In the last few weeks, I have been speaking to a number of top-tier fund managers dotted around the world. On balance, each probably has a quite a few billion dollars tied up in their Australian bond and fixed income portfolios and with the stunning strength of the Australian dollar and remarkable rally in the Australian bond markets in recent times, they are sitting on handsome profits.
They are truly fascinated with the Australian economy and its financial markets, partly of course because they are sitting on massive gains that will see them out-perform their peers, but also because of the policy and political debate that is rapidly unfolding.
Most have been around the traps as fund managers for a few decades and I spoke to some of them when I was chief economist at Citibank 15 years ago through to when I headed global research for TD Securities a few years ago. In total funds, their global portfolios total a few tens of billions of dollars which means these people are the players that matter when it comes to credit rating agency assessments, shock economic news and political risk.
In other words, these fund managers are the transmission mechanism that will either help keep Australian financial markets calm as they have been in recent times or cause a blow up that will require remedial action from the policy makers in Canberra or Martin Place.
It is also important to recognise that these fund managers have been around long enough to see what appeared to be stellar investment turn into dogs in a blink. They hate being caught out and would clearly prefer to be one of the first to reach the exit by selling their position ahead of the pack, rather than being crushed financially if they are the last person to sell.
The general questions that were discussed focused on unfolding risks. While no investor was seriously asking ‘when exactly do I sell’, concerns about Australia’s terms of trade decline, a mining bust, excess capacity in mining, the hollowing out of the non-mining economy due to the persistent strength of the Australian dollar and politics seems to have moved a touch closer to the centre of their radar of issues to worry about.
It was clear that, on balance, there is no wish to add to already long or overweight positions in Australia. This is probably no bad thing from Australia’s perspective as it will stem one of the main drivers of Australian dollar over-valuation. This probably means the dollar is now more likely to fall than rise.
The growing caution also stems from politics and the fact that there is likely to be change of government in September which opens a range of political and policy uncertainties.
Will a Coalition really cut government spending even if there is a weak global and domestic economy?
Related to that were questions as to why many Australians have an almost morbid obsession with budget surplus and government debt when they have some of the best government finances in the world; why?
What are the risks of a recession if the new government tightens fiscal policy too much?
How concerned would the RBA be about having to put official interest rates towards 1 per cent in this scenario? And how much will the Australian dollar fall?
What will happen to bond market liquidity if the new government reduces gross debt?
Why is Shadow Treasurer Hockey proposing to issue a 50 year bond when there isn’t even a 20 year bond on the market?
One fund manager even asked that if Mr Hockey sacked RBA Governor Glenn Stevens and a few fellow Board members, how would the RBA look?
These are all legitimate questions given recent atmospherics where, for the moment, there are no firm answers. First of all, the Coalition have to hold its thumping poll lead into polling day and then deliver its promises for these issues to develop.
There is also a risk that the Coalition will not get its agenda through a hostile Senate which could mean a policy stalemate and another election in 2014.
These fund managers will always hold a core position in Australia, but they can and one day will sell their excess or overweight position as they literally take profit. Perhaps it will take a further commodity prices dip and the risk of a sharp Australian dollar fall that sees these investor join the bandwagon of selling.
It could well be a self fulfilling prophecy for a lower Australian dollar – worried about an Australian dollar fall, the fund managers sell Aussie dollars causing it to fall and then others get on the momentum lower as the rush to the exit intensifies.
It is often the toughest question when trading the markets – when to sell. For Australian and global fund managers, the time is getting near.