The income game has changed and Pendal’s income strategies have evolved to look very different to traditional income portfolios. Pendal portfolio manager AMY XIE PATRICK explains

LOW YIELDS and skinny corporate bond coupons are not the makings of a traditional income portfolio.

That’s the challenge that many bond-only income products face today.

A 30-year bond bull market has been a massive boon for income portfolios heavily reliant on credit. In a falling yield environment, you can reap the full benefits of corporate bond yields — and many investors have pushed into riskier and high-spread exposures.

This has been very supportive for credit as an asset class. But the game is now changing.

The 30-year bond bull-run has come to a close. Inflation is the market zeitgeist. Any traditional income portfolio will lack the necessary levers to confront it.

Rising bond yields need to be hedged. Those hedges eat into the already scant levels of income such portfolios are now generating.

A rising yield environment will also cause more dispersion in the performance of credit. Portfolios that have loaded up on lower quality offerings in recent years are likely to see more headwinds.

That’s why Pendal’s income strategies look very different to those traditional income portfolios.

Other levers needed

High-quality credit serves as an essential income building block, but the overall portfolio needs other levers to manoeuvre through different market environments.

If the environment is inflationary, there need to be other sources of income besides fixed rate credit.

The Pendal Monthly Income Plus Fund currently has a 19% allocation to Australia equities, with room to add further.

This is not only a way to help the portfolio keep up with the reflation narrative. The income from equity dividends frees us from relying heavily on accruals from fixed rate instruments.

As a result, the Monthly Income Plus Fund’s exposure to interest rate risk is the lowest it’s been for more than five years.

Importantly, should sentiment suddenly turn more bearish, de-risking will be far easier in equities than in credit due to its liquidity advantage.

In the Pendal Dynamic Income Fund, a 20% allocation to floating rate emerging market sovereign exposure helps generate additional income, while capturing the spread compression opportunity as investors seek portfolio diversification from asset classes such as Emerging Markets.

Similarly, the Dynamic Income Fund’s interest rate exposure is currently minimal.

Having non-traditional levers to gain additional exposure to income and market upside has given us the luxury to not chase lower quality credit deals when they come to the market.

Instead, cognisant of the rising yield environment, we are running higher-than-normal cash balances that are waiting to be deployed at more attractive yield (and hence income) levels.

Flexibility via multiple levers, a focus on quality, and agility on interest rate exposures are the makings of a resilient income portfolio.

Most investors are now aware of climate change risks. But biodiversity preservation may be an even bigger and more immediate issue. EDWINA MATTHEW explains

Countries representing 90 per cent of global GDP are now covered by net-zero targets, highlighted at the recent COP26 climate change conference in Glasgow.

We will soon know if those targets are sufficiently ambitious to keep global warming to 1.5 degrees — meeting the Paris Agreement adopted at COP21 in 2015.

But net zero emissions by 2050 is not the whole story.

As Glasgow was ramping up for COP26, the southern Chinese city of Kunming was just winding down after another COP (or Conference of the Parties) which focused on conserving biological diversity.

At COP15, 195 countries pledged to reverse biodiversity loss by 2030 at the latest and agree on a framework to protect species and their habitats.

Biodiversity may not be as attention-grabbing as climate change. But it is a critical part of the overall solution and directly impacts many industries.

Agriculture. Medicine. Insurance. Real estate. Tourism. To name a few.

Half of the world’s total GDP — or some US$44 trillion of economic value generation — is moderately or wholly dependent on nature and its services, according to the World Economic Forum.

“Climate change is a very complicated issue, but biodiversity is on a whole other level,” says Pendal’s Head of Responsible Investments, Edwina Matthew.

Twin crises

Climate change and biodiversity loss are inter-related, “twin crises”, says Matthew.

Climate adaptation strategies such as protecting and restoring natural habitats offer defence against the physical impacts of climate change.

Nature-based solutions are also part of the broader universe of carbon removal projects underlying the carbon credits or offsets that are part of net zero strategies.

But climate change itself is destroying our natural capital (soil, air, water and living organisms) and biodiversity ecosystems — as seen in Australia’s Black Summer bushfires.

