Pendal portfolio manager BRENTON SAUNDERS explains which sectors look interesting for mid-caps right now — and how to think about the ESG transition

An excerpt from this podcast

When investing in the current environment, how do you think about long-term themes such as Environmental, Social and Governance (ESG) factors?

There are several different timeframes over which to think about ESG.

The development of the de-carbonised economy by its very nature will take a long time.

There will be three periods broadly:

• The existing status quo
• A transition period where we’ll have an overlap between old and new technologies, and
• A transition to the new

Once you understand that, it’s really about characterising companies in terms of where they sit in these transitions.

Are their business models aligned with any one specific phase?

If so, are they making their way across those phases to an environment where they can contend with the de-carbonised, ESG kind of world?

Or are their business models fairly constrained to one of those thematics?

In the latter case we are very careful about how and if we invest in those sectors because this transition will take place over the course of the next 10 years.

That’s definitely within the context of an investible timeframe.

So we have to be very careful about assessing a company’s ability to make the transition.

It’s accepted wisdom that inflation will be at the heart of investment strategies over the next decade. But Pendal’s NUDGEM RICHYAL believes that’s wrong. Here he explains why

• Demographics will put downward pressure on prices
• Implications for short and long-term investing
• Find out about Pendal Global Select Fund

IT’S accepted wisdom among investors that the low-inflation, low-interest rate environment of recent decades is over — and we must now contend with rising prices for a long period of time.

But senior fund manager Nudgem Richyal, who manages Pendal Global Select Fund alongside Chris Lees, thinks the wisdom is wrong.  

“For a bunch of reasons — supply chains, China, the war in Ukraine — there’s been a short-term bump in inflation.

“But the big story that’s been pushed into the background is demographics. Developed nations are ageing. That hasn’t gone away.”

A book published two years ago by eminent economists Charles Goodhart and Manoj Pradhan has quickly become a seminal piece in the debate on inflation.

The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival focuses on demographics and the participation of China in the global economy.

It argues that these two dynamic forces over the past three decades led to deflationary forces that explain falling inflation and interest rates.

Going forward, the two forces will operate in reverse, leading to growing inflation pressure, the economists write.

“Our view is the complete opposite,” Richyal says. “We think the ageing population is actually disinflationary, and Japan has shown that.”

Richyal uses an anecdote to explain the hypothesis.

“As people age, their desire for a bigger house decreases. In fact, people downsize. They go from a McMansion to a one-bedroom apartment, and that’s disinflationary.”

He argues that as people age, consumption drops.

“Their footprint decreases. The collapse in consumption and investment brings inflation down. And that’s the point Goodhart and Pradhan are missing.”

An ageing population will put price pressures in some parts of the economy, such as health care and social services, because consumption will increase.

But even in those areas, people are less able to spend as much as they get older, because incomes are lower and as people age, wealth decumulates, Richyal says.

Japan bucks the trend

Japan proves the point, Richyal argues. The country has one of the oldest populations in the developed world and has been operating in a very low inflationary environment for many years.

(Goodhart and Pradhan say Japan is an exception to their wisdom, but argue that during the past 40 years, globalisation of the labour force, the collapse of the Soviet Union, and the rise of China among other things, kept down price pressures.)

“Japan provides the empirical evidence. People provide excuses why Japan doesn’t count, but that is the empirical evidence.”

If the current bout of inflation is secondary to the demographics story, investors must rethink their short, medium and long-term strategies, Richyal says.

This has implications for healthcare, technology, real estate and all sectors of the economy.

“People don’t say inflation is transitory anymore. But we think of inflation as transitory over a secular span of time. And that’s because of demographics,” he says.

“Demographics will be disinflationary, not inflationary.”

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About Nudgem Richyal

Nudgem Richyal co-manages Pendal Global Select Fund with Chris Lees. The pair have been working together in global equities investing for more than 20 years.

Nudgem has 22 years of industry experience, joining J O Hambro Capital Management (a wholly owned subsidiary of Pendal Group) with Chris in 2008. He was previously an investment director with the Global Equity Group of Baring Asset Management, where he worked closely with Chris since 2001.

