Significant Features: The Pendal Active High Growth Fund is an actively managed diversified portfolio that invests in Australian and international shares, Australian and international listed property securities, Australian and international fixed interest, cash and alternative investments. The Fund has a significant weighting towards growth assets.
Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the Fund’s benchmark over the medium to long term.
The Reserve Bank is easing off the accelerator instead of tapping the brakes. Pendal’s Tim Hext explains what investors can expect next
THE RBA this week enacted what they would view as stage three of the great stimulus unwind.
Stage one was the end of new money in the Term Funding Facility (TFF). This concluded in June, with $187 billion taken up. This was 3-year money, so it runs off from June 2023 to June 2024.
Stage two was capping Yield Curve Control at April 2024. This was done in early July.
And now Stage three this week is a gentle taper of Quantitative Easing (QE) purchases from $5 billion a week to $4 billion – hardly impactful but a signal things are improving.
Future stages will likely see more QE tapering. The RBA is signalling the next review in February next year.
By then total QE will be nudging $300 billion.
We expect QE to be finished by August 2022. Then we adopt a wait and see before any actual tightenings.
The RBA has been very clear this can only occur once inflation is sustainably within the 2-3% band.
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We think it will be there by late 2022, but the RBA wont tighten until well into 2023. A modest hiking cycle up to 1.25% should then follow.
Why do we think any tightening cycle will be modest?
Well, it’s important to remember mortgage rates and deposit rates fell by more than 1.5% in early 2020, despite cash rates only falling 0.65%. This was due largely to the TFF flooding the system with cheap term money.
As the TFF unwinds, it is therefore expected mortgage rates will move higher, independent of the RBA.
Hikes of 1.25% by the RBA will look more like 2% in the real economy. This is more than enough to tap the brakes.
Of course all this assumes a world where vaccines do their job. It also assumes a world where inflation edges higher, but largely behaves.
Time will tell.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.
Risk is a constant theme for investors and is never more front of mind than amid a once-in-a-generation bull market.
- Investors wary of market rally ending
- But risk pricing indicates benign outlook
- Low institutional complacency a good sign
THE S&P 500 has not had a 5 per cent fall since before last year’s US presidential elections, soaring by more than a third since those lows.
In Australia, the S&P/ASX200 is up by a quarter over the same time frame.
Conventional wisdom says the longer markets rise, the more risk of correction must be building in the system.
But this time around the conventional wisdom looks wanting, according to Tom Ciszewski, a volatility analyst with Pendal’s Bonds, Income and Defensive Strategies team.
Risk measures and positioning can often be a contrarian indicator says Ciszewski.
When investors are hedging themselves it often can be supportive of further bullish performance. On the other hand low hedging and bearish positioning can be a sign of complacency and a relative market top.
“The way derivative risk and implied volatility is priced right now in equities globally, it’s actually pricing in for a pretty benign environment,” he says.
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Ciszewski says investors should keep a close watch on how big institutions position themselves in derivatives markets as they protect their portfolios against the risk downturn.
Perhaps paradoxically, Ciszewski’s confidence is founded on the fact that institutions have been buying downside protection as the market rises.
This is because in the past over-confidence and complacency among institutional investors is an indicator that markets may be close to topping out.
“You’re always looking for when and how things will blow up. What is the next downturn going to be and how will we make money during it?” says Ciszewski.
“But right now, there’s very little complacency. The institutions are giving up a little upside to buy more downside,” he says.
Measuring institutional sentiment
One way to measure institutional sentiment is the ratio of put and call options being traded.
A high put/call ratio indicates more people are buying puts than are buying calls. It’s an indicator that investors are protecting themselves against potential market falls.
The SPX put/call ratio, which measures options on the S&P500, has risen over the past year to above two. That indicates twice as many put options as call options are trading on some days.
Ciszewski says institutions may be buying downside protection simply because they have had a strong year of gains and feel they can afford to protect themselves, or it could be they see genuine risk on the horizon.
Corroborating the high level of put buying and lack of complacency by institutional investors is the current level of SPX Index option skew. The implied volatility of downside strike puts versus upside strike calls is at multi-year highs.
“Either way, it has this kind of circular effect and allows the market to continue to grind higher.”
When will the outlook change?
So, what will change the benign outlook? And what risks should investors be keeping an eye out for?
Ciszewski says inflation is the biggest potential threat, saying that if markets are wrong and the inflation showing up now around the world is not transitory, that could end the equities rally.
The other risk is if the COVID pandemic manages to outmanoeuvre vaccines and triggers new lockdowns and border closures.
Right now, neither scenario looks likely, he says.
Institutional investors are confident inflation is a temporary effect of reopening.
And markets are looking through the COVID pandemic to a time when life returns to normal.
“There’s more American cases of COVID this Labor Day than there were last Labor Day,” says Ciszewski.
