Pendal Dynamic Income Fund
Important Updates
Pendal Dynamic Income Fund (APIR: BTA8657AU, ARSN 622 750 734)
Effective 19 March 2020, the Pendal Dynamic Income Fund (Fund)’s buy-sell spread will increase from 0.14% with 0.07% payable on application and 0.07% payable on withdrawal to 1.02%, with 0.07% payable on application and 0.95% payable on withdrawal.
The buy-sell spread is an additional cost to you and is generally incurred whenever you invest in the Fund. The buy-sell spread is retained by the Fund (it is not a fee paid to us) and represents a contribution to the transaction costs incurred by the Fund such as brokerage and stamp duty, when the Fund is purchasing and selling assets. The buy-sell spread also reflects the market impact of buying and selling the underlying securities in the market. Importantly, the buy-sell spread helps to ensure different unit holders are being treated fairly by attributing the costs of trading securities to those unit holders who are buying and selling units in the Fund.
Due to the impacts of COVID 19, investment markets have experienced substantial increases in volatility and substantially reduced liquidity in some markets, resulting in increases in trading costs in fixed income markets. The Fund invests primarily in Australian issued investment grade corporate bonds and the change in buy-sell spread does not reflect a deterioration in the credit quality of these assets.
Following a review by the Responsible Entity, Pendal has determined to increase the Fund’s buy-sell spread to 1.02%, of which 0.07% is payable on application and 0.95% is payable on withdrawal. Pendal will continue to monitor market conditions and review and update the buy-sell spread regularly as required. You should therefore review the current buy-sell spread information before making a decision to invest or withdraw from the Fund.
Please refer to our website www.pendalgroup.com and click ‘Products’ for the Fund’s latest buy-sell spread.
Pendal portfolio specialist Chris Adams presents a wrap of COVID-19 market observations, likely scenarios and portfolio positioning insights from the Pendal team
WE ARE now seeing the market price in economic disruption caused by government efforts to contain the coronavirus spread and “flatten the curve”.
We’ve seen from China, South Korea and Singapore that economic lockdowns can be successful in limiting the increase in infection rates.
Such actions reduce mortality rates by ensuring healthcare systems are not overwhelmed — and appear to have brought the virus spread under control in those countries.
But the question for investors is: how much structural damage is done to the economy as a result of measures to halt the virus’s spread.
There are two parts to this question:
1. How long will the economic disruption last?
2. How successfully can monetary and fiscal measures compensate?
Uncertainty about these questions is reflected in the extreme volatility of equity markets of the last two weeks.
There is stress emerging in credit markets. Constant dialogue with our Bonds, Income and Defensive Strategies team, led by Vimal Gor, has helped us maintain a relevant and granular view of this issue.
Spiking credit spreads reflect the fear that this period of economic disruption will result in widespread business closures.
However unlike the GFC or previous crises, this episode is not the “fault” of irresponsible behaviour in a particular industry.
The stress is caused by understandable government actions to prioritise the health outcome over the economic outcome.
This notion is reinforced by the view that the health system has not been adequately prepared to deal with a pandemic. This means governments should be more inclined to back-stop industries under stress.
This contrasts with previous crises where governments were less willing to intervene in troubled industries, citing the “moral hazard” of irresponsible activity.
As a result we are likely to see governments go to unusual lengths to put a firewall between the economic disruption they are causing now and the potential structural consequences that could result.
Industry-based interest free loans, tax holidays, debt guarantees — and central bank purchases of commercial paper and even equities — are all on the table.
The goal is to reduce the risk of widespread business closure and unemployment.
Business impact
That said, the possible impact on businesses and the broader economy should not be understated.
Businesses are likely to shut down and some will go bankrupt. There are likely to be redundancies and workers on unpaid leave which will have knock-on effects on consumer demand.
While industries such as travel, energy, some retail and hospitality are feeling the first-order effects, few industries will resist some level of impact from policy measures.
That might be impact on financial companies via lower interest rates, impact on the infrastructure names via reduced traffic rates or potentially lower subscriber growth for some of the WAAAX names.
Some companies and industries will be less sensitive to social distancing measures, or may even see some benefit. Telecommunications, for example, or supermarkets while hoarding goes on. However these are relatively few.
The key factor is the market’s confidence that government measures will prove sufficient to underpin vulnerable sectors and see them through the worst of the economic disruption.
