Schroders, Fidelity, Pendal and Investors Mutual have adjusted their holdings in the largest miners as uncertainty grows around China.

China's demand for steel suggests the worst is yet to come for iron ore miners, say Morningstar analysts, a view supported by a pullback in the holdings of BHP and Rio Tinto by some of Australia's largest stock funds.

Digging into the stock portfolios of these top Australian equity funds reveals differing views on BHP (ASX: BHP), Rio Tinto (ASX: RIO) and other exporters of iron ore, one of the nation's largest cash cows.

BHP alone comprises 5.5 per cent of the total market capitalisation of the Australian Securities Exchange. It's the third-largest company in the ASX 200 with a $105 billion market cap.

In 12th spot is $33 billion Rio, while Fortescue Metals Group (ASX: FMG) and Newcrest Mining (ASX: NCM) are the 14th and 16th largest companies in Australia with market caps of $27 billion and $24 billion, respectively.

Iron ore is the biggest game in town for Australia and key to our relatively easy ride through the global financial crisis. Each US$10 change in the price of iron ore is equivalent to about $6.3 billion in GDP and $1.1 billion in Australia’s tax revenue, according to Treasury figures.

Commodities stocks rank alongside Australia's big four banks as some of the largest holdings in the portfolios of the country's largest and most successful fund managers. For the purposes of this article, I've examined the stock holdings of the following funds:

Each of these holds a Morningstar medal of either Gold, Silver or Bronze and either five- or four-star ratings.

The first of these awards the highest rankings to funds with a greater chance of outperforming over a market cycle. The star rating is based on funds' historical performance.

Schroders bearish on the big Australian

The Schroders strategy holds Morningstar Gold and has delivered a return of 7.4 per cent annually over a five-year period – versus a return of 8.47 per cent from the S&P / ASX 200 index.

As of 31 October, 27 per cent of holdings in the portfolio are basic materials companies – the highest exposure of the four funds listed above.

BHP Group is the second-largest holding overall in the Schroders fund and its largest in the category, with a 5 per cent weighting to the company known as "the big Australian" as at the end of last month.

Elevated iron ore prices – which Mathew Hodge, a Morningstar Australia director of equity research, sees as unsustainable over the longer-term – is the main reason for this overvaluation.

In turn, this is driven by what Morningstar regards as longer-term changes in demand for iron ore from China, which consumes about 70 per cent of global supply.

Iron ore contributed 48 per cent of BHP's pre-tax earnings in fiscal 2019. The mining giant reported solid growth in net profits and dividends for the financial year, but this has been overshadowed by the 30 per cent fall in iron ore prices.

Iron ore prices spiked at US$120 a tonne in January this year, largely in response to supply shortages after the Vale dam disaster in Brazil. The price has since settled below US$90, but even at this level remains well above Morningstar's longer-term price forecast of about US$40 a tonne.

Relative overweight/underweight positions on BHP

mining exposure

Source: Morningstar Direct

Schroders has held BHP and Rio – its fifth largest holding as of the end of October, with a 3.94 per cent weighting - for many years.

Since mid-2018, Schroders' holdings of BHP have been reduced from 7.45 per cent to 5 per cent now. This leaves the fund slightly underweight versus the index.

BHP's share price hit a peak of more than $41 in June and July this year. M, this suggests some profit-taking by the fund manager.

In August, Schroders portfolio managers Martin Conlon and Andrew Fleming flagged a stabilisation in the iron price when they conceded prices were unlikely to hit $120 a tonne again any time soon. Gains for the likes of BHP and Rio Tinto are more difficult to achieve given their high current valuations, trading 26 per cent and 44 per cent beyond Hodge's fair value estimates.

At a share price of $38.50 as of 1.20pm Friday, BHP is currently 28 per cent above the $30 fair value estimate set in September by Morningstar's Hodge.

He regards Rio as more over-valued than BHP – its share price opened today at $97.40 versus Hodge's fair value estimate of $69 – because it has a higher exposure to iron ore.

Schroders has remained overweight in its holdings of Rio for at least the past 18 months, when compared against the Australian shares index. The small movements in its holdings of Rio over this period are largely explained by changes in the miner's share price.

Pendal slashes, Fidelity holds on Rio

Pendal's holding of BHP shares shows the biggest change among the four strategies examined here.

Having allocated more than 10 per cent of its Australian share portfolio to BHP as of June last year, it has steadily reduced this to just over 6 per cent as of 31 October. Pendal remains overweight versus the index, but only slightly.

Fidelity has left its Australian shares strategy's allocation to BHP relatively unchanged, whereas it more than halved its allocation to Rio between June and September last year.

Since September 2018, it has largely mirrored the index in its underweight weighting to Rio.

Investors Mutual a mining bear

Investors Mutual is the least bullish of these fund managers on the outlook for Australia's big miners. Devoting only about 8 per cent of its overall portfolio to the sector, it doesn't currently own Rio Tinto, and has only a 3.4 per cent weighting to BHP.

This underweight position compared to the index has remained consistent over the last 18 months, really only varying in line with BHP's share price movements.

Anton Tagliaferro, Investors Mutual's investment director, is deterred by the highly volatile resources sector, particularly the sharp movements in the price of iron ore, and prices in a longer-term iron ore price of about $55 a tonne.

"We tend to take a very conservative iron ore price and that's what we put in our model. We're not going to change our valuations based on where the iron ore price is sitting at any given time," Tagliaferro says.

He singles out Rio, which is currently trading at more than $97, suggesting that $70 is closer to its true worth in the current market.

"You'll see that its share price moves almost in tandem with the iron ore price, so buying Rio today, you're just buying the price momentum," Tagliaferro says.