About Pendal Global Select Fund

Pendal Global Select Fund is a global equities portfolio with a distinctive, yet proven approach.

Fund managers Chris Lees and Nudgem Richyal have worked closely together for more than 20 years.

They manage a portfolio of 30-60 stocks using quantitative analysis and fundamental research based on decades of experience.

The team draws on the experience of 40-plus investment professionals at JOHCM and Regnan.

Contact a Pendal key account manager here

Rising commodity prices are triggering investor interest in companies that can recycle, process waste and optimise production to reduce costs, says Regnan’s TIM CROCKFORD

• High demand for recycling and automation solutions 
• Environmental challenges are also economic challenges
• Find out about Regnan Global Equity Impact Solutions fund  

RISING commodity prices are triggering investor interest in companies that can recycle, process waste and optimise production to reduce costs, offering opportunity for sustainable investors, says Regnan’s Tim Crockford. 

The concept of sustainable consumption and production is part of UN Sustainable Development Goal 12, which highlights that the global material footprint – the total of all raw materials used in production – has increased 70 per cent between 2000 and 2017. 

Higher inflation underpinned by soaring prices for energy, metals and food have put SDG12 at the centre of the global macroeconomic debate. 

“SDG12 is focused on minimising your inputs, minimising your wastage,” says Crockford, who heads up equity impact solutions at Pendal’s responsible investing unit, Regnan.

“That’s been a big area of focus for me and the team for the last 18 months or so. 

“There is obviously an environmental imperative there, but increasingly with the cost of inputs rising dramatically there is now a financial imperative.” 

Crockford says there is an opportunity for investors to lean in to SDG12 and identify companies that can help reduce input needs, recycle and drive towards a circular economy that reuses waste. 

“If your bill of material is increasing, and a company can sell a product or service that can reduce the bill of material for you, that company is now going to see some demand off the back of what’s going on in the commodity space.” 

Leaders in SDG #12

Crockford offers three examples of companies placed to win from the principles in SDG12:

Toronto-listed ATS Automation Tooling Systems provides automation systems to manufacturing companies in industries like healthcare, food and beverage, transportation and consumer products. 

“Its reason for existence is to help customers optimise the cost of production by reducing the cost of doing business,” says Crockford. 

Another example is Nasdaq-listed PTC, which offers digital transformation and internet-of-things software that integrates devices and sensors for businesses. 

“The idea is that you can figure out where your pressure points are in terms of manufacturing mistakes and wastage in terms of too much material being used, using sensors and data to analyse the manufacturing process,” says Crockford. 

At the other end of the production cycle, Crockford points to Germany’s Befesa, a recycling company that collects hazardous waste and residues and processes them back into raw inputs. 

“They can extract the zinc content out of recycled steel. They are solving a double problem – finding a way to dispose of this hazardous material and extract economically useful commodities out of it. 

“They are the biggest steel dust recycling company in the world. They are the only one that has started recycling in China, which is of course the largest steel producing market in the world.” 

These companies help save material – which is critical for building a sustainable future – but they also provide the immediate benefit of saving costs. 

“Environmental challenges are also real economic challenges,” says Crockford. 

And they are winners in an inflationary environment: “The financial return on investment for these sorts of products increases as the cost of your inputs goes up.” 

About Tim Crockford

Tim Crockford leads Regnan’s Equity Impact Solutions team and is senior fund manager of Regnan Global Equity Impact Solutions Fund. Tim previously managed the Hermes Impact Opportunities Equity Fund after co-founding the Hermes impact team in 2016.

Few sectors of the economy are as sensitive to changes in interest rates as property. Pendal portfolio manager JULIA FORREST explains the outlook for REITs in this fast podcast

An excerpt from this podcast

The REIT sector has priced in assets falling probably 15 to 18%. So it has been fairly efficient in terms of predicting where interest rates and bond rates would go, and the likely impact on asset values.

We’re already seeing that reflected in pricing at the moment.

So the sector does look like reasonable value, factoring in where we think interest rates will go.

We’re not expecting any severe stress in the sector, unlike in the GFC.

