In a world without bank hybrids, investors should re-consider their income plan, says Pendal’s head of income strategies AMY XIE PATRICK

• Hybrid securities can suffer meaningful shortfalls
• It’s “unwise” to rely solely on hybrid income through all market environments
• Find out more about the Pendal Monthly Income Plus Fund

FOR years, Australian investors have flocked to bank hybrid securities as a cornerstone of income-generating portfolios.

Hybrids — debt instruments issued by banks that can convert to equity in times of trouble — have been popular with everyday investors due to their accessibility.

But investors will soon need to find alternatives, after the Australian Prudential Regulation Authority announced plans to phase them out from 2027 (see more in our recent quarterly update).

ARPA wants to “simplify and improve the effectiveness of bank capital in a crisis” and replace hybrids with “cheaper and more reliable forms of capital that would absorb losses more effectively in times of stress”.

Below we examine whether hybrids truly delivered on their promise to investors — and we discuss an alternative that could help fill the gap.

The myth of defensiveness

Hybrid securities, as their name suggests, sit somewhere between the asset classes of fixed income and equities.

They serve as one of the first lines of defence in a bank’s capital structures in times of turmoil, and outside of those times pay regular coupons, like bonds.

Though the coupon feature means they are often classed as “defensive”, their purpose as a capital instrument makes them inherently ill-suited to serving a defensive role in portfolios.

Through multiple market cycles, bank hybrid securities globally have exhibited a positive correlation with equity markets.

When things are fine, these securities pay their coupons and may even deliver some mark-to-market capital gains should their credit spreads tighten.

In times of severe market stress, hybrids can behave more like equities than bonds. During the collapse of Credit Suisse in April 2023, the bank’s hybrid securities were written down to zero – a worse outcome than Credit Suisse shares.

As the figure 1 graph below highlights, using the example of CBA, the long-term performance of hybrids has lagged even more senior bonds.

These securities tend to behave like high-quality bonds when all is fine, and like equities when all is not.

The capped potential for capital growth in hybrid securities means they are not capable of generating levels of reward commensurate with the likely volatility investors will experience along the way.

Figure 1: All the risk without the reward
Long-term returns of CBA equity, CBA hybrids (“Perls”) and major bank senior bonds

Exchange-traded ≠ liquidity

Another selling point of hybrids has been their exchange-traded status.

Many investors assume this means that hybrids can be easily bought and sold.

In reality, market liquidity for hybrids has always been contingent upon the ability of brokers to match buyers and sellers in the market. In such a retail-dominated asset class, costly buy-sell spreads can also be a feature.

The fallacy that “listed equals liquid” has been exposed in times of crisis, when the exit doors for hybrids can become very narrow.

Repeatable income? Not so fast

Since hybrids come with a higher risk of capital loss than senior bonds, these securities compensate investors with a higher credit spread, translating ultimately into higher coupons than more senior bonds.

Unlike senior bonds, hybrid coupons can be reduced, delayed or completely switched off. This feature of hybrid securities is a benefit to the issuers as it offers a lifeline in times of need.

For investors, it’s a reminder that the higher income potential in hybrids is far from guaranteed.

Figure 2: More risk should command more reward
Risk and reliability of income through the bank capital structure

 

While Australian bank hybrids have not experienced any volatility in coupon payments in recent history, both the events of the Credit Suisse crisis in 2023 and that of many other European banks during the European Sovereign Crisis in 2012 have shown that it has been unwise to rely solely on income from hybrids through all market environments – particularly considering that the majority of income-seeking investors tend to be conservative in their risk tolerance.

A smarter way to use the capital structure

We’ve uncovered that hybrid securities suffer meaningful shortfalls.

Their contractual terms allow issuers to skip coupon payments. Investors’ ability to access their capital is likely to be variable and limited when they most need it. Their potential for capital growth does not compensate for the meaningful volatility that investors can experience along the way.

But what if there has always been a smarter way to use the capital structure?

Figure 3 expands on the bank capital structure to a broader set of asset types. More importantly, the diagram looks at what jobs these assets are good at doing that could be important to any investor.

Figure 3: Asset utility through the eyes of the investor

The key revelations from Figure 3 are as follows:

• Different assets are good at doing different things
• No single asset class can satisfy all investment objectives
• Hybrids satisfy none of the basic requirements

The idea that different asset types need to be employed may seem daunting, but Figure 4 illustrates that the idea is simple.

In the graph below, we compare the long-term return outcomes of holding CBA hybrids, versus holding most of your capital in cash and putting only 10% into CBA shares.

Nothing beats equities for generating capital growth. And a cash-heavy portfolio has significantly diluted adverse volatility events along the way.

