against tax residential property is sensible, but the other changes will end up hurting living standards here.

Jennifer, would you agree with that analysis?

Yes, I think that's correct. I think if you sort of might take the housing question just as a specific. I think what I think we keep doing in Australia is forgetting that housing is a complex system. And so we try and do one thing and then we find that loops that's created. So we do a lot of stuff on the demand side, first homeowners grants, stamp duty concessions. And there's nothing in and of themselves wrong with that if you're kind of corresponding on supply. But we haven't done enough on supply. And that's just -- that's more than just zoning land. That's actually a lot of complexity now about reducing the cost of production, which is why I'm a big supporter of modern manufactured construction methodology to see if we can reduce the cost of the actual construction of the house. I mean at the moment, in Sydney, it's not feasible, particularly in Western Sydney to build medium density housing because of the cost. So we've got to do something on the cost side. We're going to do something on the innovation side. We've got to do something on the -- on stuff that other countries have done in Europe, particularly around what they call the third sector, the housing association sector, where people have long-term secure rental through sort of like a build-to-rent model, where the housing association is not running necessarily public housing, but it's charging affordable rentals. In Canada, they call it attainable housing. You've got to get the planning system right, which we haven't talked about, where the time taken to get place approved or getting a major subdivision approved or a major residential facility or commercial building approved is just too long. And this is where AI, in my view, could be very effective by taking the noise out of the planning system and really focusing on the things that are more contentious. So I think the first mistake is always -- and to be fair, there's a lot of stuff in the budget around some of these things. There's some money for fast-tracking approvals. There's a lot of money in the budget. I think it's $10.2 billion on productivity and deregulation agendas, which is good. The question, I think, is when you look at all of the budget figures, you look at -- the figure I always look at is the growth figure. And I get nervous when I see a growth figure of 1.75%. So you sort of say, well, what are going to be the tools that drive that bigger pie that Philip is talking about. And I think that's where the jury is out. Are there enough kind of tools in that budget? And then if you go to kind of the tax on enterprise, to drive productivity, you need dynamism in the economy. You need people taking risk. You need people starting businesses, selling businesses. That's where the U.S. is an incredibly dynamic economy, and it's more productive as a result. So the question is, will these tax changes drive or stifle that level of dynamism. And that, to me, is sort of like something we should be thinking about. But I just come back to, we need a big growth agenda in Australia. And if we don't get that growth agenda, we're not going to see those living standards rise.

Maybe we should turn to reasons to be optimistic about the Australian economy before we get too bearish about the sort of current politics and so on. We've obviously -- Australia has got through a number of economic shocks over the last sort of couple of decades and navigated them much better than a lot of other countries. Are there some things that are specific to Australia that are a strength to us to navigate some of these changes that we're facing, notwithstanding sort of structural policy reform, but the population.

I mean I've always been optimistic about our economic prospects, and that optimism was really built on a certain set of fundamentals. They would include our fantastic resource -- natural resources base, a growing population where people come from all around the world to want to live here and to prosper and to work and build better lives and theirselves. Good public policy institutions. We've got a credible central bank. We've got a decent fiscal setup, and we've got a flexible exchange rate, which means that when we get hit by external shocks, there's a lot of shock absorption there. We've got a talented industrial entrepreneurial workforce. And historically, we had cheap and reliable energy. So there are a set of fundamentals there that not many other countries have. I think another of the positive fundamentals is our strong trade link with Asia. Most of our exports go to Asia. So we've got very strong trade links there. So you put all that together, and we've got all the fundamentals to be successful. My concern is that we're now resting on our laurels. We had 35 years of good economic growth arguably the highest standard of living in the world, and we've lost the drive to keep innovating to growing and to prosper. And we don't have a growth agenda. We now have a redistribution agenda. We've got a big pie, and we're arguing over how we redistribute rather than make a bigger pie. And I feel like we're losing our way. We can find it again because we've got the good fundamentals. I think the other source of optimism I have is really kind of a political one that over the long sweep of time, our politicians end up making the right decisions. We go through periods where we're all kind of saying, well, it is not so good. But the political system does tend to deliver ultimately politicians who make the right decisions. You think kind of both the labor government under Hawke and Keating and then the coalition under [indiscernible]. They made difficult decisions. And somehow our political system can find a way to build on those fundamentals, even though at times, you think, well, kind of the future looks bleak. So I still think we can do that.

Yes. That's good to hear. Jennifer...