The sector is reasonably well positioned. It’s offering a reasonable dividend yield, 5% to 6% for the yield for the stocks that we like.

There is still some earnings growth coming through for some of the larger mall landlords.

Given what we’ve seen happen in the last two years – and the concessions that they’ve made to tenants for rents during Covid – we will see some rents coming back.

It will to some extent be moderated by rising cash rates and what that does to debt cost going forward.

But the sector is reasonably well positioned.

I think management still have the GFC in their corporate memories and have positioned their portfolios accordingly.

As a stronger US dollar attracts investors it might be time to consider high-quality, long-duration assets in sectors such as healthcare, says Pendal’s NUDGEM RICHYAL

• Opportunities in some long-duration assets like healthcare
• Only risk-off asset in the market is the US dollar
• Find out about Pendal Global Select Fund

A LESSON from the volatile global financial markets this year, particularly in recent weeks, has been the safe haven status of the US dollar.

Against a basket of major currencies, the greenback is trading around 20-year highs.

While equities and bonds have fallen, and crypto currencies have been dumped, investors have flocked to the US dollar, says Nudgem Richyal, co-manager of Pendal Global Select Fund.

Richyal uses a water tower analogy to describe what’s happened in financial markets in recent years.

“Financial markets are like a water tower. The US Federal Reserve has put a lot of liquidity into the system since 2008, and that’s the equivalent of filling up the water tower,” Richyal explains.

“But then there was too much liquidity in the system, or water in the tower, and the frothy stuff at the top flowed over.

“That’s the risk assets that we’ve seen come off in recent months like cryptocurrencies and speculative technology stocks.

“More recently we’ve seen a mopping up of the overflow – the excess liquidity. As the excess liquidity, or flow of water, stops, levels start to even up and that’s what’s happening now,” he says.

The disturbance in the market, or water tower, hits risky assets (or the highest water levels) most — but everything underneath is also affected.

“We are now getting to the point of last man standing, because pretty much everything has been hit,” he says.

Where we’re at

Richyal isn’t calling the bottom of the market.

Some sectors haven’t sold down, and they remain at risk. But it might be time to put some duration back into portfolios – stocks with long-term growth prospects, he says.

“The valuations of some duration assets have become much more attractive.

“Health care is one area we like. It is a long-term play, and usually when inflation peaks, the baton is passed from energy stocks to healthcare stocks,” Richyal says.

“Healthcare is a quality, long-duration asset, as opposed to speculative tech.”

In the meantime, investors are looking for an asset that isn’t losing value.

Risk parity – a portfolio allocation strategy that uses risk to determine asset allocation – hasn’t worked well because bonds haven’t protected investors when equities have fallen, Richyal says.

“But as both equities and bonds have fallen, the US dollar has gone up. The dollar has become a stagflation hedge.

“Another way to think about it: non-US investors might be selling equities and they might be selling bonds, but they’re not repatriating dollars.”

Richyal says it’s worth remembering crypto currencies — which have tumbled in value this year but in 2022 were considered by some investors as a hedge against inflation.

“Compare that to the US dollar, which is a risk-off currency.

“There’s a big difference. It just shows there really is only one risk-off asset in the world and it is still the US dollar.”

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About Nudgem Richyal

Nudgem Richyal co-manages Pendal Global Select Fund with Chris Lees. The pair have been working together in global equities investing for more than 20 years.

Nudgem has 22 years of industry experience, joining J O Hambro Capital Management (a wholly owned subsidiary of Pendal Group) with Chris in 2008. He was previously an investment director with the Global Equity Group of Baring Asset Management, where he worked closely with Chris since 2001.

About Pendal Global Select Fund

Pendal Global Select Fund is a global equities portfolio with a distinctive, yet proven approach.

Fund managers Chris Lees and Nudgem Richyal have worked closely together for more than 20 years.

They manage a portfolio of 30-60 stocks using quantitative analysis and fundamental research based on decades of experience.

The team draws on the experience of 40-plus investment professionals at JOHCM and Regnan.