Figure 4: A little bit of equities goes a long way
Comparing long-term returns of CBA hybrids versus a portfolio of 90% cash and 10% CBA shares

 

Pendal Monthly Income Plus Fund – a solution for defensive income

As Australian bank hybrids face extinction, our Pendal Monthly Income Plus Fund provides a compelling alternative for investors.

We start from investment objectives and map them to the assets that have a proven track record of delivering against those objectives.

That means we don’t have to accept market narratives about hybrids (or any other asset types) that have not been entirely accurate.

We don’t have to run for narrowing exits when others stampede. And we don’t have to face a mismatch between the liquidity we offer our investors versus the liquidity we are able to access in the market.

The components of the strategy are simple.

We use high-quality investment grade bonds to generate income. We actively allocate to equities to help our investors’ capital grow, with a track record of avoiding market chaos.

And we use government bonds or interest rate exposure more broadly to manage the portfolio through the rates cycle.

Since the portfolio is 100% Australian, investors also get a healthy franking credit benefit through the portfolio’s equities exposure. And since the portfolio is 100% liquid, investors are also able to access daily liquidity.

The fund’s strategy recognises the broad aims of all income-seeking investors: a regular, stable and repeatable income stream, and capital growth to help offset the effects of inflation over the medium term.

These aims help ensure that the Fund’s investment objectives align with its investors. These objectives and how we’ve measured against them are illustrated in Figure 5.

Figure 5: Monthly Income Plus Fund: our three investment objectives

The fund pays distributions monthly and, since inception 15 years ago, has never missed a payment.

While equity and bond markets the world over suffered double-digit losses in 2022, this strategy’s drawdown was limited to 5%.

And alongside regular income with limited drawdowns, the portfolio’s capital has grown every year bar one since inception.

The longer-term track record of the Pendal Monthly Income Plus Fund can be seen in Figure 6.

Here, we’ve illustrated performance against a hurdle of RBA Cash + 2% (consistent with the risk tolerance of conservative income investors), and against an index of Australian bank preference shares as a generous proxy for hybrid instruments (since shares have greater potential for capital growth than bonds).

The Monthly Income Plus portfolio could have been a replacement for hybrids all along.

Figure 6: Long-term track record

Why wait?

In early September, prior to the APRA announcement, the average gap between bank hybrid and subordinated bond credit spreads tracked around 60 basis points.

This gap was at the tighter end of the historical range of this relationship. Today, this gap stands at less than 10 basis points.

Scarcity has been the main factor behind this compression.

Since banks will no longer be issuing these higher-yielding securities, but investors still like higher yields, the demand has far outstripped supply in recent weeks.

Scarcity, however, does not change the nature of hybrid instruments.

They remain on the frontlines to take losses and cease paying coupons in times of stress.

They will still mature at par (100 cents on the dollar), so cannot offer capital growth to hold-to-maturity investors.

And they will likely be hard to sell (at least at the price investors would like) in times of market turmoil.

It is time to look for better opportunities elsewhere.

 

The door may open for the RBA to pass three cuts next year, but that may be “as good as it gets”, writes head of government bond strategies TIM HEXT

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

THE ABS released new inflation data today and – in the spirit of more information – it seems there are now more numbers to watch than before.

The most watched are the quarterly numbers – that is, the September quarter versus the June quarter.

These showed headline inflation at 0.2%, courtesy of electricity subsidies and lower fuel prices. Against the September quarter last year, prices are 2.8% higher.

Also released were the September monthly numbers.

This compares prices for September 2024 versus September 2023. Here, the news was even better, with headline prices only 2.1% higher over the year.

However, the ABS tries to strip out the noise of volatile prices by reporting trimmed mean inflation, Australia’s version of underlying inflation. The highest and lowest 15% of moves (weighted for size in the CPI basket) are excluded.

Here, the news is mixed.

Trimmed mean inflation for the quarter was 0.8% and 3.5% versus the September quarter last year.

This is heading lower, but the RBA would need to see consistent prints 0.7% or lower to feel comfortable about inflation being sustainably in its target band.

Source: CPI rose 0.2% in the September 2024 quarter | Australian Bureau of Statistics

The path ahead

So, where exactly is inflation and what path is it on? And what is the RBA reaction function?

The RBA will keep talking about services inflation being uncomfortably high. The pace of last quarter showed no improvement, stuck at 4.5%.

Services make up around two-thirds of the CPI basket, so clearly that needs to be nearer 4%. If we dig into services, the problem areas (those above 5%) remain housing, health, education and insurance.

As wage growth moderates with inflation, there is some cautious optimism that education inflation should drift back to 4%. For example, NSW teachers just signed a three-year wages agreement of 3% per year plus 1% more super.

Housing is more mixed. State government spending on infrastructure continues to create labour shortages in construction, impacting both rents and the cost of new dwellings. In this area, 5% inflation may be here to stay for a while.

Insurance premium rises should moderate but may also struggle to fall through 5%.

