Future Fund flags China concerns and rates risk

Future Fund chairman Peter Costello says it is “far too early” to call a peak in Australian interest rates and that China’s slowdown is causing the fund concern as it readies itself for higher inflation and a more volatile world.

Costello, who is also the chairman of Nine Entertainment, the owner of this masthead, said the fund has had to contend with a difficult year as inflation and interest rates spiked across most advanced economies. He expects those pressures to continue.

Future Fund chairman Peter Costello said the fund was conservatively positioned as it eyed elevated interest rates and a slowdown in China.Credit: Michael Quelch

“In the second half, investors began to think that central banks could produce a ‘Goldilocks’ outcome and soft landing equities rallied a bit,” he said.

“But data shows that, particularly in relation to services and, to some degree, wages, inflation pressures remain strong. So, we would expect elevated interest rates to continue, and it’s far too early to say in Australia that interest rates have peaked.”

The independently managed sovereign wealth fund reported a 6 per cent annual return in the year to June against its 10-year average of 8.8 per cent and below its target return of 6.9 per cent.

Costello said this reflected wider diversification across international markets and private assets, and that he expected real returns to investors to remain below those of the past decade as the fund continued to take a more conservative approach against an uncertain economic outlook.

Since 2022, the fund has slightly increased its exposure to Australian equities from 8.1 per cent to 8.5 per cent of the fund, global equities from 20.4 per cent to 21.8 per cent and debt securities from 8.1 to 8.6 per cent.

Meanwhile, the fund’s exposure to private equity dropped by 0.7 per centage points to 16.5 points and investment in alternatives dropped 0.8 percentage points to 17 per cent.

The factor causing the fund the most concern was China, Costello said.

“There was a lot of positive sentiment about China when it emerged from its COVID lockdown,” he said. “But the housing market is under extreme stress, leverage is high, large companies failing such as Country Garden and Evergrande. Demographics are a real problem in China with the birth rate falling to new lows.”

While Costello said most people were expecting some kind of stimulatory response from the Chinese government, he warned if weakness emerged from China, it would have a substantial effect on Australia.

“China has created the greatest terms of trade since the gold rush in the last couple of years,” he said. “And China’s terms of trade will have quite a significant effect in relation to Australia.”

Costello said elevated interest rates and the health of China’s economy were the two key factors the fund would need to keep an eye on in the year ahead.

“Looking forward, we see elevated interest rates,” he said.

“We see the possibility of our largest trading partner continuing in difficult circumstances. We think they are both risks to the investment climate. And we’re positioned quite conservatively I would say going forward.”

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