Contact a Pendal key account manager here

In this podcast Tim Hext explains how the nature of inflation is changing, what’s driving recession fears and which asset classes look promising

An excerpt from this interview with Pendal’s head of government bond strategies Tim Hext:

The nature of inflation is changing slightly. Things like airfares have gone up a lot and rents. Used car prices also, which should have been coming off, had another surge.

But even though it’s a very high number – US consumer prices rose 1% for the month, which obviously is incredibly high – the May US inflation data was quite concentrated and quite a lot of other items did behave themselves.

But the market isn’t listening to that. They’re listening to the central theme and the central theme is that central banks are behind the curve.

The theme now is ‘we need to be back at neutral almost tomorrow’.

Neutral is between 2.5% and 3%. The US will get there in a few months. If market pricing is to believe, Australia also will be there well before the end of the year.

But it’s very clear that, even if they get to neutral quite quickly, inflation won’t necessarily be coming down at the same time. There’ll be a long lag.

Are they prepared to sit out that long lag and be patient, or are they actually going to take rates into contractionary territory?

That’s what equity markets and bond markets are now concerned about. They’re concerned that they’ll actually have to tighten into contractionary territory.

When that happens, the chances of a recession become a lot, lot higher.

Which asset classes look promising now? Tim explains in the above podcast

Listen to the full podcast above

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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

How should global equities investors approach this market? Which sectors should investors consider? Here’s a view from Pendal’s CHRIS LEES

• Healthcare and semi-conductor stocks favoured
• Watch out for growth traps and value traps
• Find out about Pendal Global Select Fund here

GLOBAL equities investors are navigating a range of factors right now including rising inflation and interest rates, the continuing Ukraine conflict, Chinese Covid lockdowns and slowing global growth.

How should global equities investors approach this volatile market? Which sectors should they consider?

Chris Lees, co-manager of Pendal Global Select Fund, points investors towards industries such as healthcare and semicondictors.

“According to our process, healthcare is the best defensive growth sector, semiconductors are the best cyclical growth industry, and the commodity-exporting countries are attractive because they have both defensive and cyclical growth characteristics,” says Lees.

“Our top-down monthly sector/regional scorecard has seen Europe, Japan and the consumer discretionary sector all deteriorate, with the more defensive healthcare sector improving. 

“We have been buying some new stocks in the healthcare sector and think it could be one of the leading sectors for the next several years.”

But Lees warns of “demand destruction” in commodities as central bankers around the world continue to put interest rates up to slow down demand to reduce inflationary pressures.

He says it’s a good time to sell both “growth traps” — speculative, unprofitable, concept stocks, and “value traps” — cyclicals with leveraged balance sheets.

“Look to buy the dip in steady growth ‘compounders’ once the worst of the interest rate rises are over,” Lees says.

“As Warren Buffet wrote in his 1989 letter to shareholders, ‘it is far better to buy a wonderful company at a fair price than a fair company at a wonderful price’.”

The outlook for commodities

Lees also believes this commodity cycle will be different from the last one.

The 2002-2008 commodity cycle was driven by the positive demand shock from China joining the World Trade Organisation.

The current commodity cycle is driven by the negative supply shock from Russia invading Ukraine.

“If policy makers recognise and react to this new radically different regime and realise that putting up interest rates does not cure a supply-side problem, then this will probably turn out to be a mid-cycle correction,” he says.

“If not, and policy makers keep raising rates while yield curves flatten then invert, credit spreads widen, and we go into a global recession … many low-quality stocks with stretched balance sheets will have a very long way to fall.

“In that case we would move the portfolio up the quality curve and focus on those companies with rock-solid balance sheets that can weather the difficult combination of rising interest rates, rising input costs, and slowing economic growth. “

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About Chris Lees and Nudgem Richyal

Chris Lees co-manages Pendal Global Select Fund with Nudgem Richyal. The pair have been working together in global equities investing for more than 20 years.

Chris has more than 32 years of investment industry experience. He joined Pendal Group’s UK-based asset manager J O Hambro Capital Management (JOHCM) in 2008 after spending 19 years at Baring Asset Management, ultimately as head of its global sector team.