Health prices remain impacted by massive labour shortages and readjustment of wage levels in the care sector. Again, this is driven by government policy.

Putting it all together

When we put this together, the path for inflation looks like hitting 3% (underlying) early next year but remaining stuck around that point.

This means that the RBA will have a door open to cut rates, though it will be driven by employment markets and the size of cuts globally.

We remain optimistic that this will allow for three rate cuts next year.

However, without some external shock hitting the economy, that may be as good as it gets.

Market pricing has not budged with this number. A February rate cut is priced at a 50% chance, with a full cut not priced till May 2025.

This places the odds slightly in favour of a long-duration position, though US election fears are keeping volatility high and risk size modest.

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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

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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.

Contact a Pendal key account manager

Investment conditions continue to look promising in Brazil and China. Here Pendal’s Global Emerging Markets Opportunities team explains why

• Despite local currency weakness, inflation levels are nearing targets in Brazil
• Shifts in Chinese policies result in attractive equity valuations 
• Find out more about Pendal Global Emerging Markets Opportunities Fund

SEPTEMBER and October are often monumental months in global markets and economics: for example the Asian economic crisis of late 1997 and the GFC in 2008.

This year’s start to Spring may not be quite as pivotal, but we’ve nevertheless seen unexpected and drastic changes in Brazil and China.

Brazil

Brazil’s composite Purchasing Managers Index — a measure of manufacturing industry health — was 56 in July and 52.9 in August.

A PMI above 50 indicates expansion, while below 50 indicates contraction.

Yearly retail sales were broadly up 7.2% in July.

We’ve also seen strong returns from Brazilian equities in local currency terms. The local Bovespa stock index hit a record high at the end of August.

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal Global Emerging Market Opportunities Fund

This economic strength has not come with much inflationary pressure.

Inflation was 4.2% in the year to August (according to the local IPCA consumer price index). This
compared with 4.6% at the end of 2023 and 3.7% in the year to April 2024.

The Brazilian Central Bank (BCB), has responded by moving into a more hawkish monetary stance, lifting the benchmark interest rate by 25 basis points to 10.75% in September.

This move reflects waning confidence that inflation will decline to its 3% target.

Meanwhile, the US interest rate outlook has shifted in recent months, with a sharp decline in expected future interest rates and a 0.5% cut in the US policy interest rate in September.

This has eased pressure on emerging market economies and their currencies.

Together, these developments have further enhanced our enthusiasm for Brazilian equities.

Brazil is performing better than expected, but the weakness in the currency has offset this zeal for international investors.

We believe the central bank raising rates will not significantly worsen the outlook for local equities. Instead it should substantially improve the outlook for the currency (as does the US cutting interest rates).

We continue to believe Brazil equities can deliver strong USD returns.

But we now expect a larger share of that to come from the currency relative to the local equity market.

China

China’s Politburo convened in September outside its typical April-July-December timetable.

A resulting policy statement delivered a dramatic surprise for markets.

The Politburo underlined a critical shift in priorities, including “stopping the decline in housing” and “increasing lending to white-listed projects”.

There was also a Quantitative Easing-like target to “ensure necessary fiscal expenditures” through ultra-long special sovereign bonds and local government special bonds.

The People’s Bank of China had previously announced a number of monetary policies including cuts in official interest rate cuts, bank cash reserve requirements and the outstanding mortgage rate.

The bank also announced RMB 800 billion of support for the stock market.

Crucially, alongside these measures, the Politburo provided subtle updates to its monetary policy language, replacing the word “prudent” with “forceful”, indicating the direction of cuts in policy interest rates.

The market reaction was visceral.

Hong Kong-listed Chinese stocks rose 26% in six trading days on the Hang Seng China Enterprises Index. The Shanghai Composite Index rose 21.9% in the same period.

Consumer and property names (including the bulk of Chinese holdings in our portfolio) led the rise, including eight names that rose more than 40% between September 23 and October 2.

During a grinding slowdown in the Chinese economy since 2020, there have been previous policy-driven market spikes (including October 2022 and January 2024).

The magnitude of these recent occurrences aligns with previous episodes, but are moving at a faster clip.

What matters now is whether the new policies reverse current economic trends.

Our process involves paying close attention to emerging economic data, precisely because of turning points such as this.

Even amid these movements, we consider China’s low inflation, large trade and current account surpluses, earnings growth in parts of the equity market, and attractive equity valuations as reasons to maintain holdings in Chinese equities.

We have been overweight China since April 2024, have been rewarded for that stance in recent weeks, and continue to be on the look-out for opportunities in China.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund’s top-down allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

James, Paul and Ada are senior fund managers at UK-based J O Hambro, which is part of Perpetual Group.
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share fund
• Tune in: register to watch Crispin’s Beyond the Numbers webinar

THE market has been focused on the sell-off in bonds, which is tied to better US economic data as well as the possibility of a Trump win and a “Red Sweep” of Congress in the US election.