Possible outcomes
Pendal is fortunate to have a team with deep experience that has weathered several episodes of this nature.
Each crisis has its own characteristics but the challenge is the same: protect capital as much as we can and position ourselves to take advantage of the opportunities.
It is important to acknowledge that we do not know the outcome.
We are experts in analysing companies — not in virology. We have no special insight here that gives us an edge in determining the likely outcome for the spread of COVID-19 and social distancing measures to combat it.
What we do is provide a framework in how to think about probabilities, position the portfolio to perform in the most likely outcome, and make sure we are hedged against the less likely — but still possible — scenarios.
The outlook here will be determined by the virus spread and the success of measures to combat it.
We group the potential outcomes as follows:
1) Worst case: A widespread global pandemic, provoking a sustained global recession, zero rates, unconventional policy responses and further material falls (>20%) in the equity market. We think this is a lower probability outcome, particularly given the moves made in recent days to contain the virus.
2) Rolling outbreaks globally: Short-term economic downturns of 2-4% followed by quick recovery. Policy responses include zero rates and targeted fiscal stimulus. This scenario could see further markets falls — potentially of up to 10% or so — with a bounce-back by year’s end.
3) Milder outbreak: Containment measures and the northern hemisphere Spring curtail the spread. This could see a short-term slowdown, with rate cuts and limited fiscal stimulus. The market may already have seen its lows if this is the case, with a good chance of a 10-20% bounce.
4) A quick resolution: A medical breakthrough could see economic acceleration, a reversal in rate cuts, bonds falling sharply and a 20% or more rally in equities. Like the negative extreme, we see this as a low probability outcome.
Portfolio framework is important
Experience has taught us it’s important to focus on what you can control.
We cannot control the outcome of this health issue. We cannot control the market’s reaction. But we can control the framework we think best positions the portfolio.
And we can control our view on which are the best companies to hold within each of the framework categories.
The portfolio’s framework in this environment is designed to weather the more likely outcomes — scenarios two and three — and to take advantage of the buying opportunities that emerge.
We also need to be mindful of protecting the portfolio in the case of one of the more extreme scenarios playing out.
In this context, here’s how we consider the portfolio’s structure:
1) Recession insurance: We want stocks with the potential to hold up well if economic conditions deteriorate. We have some gold exposure — and also hold positions in bond-sensitives that should do well if sentiment worsens.
In terms of the traditional defensives it is important to be selective. We want to hold A-REITs backed by good assets with low gearing, avoiding those with a high exposure to consumer discretionaries.
In infrastructure, it is important to recognise that traditional correlations to bond yields may be swamped by fundamental factors — for example, Sydney Airport is likely to see a hit from travel restrictions, while we also need to be mindful of a material fall in commuter traffic for the toll roads.
2) Quality defensives: Companies that combine strong balance sheets, good management and low sensitivity to the near-term economic dislocation, with relatively limited impacts on revenue.
3) Beneficiaries of fiscal stimulus: While central banks have already moved to cut rates, governments are also increasingly expected to inject stimulus to help companies and the economy bridge the expected slowdown.
The iron ore price has held up reasonably well, helped by weather-related supply disruption in Australia and Brazil and a gradual increase in confidence that China has brought the situation under control.
We think the iron ore miners would benefit from stimulus in China, while we also see housing as a natural area for governments to inject stimulus, with James Hardie a likely beneficiary.
4) Franchise winners: These are good businesses that may see a near-term hit but are well positioned in terms of balance sheets and competitive position to withstand a slow-down. They look attractively valued on a two-to-three-year view.
5) Resolution insurance: There are several stocks we expect to surge quickly on any sign of slowing infection rates or a medical breakthrough. Qantas is our key position here.
6) Areas to remain cautious: If this was just a short-term hit to demand then the sharp drop in the oil price might make energy look more interesting. But the break between Russia and OPEC on production cuts over the weekend has complicated the issue.
If we are entering a grab for share — with some signs that Russia is looking to put pressure on the US shale industry — then the risks here are elevated relative to other commodities.
We also remain cautious on the banks. Dividend yields remain attractive, but additional rate cuts just bring further margin pressure to bear.
A stimulus package could also include some measures to allow struggling businesses to defer interest payments — although there is speculation such a measure may include the quid pro quo of cheap funding for the banks.
