The Chinese economy shows signs of overheating and investors should take measures now to mitigate the effect of a potential collapse on their investments, according to Schroder Investment Management.
"Most economies when they go through the aggressive fixed investment type of approach that China has had had a hard landing," Schroders head of Australian equities Martin Conlon said.
This would have an adverse effect on the commodity dependent Australian market.
"What is unlikely is that we take a little bit of steam out and then coal prices and iron ore prices stabilise 15 per cent lower than the current levels. Yet, if you look at the scenario that a lot of people in Australia are envisioning that is exactly what they expect will happen," he said.
"It is just not sustainable to sell iron ore at stratospheric prices to a steel company that makes no money," he said.
Although the firm does not go as far as to predict an impending collapse of the Chinese economy, it says the risks are sufficient to take precautionary measures.
"If China were to roll over it would be a very different kind of economic and investment climate in Australia. It is something that investors need to be thinking about now," Schroders head of fixed income and multi-asset Simon Doyle said.
"Now is the time to do something about it as opposed to when it actually starts to unfold," he said.
Doyle said investors should look for assets that will deliver a positive return in case the Chinese economy collapses.
"You can be fairly confident that equity markets are coming off and risk assets generally perform pretty poorly," Doyle said.
"What we are looking to do is find ideas that inversely correlate with the broader type of thematic," he said.
Doyle said he would own foreign assets on an unhedged basis, while buying options against his holdings in Australian and US dollars denominated assets.
He also said that a bust-scenario would trigger interest rate cuts in Australia, which could see a rally in the bond market and, therefore, it made sense to retain some interest rate duration in the portfolio.