“Encouragingly, governments, business and investors are starting to understand that nature and climate can’t be separated — and that nature-related impacts and dependencies need to be considered alongside climate-related exposures,” says Matthew.

“We need to invest in mutually reinforcing solutions. A 1.5-degree pathway cannot be achieved without major investments in natural capital.”

Industries threatened by biodiversity loss

Agriculture is the most obvious example of an industry threatened by loss of biodiversity.

The agriculture sector accounts for a quarter of Australia’s exports (and employs 60 per cent of the world’s working poor).

Scientists estimate $US577 billion of annual crop production is at risk from loss of pollinators like bees.

The Worldwide Fund for Nature says 60 per cent of the world’s coffee varieties are in danger of extinction due to climate change — a sector with more than US$80 billion in global sales.

Nearly half of all medicines are derived from natural sources.

“We’re also starting to see scientists linking the transmission of animal disease to humans because of a breakdown in biodiversity buffers,” says Matthew. “We had SARS, now we have COVID.”

The UK Treasury’s Dasgupta Review on the Economics of Biodiversity released earlier this year says the “devastating impacts of COVID-19 and other emerging infectious diseases — of which land-use change and species exploitation are major drivers — could prove to be just the tip of the iceberg if we continue on our current path”.

Much of global tourism is linked to natural attractions. The Great Barrier Reef brings in $A1.5 billion a year in tourism and fishing.

The loss of wetland buffers for flood-prone areas can expose real estate and insurance companies to higher risk.

Nature also helps regulate the climate itself — as we acknowledge in the development of nature-based carbon offsets. 

What it means for investors

Just as investors now understand the risks posed by climate change, so too natural capital and biodiversity considerations are starting to creep into the investor engagement and corporate reporting agenda.

“It’s twofold,” says Matthew.

“It’s about understanding biodiversity loss as a top-down, systemic issue — as a threat to the global economy — as well as understanding and managing bottom-up, company-specific natural capital and biodiversity-related exposures.

“It’s also about holding companies to account for their impacts, as we do for climate. What role do they play in adverse outcomes for biodiversity and natural capital? How are companies embedding these considerations into their own governance structures and risk management frameworks?

“And to what extent are they dependent on natural capital for their own business? How do they think about biodiversity loss and related policy and regulatory trends and shifts in key stakeholder expectations?

“A lot of the learnings we’ve had from climate change are starting to play out in the natural capital space.”

The good news is, companies are starting to respond.

“We are seeing efforts in mining, property and finance to build understanding around dependencies and impacts in business models and supply chains.”

Biodiversity and land management reporting is already a feature in some company public disclosures.

“Just last month BHP acknowledged evolving stakeholder expectations about its efforts to achieve nature-positive outcomes during an ESG investor roundtable.”

The newly launched Taskforce on Nature-related Financial Disclosure — supported by the United Nations and endorsed by G7 ministers and financial institutions — is setting up a risk management and disclosure framework for organisations to report and act on nature-related risks.

The taskforce supports a shift in global financial flows away from “nature-negative” outcomes toward “nature-positive” outcomes.

Opportunities

Similar to the transition to a “low-carbon economy”, a transition to a “nature-positive economy” also offers economic opportunities.

There is potential for almost 400 million jobs and some $US10 trillion in annual business value by 2030 across three socioeconomic systems (food, land and ocean use; infrastructure and the built environment and energy and extractives) according to WEF.

Pendal clients are exploring how they can direct capital to support nature-positive outcomes, Matthew says.

“They have a fiduciary and financial interest in the wellbeing of the economy as a whole. They expect active managers like Pendal to exercise our ownership rights on behalf of our clients to encourage the protection of natural capital.

“They are also seeking opportunities for how they can allocate capital to support and scale nature-positive outcomes.”

Pendal will “continue to work with our clients and other stakeholders to build understanding around biodiversity loss and access to nature-positive investment solutions to help tackle the next sustainable investment challenge,” Matthew says.