US 10-year Treasury yields rose 16 basis points (bps) and are up 45bps month-to-date.

This flowed through to equities, with the S&P 500 selling off 0.96%. Australia followed its lead, with the S&P/ASX 300 down 0.86%.

China also appears to be “on hold” pending the US election outcome.

The October politburo meeting will be held this week, but the National People’s Congress standing committee’s next meeting, from 4-8 November, is likely to provide the next indication on stimulus plans.

A string of updates from Australian companies noted slowing activity in the US (Brambles, Reece), Europe (Reliance Worldwide) and Australia (Super Retail, Metcash).

Offsetting this, we did see upgrades from Qantas and a good ResMed result.

This reinforces our view that we are at a stage in the cycle where stock-specific factors are more important. 

US economy and policy

There was little to change the prevailing view that economic growth remains solid.

Current anecdotes are distorted by the effect of recent hurricanes. Also, the upcoming election may be prompting some deferral of hiring and investment decisions. 

Weekly jobless claims continue to fall back to their prior levels, with no sign that the recent hurricane-related spike is the start of a sustained deterioration. 

The US Federal Reserve (the Fed) came under some criticism from former member Kevin Warsh, who suggested there was no data which would have justified a 50bp first cut.

Some debate has begun as to whether the Fed will pause and hold rates steady in one of the two meetings before year end.

The market is pricing in a 75% probability of a cumulative 50bp move.

We don’t see a reason for the Fed to pause in November and the market seems to agree – currently pricing only a 5% probability of no rate cut.

US election

With only nine days to go, Trump remains in better position today based on the polls, though his upward momentum has stalled in the past week.

The RCP Betting Average has him slightly ahead – but well within the margin of error – in the seven key battleground states.

Overall, he is currently a 60% chance of winning, but there is some debate as to whether betting odds can be relied on – noting that in 2016, Trump’s odds of winning were 16% on the day of the election.

Key “Trump trades” – such as a stronger USD, financials and rising bond yields – are outperforming, so the case can be made that a lot of a potential Trump win has been priced in.

Geopolitics

After waiting 25 days, the Israelis retaliated against Iran.

They appear to have targeted military sites, weapons and drone manufacturing facilities, as well as air defence.

The initial interpretation is that this was constrained enough so Iran will not be compelled to respond in an escalating way.

It may be perceived as a sign that tensions will ease for now – and may see oil prices fall.

Markets

Rising bond yields are beginning to hit technical resistance levels, and are likely to pause ahead of Friday’s payroll data and then the US election result.

The negative view on bonds is tied to the fear of inflationary effects from potential Trump policies such as tariffs and lower immigration, which may lead to a tighter labour market.

As mentioned above, much of this concern seems priced in for now.

There weren’t many relevant signals from US quarterly earnings last week. Of the Mag 7, only Tesla reported, with better-than-expected margins driving that stock higher.

Thirty per cent of the S&P 500 has reported to date. The proportion of earnings beats is in line with the historical average of 50%, while 15% have missed expectations.

Another 45% of the market reports this week, including a further five of the Mag 7.

Australia saw a rotation to defensives, such as consumer staples and telecom. Consumer discretionary underperformed on negative stock-specific news, tech was down due to the fall in Wisetech Global, and higher bond yields weighed on REITs. 

A series of trading updates suggested a slightly softer environment for a number of companies. This was often sector and region-specific, though it is clear that anyone with Europe exposure is seeing more generalised softness.

The Metcash downgrade highlighted the effects of weakening home construction, which goes to the structural challenges for building in Australia.

An upgrade from Qantas and a good result from ResMed did provide some balance.

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About Crispin Murray and the Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

PENDAL has been recognised – and awarded – at the 2024 Zenith Fund Awards

HELD annually, the Zenith Fund Awards aims to recognise the best in funds management across 24 categories and help raise the standard of funds management for the benefit of investors.

Pendal was recognised in the Multi Asset – Diversified and the Sustainable and Responsible Investments (Income) categories – the latter of which it won.

“As has been our focus in previous years, [the] awards recognise and honour excellence in funds management across all asset classes and disciplines,” said Zenith managing director Jason Huddy.

“We believe that this is fundamental to continuing to raise the standards of funds management in our industry for the ultimate benefit of investors.”

To view the full list of 2024 winners, visit the events page

Here are the main factors driving the ASX this week, according to Pendal portfolio manager PETE DAVIDSON. Reported by investment specialist Chris Adams

• Find out about Pendal Focus Australian Share fund
• Crispin Murray: Five key questions for 2024 (and how we’re going so far)

WITH global monetary policy (ex-Australia) easing and more fiscal stimulus from China, it appears as if the economic and market cycle will hold or possibly even re-accelerate.

