Why the Australian Future Fund has turned bearish
The Australian Future Fund, valued at $258 billion, is undergoing significant strategic shifts under the guidance of Chief Executive Raphael Arndt and Chair Peter Costello. These changes are driven by expectations of prolonged inflation, overvalued stocks, and the heightened risks stemming from China’s economic slowdown.
Turning conservative the Future Fund is now bearish.
The reasons cited are all subjects we have alerted investors to recently here at the blog, and given the Future Fund’s latest reported comments come only six months after it announced it was betting more heavily on active managers – especially small-cap managers – they’re worth exploring.
Arndt’s response to the triple threat of sustained inflation, equity overvaluation, and the China slowdown is steering the sovereign wealth fund towards a contrarian response that will potentially result in divergent returns over the next few years.
Some of the Future Fund’s most significant transitions in recent years and after the pandemic, include reducing equity exposure while augmenting investments in bonds, private equity, and alternatives. The fundamental gamble here is on persistently high-interest rates, especially in the U.S., even though the market is split on this perspective.
For what it’s worth, it is my view the Reserve Bank of Australia (RBA) has entered a more stable phase with respect to rates, and I expect the overnight cash rate will, more likely than not, remain roughly where it is now for an extended period. Humans are very good at projecting the recent past into the future, and very bad at predicting change or turning points. Because rates have moved around a lot recently, the current expectation is that they will continue to move around – up or down. The contrarian view is believing that rates will now remain unchanged for a long time. That could disappoint equity investors who have now embraced a soft-landing scenario combined with expectations of falling interest rates next year.
Arndt’s view is subtly different. He believes the persistence of high inflation will inspire further hikes in interest rates that will result in a repricing of equities. Referring to the U.S. situation, he has reportedly said, “With cash and bond rates hovering around 5.5 per cent, it’s unrealistic for equities to remain stagnant, unless one assumes the Federal Reserve will drastically slash rates – an unlikely scenario.”
Meanwhile, Future Fund Chair Peter Costello has expressed concerns about China’s economic trajectory. While he acknowledged the initial positive outlook on China post its Covid recovery, he pointed to the severe distress in its housing market, faltering large corporations, and demographic issues. Costello warned, “A faltering China will significantly impact Australia, given its historical economic ties.”
We recently wrote about the dangers of China’s economic malaise in this blog post entitled, China Wakes up, but Is the Nightmare Just Beginning? It’s worth remembering China’s circa 10 per cent annual economic growth rates, recorded between 1979 and 2011, are a distant memory. Today, growth (if you believe the official data) is under three per cent and returns, on the debt used to fund the 70 per cent of growth that was fixed asset investment, is negative.
Costello concluded his recent public pronouncements, “With sustained high inflation and potential challenges from our main trading partner, we’re poised conservatively for the future.”