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About Pendal Global Select Fund

Pendal Global Select Fund is a global equities portfolio with a distinctive, yet proven approach. Fund managers Chris Lees and Nudgem Richyal have worked closely together for more than 20 years.

They manage a portfolio of 30-60 stocks using quantitative analysis and fundamental research based on decades of experience.

The team draws on the experience of 40-plus investment professionals at JOHCM and Regnan.

When is the right time to buy global equities and how best to value stocks during volatile times? Pendal global equities fund manager NUDGEM RICHYAL has some answers in this quick podcast

You can also listen to this podcast on Apple or Spotify or read an edited transcript below

An excerpt from this podcast:

What signpost should global equities investors be looking for right now?

Nudgem Richyal, co-manager of Pendal Global Select Fund: It goes back to the need to see a shift in Fed policy. Once we see a clear change in language, that the Fed is no longer worried about the politics and inflation, at that point, it will be safe to go back in.

The challenge is, markets are discounting mechanisms.

The market may anticipate any such shift in the Fed before it’s actually articulated. That’s always the $64 million question.

So that’s what we’re looking for. What we’re expecting is the market will discount a change in Fed policy, and so we’ve got to anticipate that.

One of the ways to do that would be to see if the inflation data itself peaks. That hasn’t happened. It was expected to happen last week, but it didn’t.

Chair Jerome Powell isn’t talking down interest rate rises at the moment.

But at some point the market will anticipate he will shift.

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About Nudgem Richyal

Nudgem Richyal co-manages Pendal Global Select Fund with Chris Lees. The pair have been working together in global equities investing for more than 20 years.

Nudgem has 22 years of industry experience, joining J O Hambro Capital Management (a wholly owned subsidiary of Pendal Group) with Chris in 2008. He was previously an investment director with the Global Equity Group of Baring Asset Management, where he worked closely with Chris since 2001.

About Pendal Global Select Fund

Pendal Global Select Fund is a global equities portfolio with a distinctive, yet proven approach.

Fund managers Chris Lees and Nudgem Richyal have worked closely together for more than 20 years.

They manage a portfolio of 30-60 stocks using quantitative analysis and fundamental research based on decades of experience.

The team draws on the experience of 40-plus investment professionals at JOHCM and Regnan.

Contact a Pendal key account manager here

Europe is likely to accelerate renewable energy as a preferred solution over fossil fuels. Regnan’s TIM CROCKFORD explains why

• Russia’s invasion has upended Europe’s energy supply
• LNG and nuclear could take years to roll out
• Renewables, hydrogen, batteries can be operating sooner

RUSSIA’S invasion of Ukraine could accelerate the uptake of renewable energy as European regulators fast-track approvals and sweep away bottlenecks to alleviate the continent’s energy crisis, says Regnan’s Tim Crockford.

Russia’s aggression has upended energy markets and propelled oil and gas prices to multi-year highs, triggering question-marks about what Europe can do to diversify its energy supply.

Before the invasion, Europe was heavily dependent on Russia for gas, oil and coal. Russia accounted for 55% of Germany’s natural gas supplies in 2021, more than a third of its crude oil and about half its hard coal.

While the humanitarian crisis remains a priority, focus is turning to “how governments respond and what effect this will have on renewables,” says Crockford, who heads up Regnan’s Global Equity Impact Solutions Fund. (Regnan is part of Pendal Group).

“We believe in the short term, it’s going to accelerate production increases in fossil fuels as well as renewables,” says Crockford.

“But it brings a longer-term, heightened risk for investors of stranded assets in the fossil fuels space” because the additional supply coming online is contingent on current higher prices lasting into the longer term.”

Part of the fossil fuel price reaction to the invasion can be explained by the fact that declining investment in fossil fuel capacity in recent years has not been matched by equivalent investment in renewables.

“So, while people have been talking about growth in renewables, we would actually argue that the growth has happened at a slower pace.

“Now you’re starting to see the catch up being played out.”

LNG ramp-up faces hurdles

The EU has a difficult balance to achieve — energy security within existing decarbonisation targets.

The likely outcome is a ramp-up in liquified natural gas (LNG) — which is expected to rise 70% by 2024 in continental Europe, albeit amid falling overall gas consumption.