Equity markets are optimistic as we approach year-end, rebounding from the August correction which was driven by some weaker US data points and the Yen carry-trade unwind.

This increased level of confidence saw the S&P 500 rise 0.87% and the S&P/ASX 300 rise 0.81% last week. The latter is up more than 8% since the start of July on a total return basis.

This optimism has been partly fuelled by positive economic surprises, especially since early September. Most prominent are the latest employment reports in the US and Australia, which suggest labour market concerns were overdone.

Betting odds are pointing to a Trump victory and the market seems more comfortable with this outcome.

This looks set to be the closest election in US history.

Harris is picking up the college-educated and female vote, while Trump is gaining amongst non-college educated males and minorities. Gold may spike if there is post-election uncertainty.

High valuations and already bullish sentiment pose risks to the market. However, there is no clear catalyst for a downside move and the global rate cycle (ex-Australia) is helping.

US macro and policy

On the whole, stronger US data is pointing to a soft or even no-landing scenario. 

Retail sales data suggests the US consumer is still looking good, the Fed is now cutting, and the fact that monetary policy is becoming less restrictive is helpful.

Interestingly, the savings rate has been revised up to 4.8%, which supports a stronger consumer.

That said, bank credit is tight and most data doesn’t reflect what is happening in the small business economy, where there are anecdotes of pressure.

The housing market is also soft.

The US labour market is interesting. Businesses have been pulling back from hiring activity over the past year to cut costs, despite GPD growth. This has also been reflected in falling aggregate hours worked.

With fewer people quitting their jobs, it is plausible that a slowdown in the labour market will be seen in the form of layoffs this cycle, which does feed into the risk of recession.  

China macro and policy

China appears to be shifting gear with a set of new policies from late September to support its economy and property market.

The measures include bank reserve requirement ratio cuts, capital injections to banks, as well as moves to support local government debt restructuring and boost the capital market.

There have been additional policies focused on supporting and stabilising the property market, including funding to reduce the inventory of unfinished and unsold housing stocks.

These measures appear targeted at easing specific pressure points, such as local government balance sheets and unsold housing.

Thus far, there has been no large consumer-related fiscal package. But at least there is some movement at the station.

Markets are anticipating additional stimulus packages for housing and the economy. This can’t hurt the Aussie resources sector.

However, there is the risk that a US tariff package could take as much as 2% off growth.

Beijing is watching the US Presidential Election closely and, if tariffs look likely, may implement more fiscal and monetary in response.

Europe macro and policy

The labour market in Europe (EU) remains tight, despite very low GDP growth.

Consumer spending is tilting towards the labour-intensive services sector.

The German economy remains weak – as does its manufacturing sector, even relative to the rest of the EU. Yet, its unemployment rate is only 0.5% above the cycle low and labour costs continue to rise at a pace inconsistent with sustained 2% inflation.

One factor is the bloc’s severe energy pricing disadvantage, with the European Commission estimating that industrial power prices in the EU are 158% higher than in the US, while industrial gas prices are 345% higher.

Australia macro and policy

Australia’s GDP growth remains positive but muted, not helped by the fact that it is one of the few places in the world where financial conditions (as measured by the Goldman Sachs Financial Condition Index) have increased over the past twelve months – and markedly so.

The labour market remains in decent shape, though growth in government jobs in areas like education and healthcare are a key factor.

The yield curve shows that confidence around rate cuts is waxing and waning – with expectations of cuts ticking down in the past week.

Further rate cuts overseas might assist. Some indicators are pointing to higher unemployment, which might also make the outlook for rate cuts more likely.

Housing finance approvals are rising in Australia, even though the RBA has not yet started to ease policy.

However, the strongest growth is in approvals for either owner-occupiers or investors to buy established dwellings. Finance approvals for the construction of new dwellings remain weak.

Markets

The outlook for FY25 ASX earnings remains muted, due largely to the resources and banking sectors. Industrials are expected to be provide some positive offset.

Meanwhile, investor sentiment is strong – with a benign outlook for inflation and growing confidence in a soft-landing. 

So the market seems quite happy to overlook near-term earnings and is prepared to pay high valuations for banks, if not for resources. 

We are into AGM season; most companies are simply affirming previous guidance.

Some notable improvers on AGM Day were AMP (better flows), Evolution Mining (a beat in production, Red Lake going better) and Bank of Queensland (low impairments).

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About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

Here’s what the latest jobs data means for markets, according to Pendal’s head of government bond strategies TIM HEXT

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

THE Australian job market continued showing strong resilience in September.

Jobs increased by 64,000, of which 51,000 were full time.

Labour supply also showed strong growth.

A record participation rate of 67.2% and strong population growth drove growth in labour supply, only slightly below jobs growth. As a result, unemployment was steady at 4.1% (though it fell from 4.14% to 4.07% before rounding).