About Edwina Matthew

Edwina Matthew is Pendal’s Head of Responsible Investments. Edwina is responsible for maintaining our leadership position in the provision of sustainable and ethical investment products.

Edwina is actively involved in the implementation of the UN-supported Principles for Responsible Investment. She also represents the company in working groups with a number of industry associations and initiatives relating to responsible investment.

About Pendal Group

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

We believe sustainability considerations ultimately drive higher and more stable investment returns over the long term.

Pendal Group has a proud heritage in responsible investing, extending back decades. Our specialist responsible investing business Regnan includes highly experienced ESG research and engagement experts and offers a growing range of investment strategies.

Some of our responsible investing strategies

• Pendal Sustainable Australian Fixed Interest Fund
• Crispin Murray’s Pendal Horizon Fund
• Regnan Global Equity Impact Solutions Fund
• Regnan Credit Impact Trust

Contact a Pendal key account manager here

ASX small caps have outperformed the top 100 companies over the past year. But investors need to be increasingly aware of ESG factors which often go under-reported. Pendal’s LEWIS EDGLEY and DAMIEN DIAMANT explain

SMALL CAPS provide a chance for investors to diversify portfolios away from the more mature behemoths that dominate the top end of town.

They are often driven by very different themes to the macro factors that typically affect the ASX100.

Pendal Smaller Companies portfolio manager Lewis Edgley points to successful technology businesses, innovative online retailers and companies producing materials used in batteries such as lithium, cobalt and nickel.

 “These are new-world businesses that offer exposure to disruptive business models — much more so than the large cap index,” says Edgley.

Small caps are further up the risk return spectrum relative to their large cap counterparts. But they provide access often to undiscovered companies that can present outsized returns relative to their risk profiles. 

The ASX Small Ordinaries index (which measures companies in the top 300 minus the top 100) — outperformed the ASX100 over the past year.

“Small caps are generally under-researched relative to their large cap counterparts, while offering more attractive growth prospects” he says.

“We find many opportunities to invest alongside business founders and management teams that have significant shareholdings, which creates a strong alignment of interest with investors.”

New opportunities

Small caps also offer a continual flow of new opportunities.

“About 20 per cent of the Small Ords listed in the last five years. That amount of refresh in our investable universe means the small cap sector is never stale.

“In the last two years our team has evaluated literally hundreds of new IPOs, the majority of which don’t make the cut… In the last month alone, we’ve had nearly 10 IPOs worth more than $1 billion each come across our desk.

“Investors need to be discerning about which to participate in. Some are blatantly opportunistic, just trying to take advantage of bull market conditions and the broader market’s willingness to discount risks.

“By sticking to our proven investment process we expect to do well on the select few IPOs we’ve recently supported.”

ESG a factor to watch

For all the opportunities, the sector is not without risk. Environmental, Social and Governance (ESG) issues are a significant emerging factor that small cap investors need to watch.

Unlike large companies, small caps often do not have the resources or expertise to measure and report on ESG risks. They can go unheralded in company reports.

“Most of the companies we talk to are not sufficiently resourced to have a fully enunciated plan in terms of how they are going on their ESG journey,” says Edgley.

“We work with companies to provide our insights on what is important from an ESG perspective. We share what we think is important and help them formulate a framework so they can set sensible and realistic targets.

“We find many small caps are doing a number of things that would already rate them well on an ESG screen — but they’re not actually recording and reporting on them.”

City Chic Collective (ASX:CCX)

Pendal small cap investment analyst Damien Diamant gives the example of fashion retailer City Chic Collective (ASX:CCX), an ecommerce company held in the Pendal Smaller Companies Fund.

“We spent time with the company running through their supply chain and actions they’re taking to ensure they have a positive impact on communities.

For example CCX — which focuses on plus-sized fashion — has moved to ban raw materials sourced from high-risk regions, such as cotton from Xinjiang.

Xinjiang cotton is regarded as high-quality, but human rights campaigners say it is produced by forced labour.

CCX has also focused on water and waste management, sustainable packaging and recycling.