But there is no short-term solution to lifting fossil fuel output, says Crockford.

One reason is that most of the existing production of LNG is tied to long-term contracts — predominantly going to Asia.

“So, while theoretically, LNG should be the energy source that is most responsive to the greater need, it’s not actually materialising.”

Another problem: Europe has little spare “regassification” capacity to make use of liquid LNG imports.

What it does have is designed for gas to flow from east to west. LNG receiving facilities in Spain have capacity, but there are no pipelines to send the gas back eastwards across Europe.

“This is something that will take three to five years to put in place from when the investment decisions are made,” says Crockford.

Expect Europe to accelerate renewables

Among alternative energy sources, coal is not feasible partly because it is politically unpalatable but also because it has been through a major decommissioning process in recent years, says Crockford.

Meanwhile, public perception towards nuclear “has done a 180, but it’s not as simply as flicking a switch and turning the plants back on again — the leads times are seven to 10 years”.

While renewable energy is equally no quick fix, Crockford says investors should expect many governments across Europe look to accelerate renewable investment.

“In addition to making it more likely that they will be brought into line with net zero commitments, renewables can be operational sooner than new fossil fuel and nuclear capacity.

“This is particularly true for small-scale solar and onshore wind, but even offshore wind has a theoretical lead time of 18-24 months after an investment decision has been made.”

He says the main bottlenecks for renewables are getting permits from regulators and grid connections, but EU policy makers are acting on this by directing governments to speed up the permitting process.

Other beneficiaries of the push for energy independence are likely to be energy storage — both hydrogen and batteries — and companies that help businesses and households improve their energy efficiency.

Renewables, hydrogen, batteries set to win out

“In summary, while we are likely to see a rise in short-term support for fossil fuels, it is likely to be curtailed by supply and lead-time constraints,” says Crockford.

“It is our view that this increases the medium-term risk of assets becoming stranded, as capital is likely to be sunk into assets that command a higher cost per unit of energy relative to older capacity and therefore require commodity prices to remain higher for longer to achieve their expected ROIs.

”At the margin, therefore, it would seem to us that renewables, hydrogen and battery storage and energy efficiency are poised to win out.”

About Tim Crockford

Tim Crockford leads Regnan’s Equity Impact Solutions team and is senior fund manager of Regnan Global Equity Impact Solutions Fund. Tim previously managed the Hermes Impact Opportunities Equity Fund after co-founding the Hermes impact team in 2016.

ESG investors can have a lot of influence over businesses, but countries are harder. Will this change in the wake of Russia’s invasion of Ukraine? We asked Pendal ESG credit analyst Murray Ackman

An excerpt from this podcast:

ESG investing has two main objective, says Pendal ESG credit analyst Murray Ackman.

“One is about avoiding a financial loss or achieving an upside, and two is about bringing about change.

“Avoiding your financial loss or achieving an upside becomes pretty relevant when we’re looking at unsustainable areas or sectors that might be regulated out of existence.

“The quintessential stranded asset is coal plants, which will have limited use when renewables make up a much larger part of the electricity grid.

“It could also be areas where regulations, sanctions or potential changes in the future will impact the viability of various assets.

“This doesn’t necessarily mean that these types of assets are going to go to zero. It just means it could be unpopular, shrinking or there’s low liquidity in the area.

“The non-financial components can be simply that you don’t like what the industry or a particular company is doing.

“We’ve seen controversies becoming much more prominent as a reason why investors are looking to get out of a particular investment.

 “You can have a lot of influence over businesses, but countries are a lot bigger and a lot harder to influence, though there have been examples such as South Africa.

“The Russian example is perhaps a little idiosyncratic because there’s widespread sanctions and the speed and scale of condemnation in the west is very unique.

“Very few businesses have applied the same standards to other countries that have invaded sovereign nations although we can see the English Premier League is starting to question this in regard to Saudi Arabia and Yemen, so maybe this will change.

“We’ve seen that things happen and there is a resetting of the status quo view, so perhaps this is a watershed moment on the way in which we invest in countries.”