The days of holding a set-and-forget 60:40 portfolio are over, says Pendal’s Vimal Gor. Investment managers need strategies and sub-strategies within a defensive portfolio. Here’s why

• 60:40 portfolio construction is no longer enough
• Investors need to look for more advanced defensive strategies
• ‘New way of thinking’: Vimal Gor

THE DAYS of set-and-forget portfolios are over and successful investing today requires actively managed defensive strategies, says Vimal Gor, who heads up Pendal’s Bond, Income and Defensive Strategies team.

Traditional investment wisdom says investors can run a portfolio with 60 per cent equities and 40 per cent bonds and get exposure to rising markets while enjoying protection when things turn down.

But policymaker action to keep interest rates low means bonds no longer play the role they once did in a portfolio of providing income alongside downside protection, Gor says.

“People know their fixed income defensive portfolio is broken — they just don’t know what to do with it,” says Gor, speaking at Investment Magazine’s recent Absolute Returns Conference.

“They are navigating this period where the 60:40 portfolio is no longer as relevant as it was in the past.”

Gor recommends investors take a whole portfolio approach and build strategies and sub-strategies within the portfolio that perform at certain times.

“The key thing for clients is that you want to have confidence in the defensive part of the portfolio to perform when you need it.”

The idea is to avoid an asset-class approach and recognise that defensive strategies can be found across the markets, he says.

“It’s like a new way of thinking about it. You’re not so much trying to put together types of asset classes and then getting an outcome, it’s really a focus on the outcome first.

“If the equity markets are all down, what do I need my defensive book to do? And do I have confidence that it will actually work or not?”

Volatility as a strategy

That approach has led Gor to use volatility as a trading strategy, adding equity volatility in recent years and even using cryptocurrency to provide defensive protection.

“It’s really about making sure we’re thinking about the whole portfolio as opposed to saying here’s a fixed income fund.”

Relying on bonds and traditional portfolio construction strategies is effectively equivalent to using old technology, he says.

“We’ve got to this point where there’s complete death for the 60:40 portfolio and if we get bond yields rallying further well then risk parity is largely dead as well.

“But then how do you think about building that defensive path?

“If you don’t use volatility and you don’t use equity vol and you don’t use strategies like intra-day momentum – these kinds of things which are proven to be defensive – well then just relying on an old product set isn’t going to get you to where you want to be.”

What impact will China’s economic slowdown have on Emerging Markets investors? And what are the alternatives? Here’s a quick overview from Pendal’s James Syme and Paul Wimborne

THERE has been substantial media and analyst commentary around the changing political and regulatory environment in China.

Important as this is, we think it is at risk of overshadowing what economic data releases in July and August have shown about the Chinese economy: genuine economic weakness across the board.

Almost every Chinese economic release in those months was weaker than the previous data point, and below expectations.

A selection of this month’s data would include:

• Retail sales (July): +8.5% year-on-year compared with consensus expectations of +10.9% and a previous print of +12.1%)
• Industrial production (July): +6.4% year-on-year compared to consensus expectations of +7.9% and a previous print of +8.3%)
• Property investment sales (year to July): +12.7% year-on-year compared with consensus expectations of +12.9% and a previous print of +15%
• Caixin Manufacturing PMI survey (August): Down to 49.2 compared with 50.1 expected and 50.3 in July.

More ominously, the datapoints that we believe lead the real economy were also soft.

M2 money supply growth in July declined to 8.3% year-on-year and growth in claims on the financial system declined to 7.4%.

These together reflect monetary policy as tight as that in the 2018/2019 period.

Bond yields are also suggesting a slowdown. Chinese government 10-year yields are lower by 0.3% year-to-date. This is during a period when most countries’ sovereign bond yields have risen.

Despite this, commodity prices have not reacted as might have been expected.

Copper has remained around US$9400/t, having started the year at about US$7700/t.

Iron ore has come back to US$145/t from its US$235/t peak in May, but is only slightly lower than its US$156/t start of 2020.

From an equity investor’s viewpoint, MSCI EM Materials has performed well year-to-date and in the past two months.

We cannot see this lasting and we remain zero-weight industrial metals producers in the portfolio.

Brazil and South Africa upcycle

We continue to hold overweight positions in Brazil and South Africa, both of which are major commodity producers.

Why are we less concerned about these markets, given our view on the direction of the Chinese economy?

Emerging economies can generally be thought of as having a trend rate of economic (or earnings) growth, and then a business cycle around that trend.

Even if the medium-term trend is less attractive, markets undergoing a strong business up-cycle can offer compelling opportunities for investors.

This is what we believe is the situation in Brazil and South Africa.

In the eight years that followed the 2002-2011 commodity boom, Brazilian GDP growth averaged just 0.5% year-on-year. Unemployment climbed from 5.2% to 11.3%.