“We’re happy with the progress made to date” says Diamant. “As a smaller company there are obviously limitations to the resources that go into developing a detailed ESG reporting framework. 

“But they have a strong awareness of the risks and are taking a proactive response to ethical trade.”

The small caps team is further integrating ESG into its investment process, says Edgley.

“We’ll continue to work closely with our investee companies to gain a deeper understanding of their priorities in this emerging space,” he says.

“We’re fortunate to have the support of a dedicated Responsible Investment team at Pendal. Their insights and guidance have been invaluable as we embark on this ESG journey.”

Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams

MARKETS enjoyed a good, broad-based rally last week. This was despite a continued rise in bond yields and ongoing concern about Chinese growth.

The diminishing probability of a hike in US corporate taxes helped sentiment. So, too, did generally supportive US earnings.

The S&P/ASX 300 rose 0.72% and the S&P 500 1.67%.

COVID and vaccines

Case trends in the US and Asia are generally headed in the right direction, though there are concerning signs in Europe.

A renewed wave in the UK suggests it may be following the same path as Israel, where case numbers picked up as vaccine protection waned.

German cases are also increasing. Some Eastern European countries, where vaccination rates are low, are also seeing a surge. Romania is a case in point.

There is also an outbreak in Singapore, which is notable since 81% of the population is vaccinated.

We may be at an inflection point for a renewed surge in cases, led by Europe. The critical relationship between vaccinations and fewer severe infections and hospitalisations continues to hold, but needs to be watched.

Pfizer released results from its first booster trial.

A sample of 10,000 vaccinated people showed five new Covid infections among the half who received the booster and 109 in the remainder who had a placebo.

Importantly, there were no severe infections in either group. This reinforces the idea that while a vaccine’s ability to prevent infection wanes, its ability to prevent severe infection may be more enduring.

Economics and policy

It was generally a good week for data.  Flash PMIs, a leading indicator of activity, came in better than expected in Japan and the EU.

In the US, the manufacturing flash PMI was weakened by supply chain factors, but strength in the services PMI more than made up for it. This is important, since the service sector — which is benefiting from re-opening — is roughly five times larger than manufacturing in the US.

It is worth watching US credit growth. This was persistently disappointing in the post-GFC era, one symptom of the lacklustre recovery.

It has remained muted in this cycle due to excess household savings accrued during Covid. But US bank results suggest we might be seeing credit growth building. If this occurs it will further support the sustainability of economic growth.

So the demand environment remains firm.

If this coincides with alleviation of supply chain pressure, it should be a positive environment for equities.

Inflation and yields

The inflation issue remains very live.

The UK is seen as something of a bellwether. September inflation data in the UK was a little softer than expected, but forward expectations are rising sharply. The market is pricing in a 21bp rate increase in November as the Bank of England needs to be seen to react to rising inflationary expectations.

Longer-term indicators of US inflation — such as house prices, wages and retailer pricing power — continue to rise. So too are prices in the service sector.

This is flowing through into a continued re-pricing of the short end of the bond curve.

US two-year government bond yields have doubled from about 20bps to 46bps in October, reflecting expectation of tightening. The consensus view is that when tapering begins it will do so at the higher end of the range (about US$20 billion per month) and the first rate hike will come in June. 

Policy moves

Negotiations around President Biden’s reconciliation bill are nearing a conclusion. The final package looks likely to be around US$1.8 trillion rather than the original US$3.5 trillion plan.

The debate over how it is funded has been interesting. Democrat senator Kyrsten Sinema of Arizona refused to withdraw an objection to any change in corporate, capital gains or personal tax rate. If corporate tax hikes don’t eventuate — which is now quite possible — US earnings expectations could rise 5 per cent.

In China, beleaguered property developer Evergrande paid interest on its first bond, due just before the end of a 30-day grace period. It has avoided default for this week. But another payment is due Friday and there are more after that.

Meanwhile Beijing is dealing with another Delta outbreak — 10 of 31 provinces have reported cases. Restrictions have been imposed, potentially providing another economic drag.

