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Income and Fixed Interest
AMY XIE PATRICK: China’s going lower on rates. Here’s what it means for investors
As the West hikes rates, China keeps cutting, hoping to counter the impact of its Covid-zero policy and spark demand in a debt-laden property sector (see graph below).
Will Beijing continue the course? And what does that mean for investors?
China’s monetary authorities are not independent as we know them in Australia and the US, explains Pendal’s Amy Xie Patrick in our latest fast podcast.
“The central bank in China has been lowering interest rates because the economy quite frankly is in a rut.
“Most major investment bank analysts expect growth in China will fall to levels not seen over the last decade. Frankly China will struggle to get above the 4% threshold for the next year or perhaps even more.”
If these headwinds continue to build for China, and stimulus efforts continue to be piecemeal, the outlook for global fixed income could be very bullish, says Amy.
FAST PODCAST: Will country-level ESG become more important after Ukraine?
Play podcastFAST PODCAST: Will country-level ESG become more important after Ukraine?
Will ESG have a bigger impact at country level after the corporate reaction to Russia’s invasion of Ukraine? ESG investing has two main aims, says Pendal ESG credit analyst Murray Ackman in our latest podcast. “One is about avoiding a financial loss or achieving an upside, and the other is about bringing about change.” Can investors bring about change in a country, for instance engaging with sovereign bond issuers? “You can have a lot of influence over businesses, but countries are a lot bigger and a lot harder to influence, though there have been examples such as South Africa. “The Russian example is a little idiosyncratic because there’s widespread sanctions and the speed and scale of condemnation in the west is very unique. “Very few businesses have applied the same standards to other countries that have invaded sovereign nations, though we can see the English Premier League is starting to question this in regard to Saudi Arabia and Yemen, so maybe this will change. “We’ve seen there is a re-setting of the status quo view, so perhaps this is a watershed moment on the way in which we invest in countries.”
FAST PODCAST: Where inflation is heading and how to think about bonds now
Play podcastFAST PODCAST: Where inflation is heading and how to think about bonds now
How should investors be thinking about bonds now?
The market is factoring in 3% cash rates and believes we’ll get there around Christmas, says Pendal’s Tim Hext in this podcast.
“I think they’re probably going to end up closer to 2% than 3%, but the point is the market pricing.
“If you buy a bond today, you’re buying the expected interest rates in the future, which are quite high. A 10-year bond is now 3.5%.
“Last time we spoke on this podcast we were heading through 2.5%. I said then, if you’re underweight bonds, you might want to start thinking about getting back to neutral.
“Now they’re starting to get into territory where you could even look at going overweight bonds.
“I believe inflation eventually heads back 2.5% to 3%. And real interest rates – the return you get above inflation – shouldn’t move a lot higher than where they are now, around about 1% for 10 years.
“If you give the government your money today, you’re in a sense locking in an inflation rate around 2.5%, plus an extra 1% return on top, which in my mind for a risk-free asset is quite a good return.”
FAST PODCAST: How the China slowdown is affecting Aussie investors
Play podcastFAST PODCAST: How the China slowdown is affecting Aussie investors
What does China’s slow-down mean for the global economy – and specifically for fixed income investing?
“We’ve been sheltered so far because our comeback from Covid – thanks to a lot of fiscal stimulus around the world – has helped buffer these headwinds coming out of China,” says Pendal’s Amy Xie Patrick in this week’s fast podcast.
“But at least in the short term China’s lockdown measures are leading once again to bottlenecks in supply chains and logistics.
“Slowing growth should mean bonds have their heyday again. But in the near term it’s difficult to say this is the turning point in bond yields, because inflation is still a worry.
“If the growth situation in China gets materially worse – which isn’t our base case – fixed income portfolios that look a lot like equity portfolios with a lot of credit and high yield in them will fare poorly.
“But if you are willing to dip your toe into purer fixed income portfolios that rely much more heavily on that duration lever – those portfolios will be more reliable at delivering a defensive performance profile if the worst scenario eventuates out of China.”
FAST PODCAST: Not all income funds are well positioned for rising bond yields
Play podcastFAST PODCAST: Not all income funds are well positioned for rising bond yields
Bond yields have been rising and fixed income investing is gaining advocates.
But not all income funds are in the right position to take advantage says Pendal’s head of income strategies Amy Xie Patrick.
“One year ago, to invest in risk-free bonds in Australia, you were getting paid virtually nothing,” says Amy in her latest podcast. “Now you’re getting paid nearly 2.5%.
“But if you don’t have the flexibility within your portfolios to take advantage of this higher-yield environment, then this is a really large prize you are being forced to forego.
“Investors need to look at what kind of income fund they’re getting into. Is it a buy-and-hold, steady as she goes, let’s-not-do-much-about-it kind of income fund?
“Or has your income fund actually been incredibly active to insulate you against the rising interest rate risks, the rising macro risks, that have occurred over the last 6-to-12 months?
“The latter is positioned with more flexibility – and more dry powder – to take advantage of the higher yields we have today.”