How we’re positioning
Within this context, as we stand today, we have a skew to the defensives and recession insurance and beneficiaries of stimulus.
We are being opportunistic around the franchise winners. We are broadly neutral in terms of those companies that we consider resolution insurance.
Given uncertainty about the duration of economic disruption, we need to understand how the first, second and third-order effects of an extended disruption would impact companies.
The size of our team means we are doing this for every stock under our coverage, which includes every stock in the ASX 100, plus a material portion of the Small Ords.
The goal is to identify vulnerabilities that the markets not thinking of now, but which may emerge if the situation deteriorates.
We are modelling companies on the basis of what we think would happen to revenues and earnings if the disruption lasted three months, six months, nine months or longer.
What does that mean for revenues, for working capital, for balance sheets and debt covenants? This has been the key focus this week.
It provides concrete insight which then feeds into our framework — helping select the very best stocks to fit each bucket and help the portfolio perform in an uncertain environment.
Market observations
Markets are now starting to price in the risk of a material downturn in earnings and recession.
It is worth mentioning that equity market volatility has probably been exacerbated by people hedging credit market exposures. Credit ETFs have created an expectation of liquidity that has not been the case now we are in a period of stress.
We are seeing signs that equities are being used to hedge illiquid credit positions in some instances, contributing to volatility.
The influence of ETFs and passive investing is clearly apparent in the indiscriminate nature of the market sell-off.
This has been exacerbated by the effect of risk parity strategies and other systematic approaches needing to de-risk.
The market’s sell-off is rational, but indiscriminate selling has led to outcomes which are irrational — such as the poor performance of traditional hedges such as gold.
We are mindful of heightened near-term uncertainties and second-order effects.
But when stocks with limited or even positive sensitivity to near-term economic environment are sold off to the degree we have seen, there is no doubt there is mis-pricing and opportunities for active managers.
At this point the market has been hit by a valuation de-rating.
Several companies have withdrawn earnings guidance, though we are yet to see widespread earnings downgrades.
These will come. But it’s only once companies and investors start to understand the duration of economic disruption and the softening effect of policy that we will start to gain a sense of the full market effect.
Key factors to watch
Key factors to watch here include the rate at which infections spread and when they peak, as well as the scale and focus of fiscal and monetary policy measures.
We’re likely to face further volatility until we have a handle on how long the economic dislocation will extend — and until we gain confidence that government actions will underpin the economy during this period.
At that point, we expect investors will start to recognise the undoubted value that is emerging in parts of the markets on a three-to-five-year view.
In this environment active portfolio construction and risk management is crucial.
The ability to weigh risks, recognise the opportunities as mis-pricing surges, and provide a clear and disciplined framework to account for an uncertain range of possible outcomes has paid dividends thus far.
We believe will continue to do so as the current crisis unfolds and the path to recovery becomes clear.
Financial markets have been through all sorts of crises and this is one from which the economy will eventually emerge, explains Pendal Head of Multi-Asset, Michael Blayney
Commuters take precautions against cornonavirus in the central Chinese city of Chongqing, January 23, 2020. Source: Shutterstock
TWO THINGS are clear about COVID-19 (coronavirus) at the time of writing:
a) The attempt to contain the coronavirus spread in China will have a very significant impact on economic data and corporate results.
b) The scale of the impact is very unclear and most commentators are just guessing.
We do not have any unique source of information regarding the Chinese economy and its implication for Chinese financial markets.
As per our process, though, we believe levels and trends in shorter-term economic data are generally under-appreciated by equity investors.
This note aims to focus on some of the data series we believe will be important to understand growth and activity levels in the Chinese economy.
It is important to note, when looking at all Chinese data, that the first quarter includes the Spring Festival (Lunar New Year), which is highly disruptive to calendar month data. In 2019 the New Year was in February but in 2020 it’s January.
Key data sources
In terms of sources, firstly there are Chinese government-related media sources.
These include the Global Times (a news service run by the Chinese Communist Party’s People’s Daily news organisation) and the Xinhua News Agency (the official Chinese state press agency).
For example, a Global Times article published on February 3 opened: “The novel coronavirus outbreak in China is expected to harm economic growth by at least two percentage points during Q1 2020, according to forecasts.”