The central government is telling provinces to accelerate their issuance of government bonds, to use up the 39% of annual allocation they have remaining for 2021. The spending is unlikely to make an impact this quarter, but is supportive of Chinese growth in coming years.

This week the European Central Bank will meet. At this point the market is pricing a 40bp hike in rates by the end of 2023. It will be interesting to see if there is any push-back by the Bank — or if it acknowledges building inflationary pressure.

Markets

While inflation pressures remain significant, there is a case for nearer-term stability in bond yields as China remains in a slumber, global Covid cases start to rise again and supply chain pressures ease.

This would support a rotation back to growth.

We retain a material growth exposure with companies targeted at corporate or institutional end markets, rather than the consumer. 

US earnings

About a quarter of the US market has reported quarterly earnings so far. Some 65% have beaten consensus expectation by more than one standard deviation. If this holds it will be another strong quarter with earnings running 8% ahead of estimates.

Revenue growth has exceeded expectations in 57% of companies compared to a long-term average of 35%.

The market is focused on labour costs, which are rising. But to date most companies have indicated they can offset this via higher prices.

While the quarter looks strong, this has not flowed through to large consensus upgrades for CY22, since the market remains wary of supply chains and labour costs.

It’s worth noting that social media company Snap Inc’s result highlighted a second-order effect of supply chain issues: companies with less product to sell are scaling back advertising.

This may provide read-through for Google and Facebook, which are yet to report.

Australia

Stocks leveraged to Chinese supply chains started to do better, reflecting our observation last week that signals such as power availability and freight rates were improving.

We saw a disconnection in commodity markets. Oil remained well supported but there were corrections in other commodities. It is worth noting technical signals that some commodities such as aluminium have peaked for now.

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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 an independent, 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 here.  

Contact a Pendal key account manager here.

Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams

WE SEE constructive signs emerging in recent market action after a period of consolidation.

Concerns over inflation and China remain heightened and persistent. Inflation, in particular, is likely to remain a key issue for markets for some time. But there are indications of small improvements at the margin for sentiment on these issues.

Further indication that concerns on these issues have peaked — combined with continued economic recovery and a period of seasonal strength in markets — could set up equities well into the year’s end.

It is far too early to declare victory in this regard. But equities moving higher despite ostensibly bad news, as we saw last week, can be a strong positive signal. The S&P/ASX 300 was up 0.65% and the S&P 500 1.84%.

Whether or not this continues in coming weeks is likely to rely heavily on US earnings season and Chinese data and policy signals.

Economics, policy and markets

The market has 3 broad concerns at the moment;

1. Inflation and its implications for policy tightening: The risk is that we start to see stagflation, where price rises choke off demand and economic growth, or that we see the Fed forced to tighten earlier, also weighing on growth.
2. Chinese growth: People are concerned that a slowing property market and power constraints will drive a sharper-than-expected slowdown in growth.
3. US debt ceiling: The fear is that political discord disrupts the government’s ability to function.

At this point there are signs that each of these issues may have reached a near-term crescendo, which is helping markets rally. 

In the US, Congress and the Biden administration have been able to delay the debt ceiling issue to December. It hasn’t disappeared, but they’ve bought time.

Outlook on China

There are signs that China is addressing power shortages. Beijing is looking to source coal and gas from all available sources – including Australia, despite previous embargoes.

This will not flow through immediately, but the signal is that China is looking to solve the problem and not stubbornly stick to old policies.

Property remains more complex in China. The Evergrande issue has seen credit spreads blow out in the property sector. So far this looks contained within that sector and has not spread to other parts of the market.

There are indications in the data that monetary policy is too tight in China. There are various committee meetings this week which may result in some indication of easing.

Outlook on inflation

Inflation is the greatest long-term threat to markets.

In the past few weeks there has been a shift in expectations including a realisation that inflation is likely to be higher and more durable than previously thought.