This continues an impressive run for jobs, despite an economy growing at only 1%.

Job growth this year has been averaging almost 40,000 a month – above longer-term averages nearer 25,000.

As population growth moderates, the RBA will be hoping job growth moderates with it to stop labour markets getting tighter rather than looser.

Next week, we get the quarterly break down of jobs by sector.

If the trend of the past few years is to continue, the majority of growth will be in the Construction sector and the Health and Social Assistance sector. This is all driven by state and Federal Government spending, which is independent of interest rates.

Until the governments get their infrastructure and NDIS spending under control, something that will not happen near term, unemployment will stay reasonably low.

Attention will then turn to where full employment is.

As we covered off in our Australian Quarterly, the RBA believes it is nearer 4.5% unemployment. We think this too high. The US Federal Reserve revealed recently that it believes it is nearer 4% for the US economy.

Globally, we see the trend for lower inflation but strong employment being repeated across most developed markets.

The theme underlying this is relief on inflation as supply chains fully normalise, as well as strength in employment driven by big-spending governments.

Bond markets have moderated rate cut expectations this month.

What’s next?

After today’s employment numbers, a February rate cut of 0.25% has gone from 100% chance to only 75%. Anything lower than 50% gets our attention as a good risk-reward trade given our view of a likely cut.

Markets will range trade for now, but the next important data in Australia is Q3 CPI, which is due on 30 October.

This should be market-friendly (our forecast is headline 0.1% and underlying 0.7%) and see the RBA revise down its future inflation expectations in its early November Monetary Policy Statement.

This will leave the door wide open for a rate cut in February.

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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

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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.

Contact a Pendal key account manager

A green bond that could fund a national park | Market reaction to US election polls | Go for balance in uncertain times | Debunking a sustainable investing myth

Investors looking to fund nature repair often lack high-quality opportunities. But a proposal to restore national parks in Victoria could be just the thing, say MURRAY ACKMAN and DAVID LINDENMAYER

• $224m green bond to fund forest regeneration and regional investment
• ANU monitoring and oversight
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

A PROPOSED green bond offers the opportunity to unlock hundreds of millions in private capital to support the expansion of national parks in Victoria’s central highlands, including a “Great Forest National Park“.

The park is under consideration by the Victorian government as a possible use for public land in Gippsland and North-East Victoria previously allocated to timber harvesting.

No decision has yet been made. But advocates say the national park would attract an extra 379,000 visitors annually, add more than $42.5 million to the local economy every year.

It could also support 750 direct and indirect jobs in environmentally sensitive industries such as invasive species management and ecotourism.

Carbon stock gains from improved protection and avoiding logging is estimated at 55.4 million tonnes. The proposed regeneration of 18,000 hectares of regenerated mountain ash forest would sequester 202,500 tonnes of CO2 by 2035.

Some 214 billion litres of water would be added to the catchment each year, enhancing water yields and supply for more than five million people in Melbourne.

Jacinta Allan’s state government has this year overseen the end of logging in Victoria’s state forests and the closure of state-owned forestry business VicForests.

But decades of logging have left behind some 15,000 hectares of unregenerated forest that now requires extensive restoration, says world-leading forestry expert Professor David Lindenmayer.

Lindenmayer proposes an Australian-first $224 million green bond that would fund the forest’s restoration using private capital.

“The giant mountain ash forest outside of Melbourne produces almost all the water for the city,” says Lindenmayer, who has spent more than 40 years studying Australia’s forests.

“It is the most carbon-dense forest in the world.

“In any other city on the planet, there would be an amazing national park right next door to the city. But as a consequence of 60-70 years of intensive logging operations, the forest in many places is degraded.

“It’s still beautiful – but it’s now an endangered ecosystem. There’s a lot of work to be done to put the forest back together again and a lot of thinking to be done about true nature repair.

“How do you bring investment into a place like this?

“How do you rejuvenate the forest, create ecotourism opportunities, assist First Nations people to work on country, and bring Victorians to a place that many don’t even know exists?”

How a green bond could help

The term ‘green bond’ is used to describe a bond issued to raise finance for projects that have a positive impact on the environment, says Murray Ackman, a senior ESG and impact analyst at responsible investing leader Regnan and asset manager Pendal.

The Victorian government has an established track record of issuing green bonds, with the first issued in July 2016, while the federal Albanese government issued its first green bond in June this year.

“From an investor perspective, everyone’s talking about nature repair and biodiversity but there are generally no investable opportunities,” says Ackman.

“So, for us, the exciting thing about this Victorian green bond is that world experts and leaders in academia have come together to propose a viable, exciting, and reliable way to invest in nature repair.”

As longstanding investors in these types of bonds, Pendal’s Income and Fixed Interest team hopes to increase supply in high-quality bonds which have the potential to bring about significant impact.