The Chinese Communist Party (CCP) expects Q1 to be bad. This is not an exercise in managing market expectations on anything.
Car sales are often an important metric of domestic demand in middle-income economies and China has high-quality vehicle sales data released in the second week of the following month.
This has to be taken in the context of the economic cycle (and also the possible realisation of “peak car” in urban China). Year-on-year car sales have been negative since mid-2018 but the next few months will be an important guide.
Trade data is highly useful.
Import data (in both US dollar and Chinese yuan we prefer the dollar data) also comes in the second week of the month.
Like the car sales data series, this showed clear signs of a recovery in the December numbers. The size of any reversal will be key.
Similarly, China takes 25.1% of Korean and 23.9% of Taiwanese exports. Korean preliminary export data (released around the 22nd of the month, covering the first 20 days of that month) are particularly advanced.
The January print showed a continuation of a recovery that began in October 2019. The next release, due February 21, will be another important sign.
Other data released on a timely, monthly basis include rail, air, toll road and port volume metrics. For example, train passengers departing Beijing in the first 21 days of the Spring Festival travel rush were -11% year-on-year.
Classic economic data that must also be considered include PMI surveys and credit and loan volume data (we have written extensively on the importance we place on credit and loan data in EM in general and in China in particular).
Less reliable data
Some of the less reliable higher-frequency data sources include Leading Economic Indicators (LEIs), commodity prices and market moves.
LEIs are infamous for correlating with market moves. But the OECD China LEI, as an example, has six underlying constituents — one of which is… the Shanghai Stock Exchange.
Similarly, it is too easy to construct a process that notes the rising price of a commodity, extrapolates strong demand in China for that commodity, and then buys the shares of the producers of that commodity which have already benefited from the rising product price.
Ultimately, we believe monthly top-down economic data is generally overlooked by equity investors focused on quarterly or semi-annual bottom-up corporate results.
We expect this process to be of significant advantage in the next few months in China, as the impact of coronavirus plays out.
With concern growing among clients about the impact of their investments on the environment and society, combined with the increase in fund managers talking about ESG and responsible investing, the Sustainable Development Goals (SDGs) are in the spotlight. 
They are shaping the way investors of all sizes and persuasions are thinking about the social and environmental impacts of their investments. Fund managers are responding with products that contribute to the achievement of the SDGs.
But what are they, and how do they actually apply to investments?
The SDGs were borne out of the United Nations as a blueprint for economic development that is just and sustainable, now and into the future. The SDGs agenda is a set of 17 globally agreed Goals – each with a subset of targets and indicators – to be achieved by the year 2030.
While the SDGs were intended to guide policy makers around the world, there is a clear role to play for the private sector. Companies and investors alike are well positioned to allocate capital that will contribute towards the Goals.
There are a number of ways the SDGs can apply to investments – and some are more credible than others. The SDGs are especially helpful for those interested in ‘impact investing’, or achieving environmental and social outcomes alongside financial returns.
In this article, we provide context on the SDGs, outline investment approaches that make a meaningful contribution to the Goals, and support investors in navigating this emerging investment theme.
Pendal Global Emerging Markets Opportunities Fund
(APIR: BTA0419AU ARSN: 159 605 811) – Important information
Reduction in management costs from 6 February 2020
With effect from 6 February 2020, the Fund’s management costs will reduce from an issuer fee of 1.40% pa to 1.18% pa.
The Australian bushfire crisis has prompted an unprecedented response from everyday Australians offering help to those affected.
Pendal is supporting these efforts with a program to match employee donations for bushfire relief and recovery.
We are matching 1:1 staff donations to registered charities assisting with bushfire relief and recovery up to a total of $200,000.
As a global initiative this includes staff at our UK-based subsidiary J O Hambro Capital Management.
Pendal is providing additional paid leave for Australian employees directly affected by the bushfires or involved in recognised voluntary emergency services.
We are also providing Australian employees with five days of paid volunteer leave for the purpose of helping with bushfire related volunteer work.
Counselling services for employees are also available.
Pendal offers our thanks and acknowledgement to volunteers helping to fight fires and support recovery efforts across Australia.
Pendal International Share Fund (APIR: BTA0056AU, ARSN 087 593 299)
Investment Manager
As stated in our notice of 22 November 2019, we have decided to replace AQR Capital Management, LLC (AQR) as the investment manager of the Pendal International Share Fund (Fund) and appoint the Pendal Global Equities team. The change will take place on or around 21 February 2020.