At his Jackson Hole speech on 27 August, Fed Chair Powell was able to calm inflation concerns with the idea that it was transitory. His key reasons were:

1. It is not broad based
2. The largest surges are already receding
3. No threat yet from wages
4. Inflation expectations are anchored
5. Globally, pressure on inflation is downward

Since then inflationary pressures have strengthened, due to:

1. Expanding supply chain bottlenecks: Lockdowns in some countries and Chinese power issues have constrained production.
2. Labour availability: This continues to disappoint in the US, where it’s increasingly apparent there has been a reduction in supply, driving real wage increases and rising friction between employees and employers.
3. Commodity prices: Key inputs such as gasoline and power prices have continued to rise.
4. House prices: Continue to rise and are flowing through into rents.
5. Strong demand: Bolstered by re-opening and reducing delta concerns.

What was “transitory” is now being described as “transitory for longer”.

This is because the “transitory” argument is now falling foul of its own rationale outlined in the Jackson Hole speech:

1. It is not broad based: Inflation is showing up in a broader range of sectors as new supply chain problems occur and fuel prices rise. Last week’s CPI data shows prices in longer-duration areas are rising. Rents, for example, are increasing at their highest monthly rate since the housing bubble in 2006.
2. The biggest surges are already receding: This is true in some categories. In others, such as timber and autos, there have been recent rebounds. New auto prices were up 1.3% in the month.
3. No threat yet from wages: Average hourly earnings have not surged, but are steadily picking up.
   – We are also seeing greater friction in labour markets. For example workers at machinery maker Deere and Co knocked back a front-loaded 11-12% wage increase over six years and called a strike for the first time in 35 years. This kind of action reflects the recognition that supply chains need to be shortened and the threat of off-shoring has diminished.
   – There are further indications that early retirements and career changes are having a negative impact on labour supply.
4. Inflation expectations are anchored: This is still the case, but they are rising. The risk is this starts bringing forward consumption and drives higher wage demands.
5. Globally, pressure on inflation is downward: It’s true that inflation is less of an issue outside the US. But rising fuel prices are having an impact. The move in global bond yields indicates some concern on inflation.

The market realises the Fed is in something of a bind. It wants to promote growth while being mindful of the need to keep inflation expectations anchored.

The balance in recent weeks has been a shift in expectations to the Fed having to move sooner on tapering and rate hikes.

As a result we saw a “bear flattening” in bond markets, with two-year yields rising while 10-year yields remain flat. Despite this, equities and commodities made gains.

One factor could be that supply chain fears have perhaps reached their nadir. Freight rates from China to the US east and west coasts have rolled over recently.

Surveys suggest the proportion of US firms reporting inventories as “too low” has also rolled over.

The Biden administration has recognised the importance of this issue. It’s been working with stakeholders to keep the Port of Los Angeles open 24/7.

This alone won’t solve the problem. But combined with factories re-opening in Asia and private companies adapting their sourcing, it can help calm fears on the issue.

We see inflation as a key issue for markets going forward. But signs of alleviation in supply chain pressure, coupled with marginally better news on China and the US debt ceiling — plus expectations of good US corporate earnings — may continue to support markets in the near term.

US economic outlook

While the big risk issues are marginally improving, the outlook for US growth is also encouraging.

US retail sales were better than expected at +0.7% m/m, with positive revisions for the previous month. This means it’s holding up despite a surge in the past year. There is strength in discretionary spending (clothing, sporting, e-commerce) which was up 13.9% year-on-year (and 15.6% ex-autos).

Fiscal stimulus has played an important role in this. It also goes some way to explaining some of the supply chain issues we are seeing.

Consumer spending is expected to shift from retail to the service sector as restrictions are rolled back. It remains supported by $US2 trillion in excess savings as a result of stimulus. Income growth also remains greater than expenditure.

Markets

We are seeing some important and positive signs, such as:

1. Commodity prices appear to be breaking higher, having consolidated for six months. This reinforces the notion that concerns over supply chain issues may be peaking.
2. The sectors most affected by supply chain issues are beginning to perform. This suggests the market is looking through near-term issues and expecting a strong catch-up in demand next year.
3. Chinese bond yields have begun to move higher. They had previously been falling since the start of the year and were a decent signal on the impending Chinese slowdown.
4. The Australian dollar is rallying against the Yen — another positive cyclical indicator.
5. There are signs the equity market is broadening, with the small cap index stabilising versus the overall market.