This period saw a significant slowdown in credit growth and a strong increase in the trade balance (reflecting weak domestic demand).

Domestic demand had begun to recover towards the end of this period (for example, car sales bottomed in 2016 and unemployment bottomed in 2017). But the impact of Covid delayed the recovery.

Risks remain, including the timing of the peak in inflation and interest rates and political risk from the October 2022 election.

But we continue to see Brazil as an economy with the economic and financial conditions to stage a near-term recovery in domestic demand — towards what we fully recognise is a mediocre trend rate of growth.

A slowdown in China, with lower commodity prices, may further reduce that trend growth rate. But it will not, we believe, prevent the recovery.

South Africa finds itself in a similar position.

In the 2012-19 period, South Africa experienced average GDP growth of 1.4% with weak credit growth and a deleveraging of the private sector and rising unemployment.

South Africa had not even begun to recover before Covid hit — yet the improvement in the trade balance was much stronger than in Brazil.

We feel South Africa will also stage a recovery back towards trend growth levels in the quarters ahead. We expect opportunities in domestic demand, while recognising urban unrest and new Covid variants are risks that must be monitored.

We do not see a 2021 slowdown in China preventing that recovery.

Some emerging markets are commodity exporters. But neither the economies of those countries nor their equity markets have mechanical linkages to commodity prices — and there will be periods of opportunity in the face of softening export prices.

We believe the second half of 2021 will be such an opportunity.

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About Pendal Global Emerging Markets Opportunities Fund

James Syme and Paul Wimborne are senior portfolio managers and co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

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

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here.
 
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. 

Investment managers analyse green investments against a range of benchmarks, but it boils down to three things, says Regnan’s MAXIME LE FLOCH

• Is it really green? Is it the best solution?
• How does it look long-term?
• Find out about Regnan Global Equity Impact Solutions Fund

FOR professional investors ESG benchmarks are now integrated into regular decision making. For individual investors, that’s not yet the case.

A recent Gallup study showed smaller US investors don’t spend time focusing on Environmental, Social and Governance factors when making investment decisions — and the majority don’t know much about it.

But that’s changing. The survey showing an uptick in smaller investors’ interest in responsible investing. And recent political outcomes, including the success of the Greens and independents in the Australian federal election, will force greater focus on ESG at a policy level.

So how should a small investor approach ESG?

“Start by make sure what you’re considering is actually green”, says Maxime Le Floch, an analyst with Regnan’s Global Equity Impact Solutions team.

“Second, focus on solutions with a strong relative advantage over competitors.

“And finally, focus on long-term opportunities.”

1. Make sure it’s green

Investors need to define what green is to them, Le Floch says. “There’s a spectrum of how green investments are and debates around that within scientific communities and within industries.”

“These are very complex multi-dimensional issues and it’s not just about climate change. It’s also about ocean health, foods, wastewater and many other issues,” he says.

Investors need a framework to benchmark green investments, and the United Nations Social Development Goals (SDGs) are a good place to start.

“That’s the roadmap. From there you need to do some work in terms of translating the goals into actionable investment ideas and that takes research. It might be around offshore wind, new types of plastic, recycling technologies or water treatment.”

As part of their impact assessment of companies, Le Floch and the Regnan team employ various tools such as life-cycle analysis.

This considers the full life-cycle of a product — from raw materials to production to use to disposal or recycling — and consider all environmental impacts in each stage.

2. Relative advantage of a solution

There is seldom just one ESG solution to a challenge and investors need to consider which is the best outcome for a problem.

“It’s important to not just look at the environmental benefits of a technology but also how it performs relative to other technologies,” Le Floch says.

The simplest example is the automobile sector. Internal combustion engine cars have become less pollutant and with the introduction of hybrid vehicles, the improvement has accelerated.

“But they can only go so far. Electric vehicles provide much greater environmental benefits and have a cost profile that’s getting more attractive. When you include how much you pay for petrol, maintenance and the depreciation of the vehicle, cost parity is coming much faster than was expected,” Le Floch says.

“An investor wants to be exposed to a green asset where the relative advantage has reached a point whereby there is accelerating growth coming to those solutions.”

3. Invest for the long-term

Investing for the long term is more important today with rising inflation, Le Floch says.

“It’s really important to stay focused on the long-term opportunities – the total addressable market, structural opportunities, the need to decarbonise that is recognised by governments, companies and investors.

“There is a big increase in the number of companies aiming for net zero carbon emissions. That will create demand for offshore wind power, for example. There are these types of structural drivers from companies making net-zero decisions.

“Investors should focus on areas where there are structural growth opportunities – offshore wind, wood-based fibres, water treatment solutions,” he says.