Investing in nature

Green bonds issued by state governments could attract significant investment for restoration of biodiversity at scale, says Ackman.

Some three billion hectares of agricultural land is degraded globally, impacting close to half the world’s population – with more than US$14 trillion of investment required for restoration.

“For investors, having external monitoring for nature repair is exciting. Nature repair is slow and there is expenditure you need to do each year for the life of the bond.”

Strong demand for green bonds could create an opportunity for investors, says Ackman

“These types of bonds tend to price close to the ordinary curve, though there is often increased demand, so slightly beneficial pricing for the issuer.

“We have also noticed quality green, social and sustainability bonds have heightened demand in the secondary market and tend to outperform.“

Expert monitoring

Ackman says a key feature of the proposed Victorian green bond is the external, expert monitoring provided by Lindenmayer’s team at ANU.

“It is not unusual for a government to issue a use-of-proceeds bond – but the appeal of this one for investors is the government signing up for measured nature repair and reporting every 12 months,” he says.

Lindenmayer says the Victorian opportunity is unique because it is founded on four decades of research collected by his team that provides a robust baseline for monitoring forest regeneration.

“Our background data goes back 42 years in these forests – we’ve monitored the forest, the plants, the animals, the carbon, all those kinds of things. So, there’s an unparalleled baseline against which to compare.

“Investors can have confidence that this is properly monitored and reported – whether it is 2000 new nest boxes or replanting 500 hectares of forest every year it will be carefully monitored so that the people investing in the bond will see what’s been done.

“There will be independent data collected to show what’s happening and what the biodiversity dividend from the investments will be. How many more golden whistlers? How many more greater gliders? How many more tonnes of carbon?

“All those things will be reported so it cannot be greenwashed.”

New jobs, tourism benefits

Victoria is the most land-cleared and degraded state in Australia, making it a fitting place to launch a green bond project like this, says Lindenmayer.

“This is a bond that will give life to the regions. It is estimated the GFNP will attract an extra 379,000 visitors annually, add more than $42.5 million to the local economy every year and support at least 750 direct and indirect jobs.

“The Great Forest National Park is a fantastic place – an extraordinary environment so close to Melbourne with so many things going for it.

“The best people in finance and investment are seeing an extraordinary opportunity.

“It just needs the state government to step up.”

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

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EQUITY markets remain in good shape with the US Federal Reserve’s put option, combined with China’s stimulus, reducing downside economic risk and supporting market liquidity.

Last week’s US inflation data was a bit stronger than expected, leading to a rise in bond yields and a stronger US dollar.

However, equities continued to rise as the narrative of a soft landing remained on track.

The current debate on rates is more about how far below 4 per cent they will go, rather than whether we will see a series of cuts in the next few meetings.

The S&P/ASX 300 rose 0.83% last week and the S&P 500 was up 1.13% in the US.

Equity market gains have come despite the CBOE Volatility Index (the “VIX”) rising above 20, after hovering between 10 and 15 for most of the past year.

This reflects the upcoming US election, which the market sees as unpredictable, though not necessarily a negative.

China’s updates on stimulus have lacked detail and indicate the initial market reaction was overstated. This led to a retracement in commodities and Chinese equities.

US earnings have just started with good results from Wells Fargo and JP Morgan.

The Australian market was quiet last week.

We saw Arcadian Lithium (LTM) agree to a takeover offer from Rio Tinto (RIO), but the bid is quite unique in nature and unlikely to herald a wave of M&A in the sector.

US soft landing watch

US September CPI data was slightly stronger than expected.

The headline figure rose +0.18% month-on-month and 2.4% year-on-year which is a three-year low.

However, core CPI rose 0.31% monthly, taking the yearly gain to 3.3% (up from 3.2% in the previous month).

• Core goods rose +0.17% – the most since May 2023, though it’s still down 1.2% on a three-month annualised basis.
• Core services (excluding rent and owner’s equivalent rent, ie “super-core”) were up 0.4% monthly – the highest since April. Medical care, apparel, auto insurance and airfares drove the increase.

The market’s reaction was muted; the numbers have been surprising on the downside for some time, so there was room for slightly higher numbers.

In addition, the Fed is saying it’s comfortable with the trend and not focused on these “super core” measures.

The upshot was bond yields continuing to move higher. It also reinforced the view that the next two moves by the Fed should be 25bp cuts. 

Jobless claims have become the most-tracked weekly indicator as the market watches for signs of economic deterioration.

Concerns here had subsided. The data spiked higher last week, though this was tied to hurricanes Helene and Milton as well as US port strikes, so shouldn’t be interpreted as a concerning signal.

It does highlight that we are set for a couple of months of messy data because of the two hurricanes.

In aggregate the US economy looks to be holding up well. The Atlanta GDPNow indicator is running at 3.2% for Q3, well above consensus of 2% growth.