In conclusion the market signals are more positive than the media headlines. This is often the right signal to watch for.

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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 an independent, 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 here.  

Contact a Pendal key account manager here.

What are the major factors driving global equities investments in this volatile period? And which plays should investors be considering right now? Pendal’s head of global equities, Ashley Pittard, explains in this fast podcast

Listen to the podcast above or read the transcript below

Interviewer Sean Aylmer: Ashley, there’s incredible volatility in Wall Street at the moment, particularly among the tech stocks. What is going on?

Ashley Pittard, Pendal’s head of global equities: It really comes down to a couple of key points. The key points are:

• Inflation: Is a transitory or is it frustratingly structural?
• In addition to that, you have the Federal Reserve tapering
• You have long-term interest rates increasing
• You have a debt ceiling negotiations in the US that are dragging on
• In addition to that, you have China’s increasing regulatory risk. China also has real estate issues with regards to their largest developer.

All of that together creates uncertainty and that uncertainty is creating volatility in companies that have re-rated over the last five years to valuation levels that are very, very high.

Interviewer: Inflation – is it transitory or is it structural?

Ashley Pittard: I get back to what Fed chair Powell said. He originally thought inflation was transitory, but it’s now becoming frustrating.

When you step back, you look at wage growth in the US which is compounding at 3-4%. You’ve got higher energy prices. We’re actually near an oil price of $80. And you’ve got massive higher transportation costs — an example is the UK’s with their fuel and transport issues.

All of those issues, in addition to commodity prices that are at near-term highs, are all contributing to inflation that I believe will be more longer-term in nature then transitory.

So it’s interesting now that we’re starting to see the Federal Reserve think that way.

Interviewer: How big a worry is China — be it the regulatory risk or real estate issues particularly around Evergrande?

Ashley Pittard: There’s no doubt China is a massive risk. The reason it’s a massive risk is because they’re trying to redistribute wealth. And whenever you try and redistribute wealth, people that have the wealth usually lose out.

So where is the majority of wealth situated in China? It is in the large property businesses. And more importantly, these large technology companies. As we’ve seen over time, restrictions being put in place which means the market will start giving a significantly lower valuation to these businesses on the tech side.

With regards to the real estate side, in addition to lowering house prices, these development companies have significant amounts of debt. And if you have debt, you can start getting into a situation that is very reminiscent of what we saw in the US housing market probably a decade ago now.

So the risk in China is very, very high because you’re redistrubuting wealth, the P/Es have to come down because of the increasing risk. And then you also have this debt burden associated with a reduction or slowing in property development, which is very reminiscent of what we saw a decade ago in the US.

Interviewer: So bringing that all to portfolio construction, what does it mean in terms of investing in global markets at the moment?

Ashley Pittard: We think that you want to be different. What do I mean by that? You want to be contrarian. If you look over the last five years, the best sectors to be in globally have been technology and pharmaceuticals. They are at all-time highs as a per cent of the index — and also their stock prices.

We believe, as inflation becomes more structural, that you want to be concentrated in a portfolio of financial and energy plus aerospace exposure.

So effectively we believe you want to be in re-opening plays and contrarion plays as inflation becomes frustratingly higher for longer and not transitory – just like Chairman Powell said.

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About Ashley Pittard and Pendal Concentrated Global Share Fund

Ashley Pittard leads Pendal’s Global Equities investment boutique. He is responsible for setting the strategy, processes and risk management for the boutique and its funds including Pendal Concentrated Global Share (COGS) Fund.

Ashley has more than 24 years of finance experience, including roles in petroleum economics, global energy investment analysis and 20 years as a global equities fund manager.

Pendal COGS Fund is an actively managed, concentrated portfolio of global shares diversified across a broad range of global sharemarkets.

Find out more about Pendal Concentrated Global Share Fund

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

Contact a Pendal key account manager here.