FAST PODCAST: What rates expectations mean for bond-buying
Play podcastFAST PODCAST: What rates expectations mean for bond-buying
Investors should be looking to upweight bonds in their portfolios on a medium-to-long term outlook, argues Pendal’s TIM HEXT in this fast podcast.
Bonds are starting to get towards levels where you could argue in the medium-to-longer term they make a lot more sense.
It’s been very difficult for me as a bond fund manager over the last couple years to recommend that bonds were a good investment down at 1%. The risks were much more to the upside.
Get ready as China edges away from zero-Covid policies
“The trend [in yields] has definitely been changing”, says Amy Xie Patrick, Pendal’s Head of Income Strategies.
“What you’ve been seeing is not only that nominal yields have been rising, but real yields have also started to rise.”
What does that mean for investors?
“The rise in real yields really reflects at an economic level, a sense that the market is expecting growth to start to return to a very healthy and positive trajectory,” says Amy in her latest fast podcast.
“Positive real yields are a sign the economy is going to be thriving. Negative real yields are a sign the economy is going to be stagnating.
“The fact that real yields have been trending up — and in our view will go positive at some point in 2022 and continue to trend up — is a good sign for the economy.”
FAST PODCAST: Outlook for rates, inflation and what it means for bonds
Play podcastFAST PODCAST: Outlook for rates, inflation and what it means for bonds
Investors should be looking to upweight bonds in their portfolios on a medium-to-long term outlook, argues Pendal’s TIM HEXT in this fast podcast.
Bonds are starting to get towards levels where you could argue in the medium-to-longer term they make a lot more sense.
It’s been very difficult for me as a bond fund manager over the last couple years to recommend that bonds were a good investment down at 1%. The risks were much more to the upside.
Pre-election rate rise on the cards
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Pre-election rate rise on the cards
Australia this week sped past the RBA’s 2-to-3% inflation target and caught up with other global economies.
What’s next?
Beyond the headlines of yesterday’s 5.1% CPI result, the contribution of new dwelling purchase price and rents are useful bellwethers, says Anna Hong from Pendal’s Income and Fixed Interest team.
“New dwelling prices came in at 5.7% for this quarter — the highest since the turn of the century. Builders are finding it difficult to quote given the cost pressures they’re facing.”
Meanwhile rents turned the corner, contributing 0.6% this quarter. “Rent growth is accelerating across capital cities and there is more to come.”
This means increased pressure on the RBA to hike rates during the election campaign, says Anna.
“Markets have already priced in aggressive rate hikes in 2022 and a cash rate forecast above 3% by end of 2023. This may come as a shock to mortgage holders.
“The RBA is increasingly looking like it must join other central banks in dampening demand to rein in inflation rather than waiting for supply to fix itself.”
Why ‘true’ social bonds are in short supply
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Why ‘true’ social bonds are in short supply
Most social bonds investors have the same aim: to make money while making a positive difference in society.
An example is the National Housing Finance and Investment Corporation, which last year issued $200 million in social bonds, making returns for investors while providing cheap funding for social and affordable homes.
But not all social bonds are equal when it comes to use of proceeds, cautions Murray Ackman, a credit ESG analyst with Pendal’s income and fixed interest team.
Pendal takes a relatively refined view, focusing on social bonds where the proceeds benefit the underprivileged.
Social bonds “don’t always meet our criteria”, says Ackman.
“For example, in the Netherlands around 70 per cent of the population is eligible for social housing. So, a Dutch Housing Authority ‘social bond’ isn’t going to fit our criteria.
“Our view is that a social bond should be an instrument to serve the underprivileged in society.”
Sustainable fixed interest: How to weigh up WA’s new green bond
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Sustainable fixed interest: How to weigh up WA’s new green bond
Australians invest some $25 billion a year in local green, climate and social impact bonds, according to the Responsible Investment Association’s latest benchmark report.
But only some meet the highest standards of sustainable investors. And it’s not always obvious which ones.
Consider these three examples of recent issuers:
- A national electricity network connecting renewables to the grid
- A telco giant reducing power consumption on its network
- Mining super power Western Australia – the only Australian state that emits more carbon now than it did in 2005
You may be surprised to learn that only the WA bond – announced last week – met with the approval of Pendal’s income and fixed interest team, including ESG credit analyst Murray Ackman.
WA’s green bond “reflects the focus of the government to green up their economy and their energy use,” says Murray.
How to evaluate Australia’s first sovereign green bond
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How to evaluate Australia’s first sovereign green bond
The federal government last month announced plans for its first ever green bond in 2024.
The bond will offer a return while funding projects – such as hydrogen, batteries and biodiversity – that support a transition to net-zero carbon emissions.
What should investors make of it?
“We’re excited to see the government show interest in green bonds,” says Murray Ackman, credit ESG analyst in our income and fixed interest team.
“But not all green bonds are equal.”
Murray has four main questions that investors should ask when considering the government’s plans:
- Is the bond supporting genuinely new projects?
- Are the projects truly revolutionary?
- Are expectations about reporting clear and transparent?
- Is the green bond connected to a genuine policy commitment to address climate change?
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