Green assets are attractive because their environmental benefits are going to be increasingly recognised and rewarded, Le Floch says.

“There will be higher demand for these technologies if they can prove they are benefiting the economy and that’s what investors should look for.”

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About Maxime Le Floch

Maxime is an analyst with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Maxime has more than 10 years of experience in sustainable investment. Before joining Regnan he was an investment analyst with Hermes where he helped launch and manage the Hermes Impact Opportunities Equity Fund.

Investors in Regnan Global Equity Impact Solutions fund are on a journey with diabetes pioneer Novo Nordisk to treat obesity. Regnan’s Maxime Le Floch explains

• 650 million adults are obese
• Novo Nordisk is an early mover in anti-obesity drugs
• Regnan Global Equity Impact Solutions fund is an investor in Novo Nordisk

INVESTORS can spend years looking for a market-leading company in a fast-growing sector that’s innovative enough to withstand challenges and stable enough to grow with demand.

There are not many such companies — though Danish pharmaceutical group Novo Nordisk might be one of them says Maxime Le Floch, an investment analyst with Regnan’s Global Equity Impact team.

“This is the poster child for finding a really strong solution that’s miles ahead of competitors in a fast-growing market,” he argues.

The market? Anti-obesity treatment.

Novo is best known as a pioneer in diabetes treatment, where it holds about 30 per cent of the global market. Its diabetes drugs reached 34.6 million people around the world in 2021.

About 422 million people worldwide have diabetes and 1.5 million deaths are directly attributed to the disease each year, says the World Health Organisation.

Novo is now developing medical treatments for obesity, which is closely linked with diabetes.

The WHO reports 650 million adults are obese (1.9 billion are classed as overweight) and some 4 million die each year from obesity.

However anti-obesity medication is almost non-existent. “It’s a new category,” Le Floch says.

Novo Nordisk launched its new “Wegovy” injectable anti-obesity drug in the US last June and expects to launch in Europe later this year.

A pioneer in diabetes treatment

Novo Nordisk’s heritage dates back to 1921.

After hearing of the discovery of insulin in Canada, Danish Nobel laureate August Krogh and his wife Marie — a doctor living with diabetes — convinced the researchers to allow production in Denmark.

The first patients were treated in March 1923.

Suddenly diabetes was no longer a death sentence. The original company grew quickly and merged with a competitor.

By 2022 Novo Nordisk was a global leader in the treatment of diabetes.

“It’s very innovative in finding new treatments,” Le Floch says. “It is improving outcomes in terms of co-morbidities, in particular cardiovascular and hypoglycaemia.”

Treatments for diabetes, which is a condition of having too much glucose circulating in a person’s bloodstream, have evolved over time, from daily injections to weekly injections, from the use of syringes to the use of pens.

That’s Novo Nordisk’s base business.

Treating weight-loss

“Over the past few years Novo Nordisk has started working on new treatment pathways using glucagon-like peptide 1 (GLP-1) and realised it had very good outcomes not just for diabetes but also for weight loss,” Le Floch says.

GLP-1 drugs treat type 2 diabetes, the most common form of the disease which affects 380 million people globally.

“They explored that outcome and it led them to develop anti-obesity medication that’s revolutionary. The cardiovascular profile for the treatment looks very compelling as well,” Le Floch says.

Anti-obesity medication

Obesity and diabetes go hand-in-hand. People with a higher body mass index are more likely to develop diabetes.

Humans are getting heavier, according to a range for government funded and private studies. Greater calorie intake, confusion over what’s nutritional and general inactivity are mostly to blame.

It isn’t a challenge just for the health system but for many sectors across the economy.

For example, in June last year, the Levi Strauss boss Chip Bergh told analysts that during COVID around one-third of customers’ waist sizes had changed. In Levi’s case it was a positive because people had to buy new clothes.

But mostly it’s a negative and the health sector is at the forefront of the fight against expanding waistlines.

Novo Nordisk is moving towards treating the source as well as the symptoms, Le Floch explains.

“For some people reducing food isn’t enough to reduce their body mass index. Now there is a treatment pathway …. And the weight loss benefits are very compelling.”

Covid link

People who have contracted COVID may also be more likely to suffer from diabetes, according to early studies.

“That’s not totally proven yet but certainly the potential is there. In France, medical authorities realised that many of the people who ended up in emergency care because of COVID also lived with obesity,” Le Floch says.

Medication for obesity is under-served.

“Anti-obesity medication is almost non-existent, or at least very, very small. It’s a new category,” Le Floch says.

“Novo Nordisk is investing in clinical trials to prove further the benefits of its treatment. It could end up in a new market where there aren’t many solutions and there is a massive opportunity.

“That’s the investment case for Novo Nordisk. Not just treatment of diabetes but attacking the source of the disease, opening up a whole new market.”