BT Wholesale Monthly Income Plus Fund (APIR code BTA0318AU, ARSN 137 707 996)

Notice of changes to the asset classes and asset allocation ranges of the BT Wholesale Monthly Income Plus Fund (Fund)

From 14 July 2015, we are removing the alternative investments asset class and asset allocation ranges and changing the fixed interest asset allocation ranges as shown in the table below.

Asset Class	Current Asset Allocation Ranges	New Asset Allocation Ranges
Cash	0-50%	0-50%
Fixed Interest	0-100%	20-100%
Shares	0-30%	0-30%
Alternative Investments	0-20%	N/A – removed

Why are the asset classes and asset allocation ranges changing?

The Fund has not invested in alternative investments since March 2011 and we no longer intend to invest in this asset class. The changes to the asset classes and asset allocation ranges will more accurately reflect how we intend to invest the Fund in the future.

More information?

If you have any questions, please contact the BT Customer Relations on 1800 813 886 between 8.00am and 5.30pm (Sydney time), Monday to Friday.

Significant Features: The Pendal MidCap Fund is an actively managed portfolio of Australian mid cap shares.

Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the Pendal Midcap Custom Index over the medium to long term.

Investors concerned about the banking crisis and recession fears in the US may be missing out on finding investment opportunities in other parts of the world, says Pendal’s CLIVE BEAGLES

• US banking crisis creating opportunities elsewhere
• UK banks trade at steep discounts
• Browse Pendal’s global equities funds

MARKETS are watching the US closely as its banking system reels from the impact of higher interest rates on regional bank bond portfolios.

Three US banks have been shuttered during the rolling crisis and regional bank shares have been volatile as markets weigh up the prospect of further failures.

But the crisis has also swept up banks and markets outside the US, which may offer opportunities for investors who can keep calm amid the noise.

Last week Pendal’s Samir Mehta argued that the US regional bank turmoil shouldn’t discourage investors from considering Asian bank stocks.

Clive Beagles, a senior fund manager at Pendal’s UK-based asset manager affiliate J O Hambro, has similar things to say about British bank stocks.

“Many of the UK banks are posting returns on equity of close to 20 per cent in the first quarter,” says Beagles.

“But they all trade at a discount to book value — some of them at 0.4 or 0.5. That includes big names like Natwest and Lloyds.

“Discounts to book value for that kind of return on equity just look silly.”

Beagles says the US market is acting like a “rotating firing squad” that seems to be picking a different name every other day to sell off.

But he believes the banks that are failing in the US are smaller players which are not globally significant.

“The differential between how the US has been regulating their banks and how the UK and Europe are regulating banks is becoming ever clearer — which is frustrating because they have been dragged down a bit by the noise.

Is everyone else still catching cold when America sneezes?

Beagles says the underlying concern many investors have is of a global recession triggered by a downturn in the US.

“There’s an old assumption that when the US sneezes everyone else catches a cold. But I do slightly wonder if it’s going be different this time.

“If this is a crisis, it’s the first one we’ve had where the US dollar is going down rather than up.

“Normally, you head to the dollar for safe haven status.”

Beagles believes the US dollar weakness indicates something different is going on from the usual global contagion. It could point to a period where the US is one of the slower-growing economies in the developed world rather than its traditional role as one of the fastest.

“The banks are just a microcosm of that — they will need more capital and need to be more tightly regulated in a slower US.”

Beagles also cautions against comparisons to previous banking crises.

“In 2008, UK banks had tier-one capital ratios of 4 per cent. Today they have tier-one ratios of 14 per cent.”

Tier-one capital refers to bank’s most reliable and highest-quality capital. A higher tier-one capital ratio generally suggests a bank is better equipped to absorb losses and maintain its financial stability.

“In 2008, there were something like £400 billion more loans than there were deposits — today it’s the other way around.

“The UK as an economy is under-geared rather than over-geared.”

About Clive Beagles

Clive Beagles is a senior fund manager with Pendal Group’s UK-based asset manager, J O Hambro Capital Management. Clive is one of the UK’s most highly respected equity income managers. He has 32 years of industry experience and co-manages the JOHCM UK Equity Income Fund.

About Pendal Group

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

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