We wish to provide further details regarding the change of manager and the potential impact to investors. This update should be read in conjunction with the notice of 22 November 2019.
Transaction costs
The change in investment manager will require the sale and purchase of securities within the Fund as we transition to the new portfolio. As is currently the case there will be costs such as brokerage and taxes involved in these transactions which will be borne by the Fund.
Pendal estimates that the total cost of changing the investment manager will be in the order of 0.35% to 0.45%. This will be a one off cost that covers: the sale of current securities; the purchase of securities selected by the Pendal Global Equities team; and the increase of the buy-sell spread detailed in our notice of 22 November 2019. This amount represents transaction costs incurred by the Fund and is not a fee paid to Pendal.
These costs were taken into account in assessing whether the proposed changes to the portfolio was in the best interests of investors.
Tax impact
Pendal does not provide advance notice of the tax impact of transactions within the portfolio to investors. This was, however, a factor in our consideration of whether the proposal is in the best interests of investors.
At 30 June 2019, the Fund had sufficient net realised capital losses to cover any unrealised capital gains. We expect these losses to be available to offset any realised capital gains in the current financial year.
Pendal Core Global Share Fund (APIR: RFA0821AU, ARSN 089 938 492)
Investment Manager
As stated in our notice of 22 November 2019, we have decided to replace AQR Capital Management, LLC (AQR) as the investment manager of the Pendal Core Global Share Fund (Fund) and appoint the Pendal Global Equities team. The change will take place on or around 21 February 2020.
We wish to provide further details regarding the change of manager and the potential impact to investors. This update should be read in conjunction with the notice of 22 November 2019.
Transaction costs
The change in investment manager will require the sale and purchase of securities within the Fund as we transition to the new portfolio. As is currently the case there will be costs such as brokerage and taxes involved in these transactions which will be borne by the Fund.
Pendal estimates that the total cost of changing the investment manager will be in the order of 0.35% to 0.45%. This will be a one off cost that covers: the sale of current securities; the purchase of securities selected by the Pendal Global Equities team; and the increase of the buy-sell spread detailed in our notice of 22 November 2019. This amount represents transaction costs incurred by the Fund and is not a fee paid to Pendal.
These costs were taken into account in assessing whether the proposed changes to the portfolio was in the best interests of investors.
Tax impact
Pendal does not provide advance notice of the tax impact of transactions within the portfolio to investors.
This was, however, a factor in our consideration of whether the proposal is in the best interests of investors. At 30 June 2019, the Fund had net assets of $181.7M of which $0.8M were net unrealised capital gains.
Pendal Core Hedged Global Share Fund (APIR: RFA0031AU, ARSN 098 376 151)
Investment Manager
As stated in our notice of 22 November 2019, we have decided to replace AQR Capital Management, LLC (AQR) as the investment manager of the Pendal Core Hedged Global Share Fund (Fund) and appoint the Pendal Global Equities team. The change will take place on or around 21 February 2020.
We wish to provide further details regarding the change of manager and the potential impact to investors. This update should be read in conjunction with the notice of 22 November 2019.
Transaction costs
The change in investment manager will require the sale and purchase of securities within the Fund as we transition to the new portfolio. As is currently the case there will be costs such as brokerage and taxes involved in these transactions which will be borne by the Fund.
Pendal estimates that the total cost of changing the investment manager will be in the order of 0.35% to 0.45%. This will be a one off cost that covers: the sale of current securities; the purchase of securities selected by the Pendal Global Equities team; and the increase of the buy-sell spread detailed in our notice of 22 November 2019. This amount represents transaction costs incurred by the Fund and is not a fee paid to Pendal.
These costs were taken into account in assessing whether the proposed changes to the portfolio was in the best interests of investors.
Tax impact
Pendal does not provide advance notice of the tax impact of transactions within the portfolio to investors. This was, however, a factor in our consideration of whether the proposal is in the best interests of investors.
At 30 June 2019, the Fund had net assets of $220.2M of which $22.1M were net unrealised capital gains (before the application of the 50% CGT discount). The Fund also had carried forward revenue losses of $10M related to currency hedging which may be available to offset realised capital gains.