China stimulus watch

A meeting of China’s policy-implementation body, the National Development and Reform Commission, disappointed a market craving a big, headline stimulus announcement.

The only number mentioned was RMB200 billion, versus hopes of RMB3 trillion-plus.

It was more water pistol than bazooka.

This should have been expected given the commission’s role is to implement certain policies rather than determine them.

This was interpreted as a signal that the Chinese government saw reaction to the stimulus as overly dramatic and was looking to cool expectations and speculative activity.

An extreme example was Hong Kong-listed, Chinese residential property developer Vanke, which rose 360% from HKD3.90 to about HKD14 in two weeks, before retracing to HKD7.31.

On Saturday, the more-important Ministry of Finance outlined its plans, flagging:

• No near-term plans for additional central government bond issuance (though the National People’s Congress could choose to do this later in the month).

• RMB400 billion additional local government bond issuance which utilises the gap between debt ceiling and debt outstanding.

• A big one-off increase in debt quota to enable the swap of local government debt. No specific number was given, but last year they did RMB2.2 trillion. It could be above RMB3 trillion, supporting financial stability and helping overall economic activity by enabling local governments to pay wages and maintain services.

• RMB 2.3 trillion available for use by the end of 2024, from bonds already issued but unused under the existing target. The target is unchanged – the key question is whether it can all be used.

• Local governments will be able to use proceeds of their special bond issuance to buy unsold apartments and convert them to affordable housing to help address excess housing inventory.

• Injection of tier-one capital into state-owned banks. There was no specific number, but around RMB 1 trillion is expected.

• Indications the 2025 fiscal deficit could be more than 3% GDP, supporting more spending next year.

The market’s reaction will be interesting. Key points to note include:

• There is no “bazooka-stimulus” headline number, especially compared with the reaction to the GFC which was cumulatively the equivalent of about RMB 20 trillion today in terms of proportion of the GDP. So there is no short-term upside surprise. Bulls could choose to point to the use of existing funds and remaining bond issuance to conclude around RMB 3 trillion of stimulus. But this looks like a degree of re-badging – not new funds – so we remain hostage to how this money will actually be spent.

• The policy is designed to reduce tail risks and prevent the doom loop of local governments continuing to cut back on spending.

• No direct boost to consumer spending. This is negative.

These measures may help prop up the equity market. But it’s unclear if this is sufficient to support commodity markets, which need to see real demand stimulated in the short term.

China’s Politburo and National People’s Congress both meet in late October. The latter would need to approve any policy requiring higher deficit spending.

One final observation: Beijing may be holding something in reserve against the risk of a Trump victory in the US election and the risk of material tariff increases.

US election watch

With barely three weeks to go, Trump gained some momentum in the betting odds last week, moving to a 54% chance of a win (according to RCP Betting Average) versus 46% for Harris.

This is his biggest lead since Harris entered the race.

The seven key battleground states (assuming Minnesota goes Democrat) are Arizona, Nevada, Wisconsin, Michigan, Pennsylvania, North Carolina and Georgia.

Most recent polls have Trump in front in all but Wisconsin, though with a very fine margin.

Market volatility has picked up, but the forward curve has this falling back post-election. To date, this has not impacted equities and is supported by credit spreads staying low.

The most likely election outcome is a Democrat or Republican presidential win without sweeping both the House and Congress – and hence being constrained in what they can achieve.

The main difference in market impact relates to bonds, with Trump’s threat of higher tariffs and less immigration potentially leading to higher inflation in late 2025, and therefore to higher yields.

This may have limited impact on equities as it could be seen to come with higher growth.

Oil watch

The latest expectation is that the US will seek to limit Iran’s ability to export oil with sanctions (and a crack-down on attempts to break them).

Saudi Arabia may step up to increase production to fill the supply gap, allowing them to re-take share and ensure oil prices don’t run up into the year’s end.

These measures may encourage Israel to avoid escalation, but the response still waits to be seen.

Markets

Despite geopolitical uncertainty, the outlook for equities is positive. Inflation is under control, economic growth is solid, financial conditions are easing and corporate earnings are growing.

Initial US results out last Friday were well received in the financial sector with JP Morgan (+4.4%), BlackRock (+3.6%) and Wells Fargo (+5.6%) all beating consensus.

The US market is seeing leadership from industrials, consumer discretionary and financial stocks and less reliance on the Magnificent 7 tech stocks, which is a positive signal.

It is also worth noting the US software index broke to new highs having been range-bound for the whole year.

Australia reflected these themes last week with banks beginning to bounce after a recent fall. The slower trajectory of rate cuts helps them.

Tech also had a good week, as did industrials.

From a portfolio perspective we tend to be overweight technology and industrials and we have added to discretionary exposure.

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About Crispin Murray and the Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

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