“It doesn’t mean they’re going to lock down. We all have to be careful about merely reading the headlines.”
About Tom Ciszewski and Pendal’s Income and Fixed Interest boutique
Thomas Ciszewski manages Pendal’s volatility fund, implements defensive derivative structures and develops multi-asset class strategies. He has 24 years of experience in managing derivative portfolios and producing positive uncorrelated returns for investors.
Pendal’s BIDS boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.
Find out more about Pendal’s Income and Fixed Interest strategies here
About Pendal Group
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Significant Features: The Pendal Imputation Fund is an actively managed portfolio of Australian shares.
Fund Objectives: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the S&P/ASX 300 (TR) Index over the medium to long term.
Debate about inflation as transitory or structural misses the point. It’s about building a portfolio that’s robust to a range of outcomes, says Pendal’s Michael Blayney.
- Portfolio construction must allow for all inflation scenarios
- A dynamic approach to investing may be required
- Liquid alternatives, property, infrastructure may be solutions
THE MAJOR global economic debate right now is whether the recent jump in prices in the US, Europe and other parts of the world including Australia, is transitory or structural.
Central banks remain convinced it’s transitory, though a few around the globe have taken steps to taper bond-buying programs. More than 25 central banks — mostly in emerging markets — have raised interest rates so far this year.
It remains to be seen whether we look back on the “inflation is transitory” line as we do now on the Fed’s “sub prime is likely contained” line in 2007.
“You can go through both sides of the argument, but in portfolio construction, that’s not the main point,” says Michael Blayney, head of Pendal’s multi-asset team.
“As an investor you are faced with a huge amount of uncertainty as to the inflation outlook … and it’s about building a portfolio that’s robust to a range of outcomes.
“Portfolio construction has to link back to a client’s objectives and make sure it can handle different scenarios.”
The difference now, compared to the global financial crisis in 2007-08, is the amount of money in the system thanks to government spending, support payments and money creation, Blayney says.
Back then monetary policy was loosened — just as it is today — but fiscal policy was much tighter.
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“There’s an awful lot of money sitting in people’s bank accounts — I’d say an unprecedented amount. It’s hard to imagine it’s never going to get spent. Also, fiscal policies are considerably looser around the world. And we’re starting to see price pressures.
“Last week’s US employment data disappointed with fewer new jobs being created last month, but wages still rose. You also have businesses wanting to de-globalise and bring supply chains closer, which might mean having to accept higher prices.
A portfolio construction approach to inflation
“If you think about all these things, it might mean you sit in the structural camp or the transitory camp. But what you need to think about is balancing portfolio construction risks over range of scenarios,” Blayney says.
Bonds don’t do as well as a portfolio diversifier in an environment where you see unexpected increases in inflation, he says. And if authorities need to tighten monetary policy you could very conceivably see a period where equities and bonds suffer together.
“When the inflation genie gets out of the bottle, traditional bonds become more of a problematic asset, at least initially. It means you have to be dynamic in your asset allocation.
“For example, if bonds sell off a bit because of inflation that might be a good entry point. Once inflation is priced in, it allows you to buy bonds at higher yields. Of course, it means you have to be comfortable not always holding lots of bonds in your portfolio.”
Alternate asset strategies
“You can hold cash, but that’s yielding virtually zero (which is around -2% real). So, you need to look at alternate asset strategies,” Blayney says.
At their broadest, such strategies included everything that isn’t bonds or equities. These strategies can also get access to inflation-linked assets such as commodities and other “inflation-hedging” strategies that are difficult for investors to implement directly themselves.
“There’s liquid alternatives strategies, which rely very much on the manager’s skill and more dynamic management of the fund,” he says. “They tend to be more active and use a lot of relative value type trades with the goal of providing diversification and returns.”
Liquid alternatives involve assets that are easy to buy and sell (liquid) and typically exhibit a lower correlation with traditional stock and bond investments.
Infrastructure and property are other options.
While both are sensitive to rising bond yields they are real assets. Underlying cash flows for many of these assets are linked in some way to inflation through rents (in the case of property), power prices (in renewable energy) or other long-term, contracted inflation-linked revenue streams.
“If you’re worried about sustained, long-term inflation, property, infrastructure and listed alternatives are all good assets to have in your portfolio,” Blayney says.
About Pendal’s multi-asset capabilities
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
These include Australian and international shares, property securities, fixed interest, cash investments and alternatives.
In March 2024, Perpetual Group brought together the Pendal and Perpetual multi-asset teams under the leadership of Michael O’Dea.
The newly expanded nine-strong team will manage more than $6 billion in AUM and create a platform with the scale and resources to deliver leading multi-asset solutions for clients.
Michael is a highly experienced investor with more than 23 years industry experience, including almost a decade leading the team at Perpetual.