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About Maxime Le Floch

Maxime is an analyst with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Maxime has more than 10 years of experience in sustainable investment. Before joining Regnan he was an investment analyst with Hermes where he helped launch and manage the Hermes Impact Opportunities Equity Fund.

Australia this week sped past the RBA’s 2-to-3% inflation target and caught up with other global economies.

What’s next?

Beyond the headlines of yesterday’s 5.1% CPI result, the contribution of new dwelling purchase price and rents are useful bellwethers, says Anna Hong from Pendal’s Income and Fixed Interest team.

“New dwelling prices came in at 5.7% for this quarter — the highest since the turn of the century. Builders are finding it difficult to quote given the cost pressures they’re facing.”

Meanwhile rents turned the corner, contributing 0.6% this quarter. “Rent growth is accelerating across capital cities and there is more to come.”

This means increased pressure on the RBA to hike rates during the election campaign, says Anna.

“Markets have already priced in aggressive rate hikes in 2022 and a cash rate forecast above 3% by end of 2023. This may come as a shock to mortgage holders.

“The RBA is increasingly looking like it must join other central banks in dampening demand to rein in inflation rather than waiting for supply to fix itself.”

Investors are closely watching the upcoming COP26 climate change conference and hoping for certainty around net zero targets. Regnan’s Maxime Le Floch explains what to look for

• COP26 can provide greater certainty for investors
• Rich v poor countries a sticking point
• Find out about Regnan Global Equity Impact Solutions Fund

WHAT’S will investors be looking for from the much-vaunted United Nations COP26 Climate Change Conference starting in a little over a week?

Greater certainty, says Maxime Le Floch, investment analyst with Regnan’s impact investment team.

Le Floch wants to see “countries arrive in Glasgow and have targets and commit to net zero. Countries arrive with a plan to reduce emissions. The most important thing is the individual country’s plans.”

Forums such as COP26 allows nations to outline how they plan to get to net zero emissions, theoretically by the middle of this century.

Those pathways give investors greater certainty on the rules they face in the future. And that certainty is good for investing.

More countries have made commitments in recent months, including China, Japan and South Korea.

Others, including Australia, are still debating the politics.

In Australia, the federal coalition is yet to outline its ambitions, in part because of disagreements between the Liberal and National parties. However it’s likely that Prime Minister Scott Morrison will have some sort of offering by the time he leaves for Glasgow. 

Game theory

Global conferences like COP26 involve plenty of game theory, Le Floch says.

“If countries turn up and commit, or have previously announced their intentions, that’s a positive for other countries to commit to reducing greenhouse gases.

“That’s why China already committing to net zero emissions by 2060 is such a big deal,” he says.

Nations that provide concrete evidence of a pathway to reducing emissions are enabling greater investment, Le FLoch says.

It might be subsidies for electric vehicles, or carbon offset schemes or changed taxation arrangements.

Those factors become part of the investment decision, albeit not the central reason for buying or selling.

“As impact investors, we don’t rely on regulation, and we’re not waiting for it to happen,” says Le Floch, who is part of a four-person team managing Regnan Global Equity Impact Solutions Fund.

“There has to be an underlying economic dynamic to unlock value, without any change to regulations.

“But we do recognise that regulation drives adoption and creates an environment in which laggards are forced to improve and leaders and green innovators can thrive.”

He points to European offshore wind subsidies which were initially generous as part of a push to achieve carbon neutrality. But they have been phased out in some jurisdictions as offshore wind generation becomes cost effective. Investors in wind farms had to look well beyond the short-term subsidies.

Stumbling blocks to watch out for

The optimism of a global event like COP26 is well founded, but it can easily become unstuck.

“Typically, in a negotiation like this, the stumbling block is the distributive impact of climate change, both in terms of mitigation and adaption. Who is responsible for what, and what should we expect from rich and poor countries,” Le Floch says.

And conferences such as these don’t operate in isolation.

The International Energy Agency earlier this month forecast a need to triple investment in renewable energy to ensure fossil fuels were replaced without triggering an energy crisis.

“There’s a big gap at the moment and the IEA is explaining what’s needed to get on track. To accelerate that you need incentives and conferences like COP26 can help do that.”

It’s been six years since the Paris Accord.

That treaty was the first legally binding agreement to limit global warming to well below two degrees — preferably to 1.5 degrees Celsius — compared to pre-industrial levels.

As part of that, 196 parties agreed to reach peak greenhouse gas emissions as soon as possible and achieve climate neutrality by 2050.

This time around the UN Climate Change conference is being hosted by the UK in partnership with Italy.

It will take place from October 31 to November 12.

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About Maxime Le Floch

Maxime is an analyst with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Maxime has more than 10 years of experience in sustainable investment. Before joining Regnan he was an investment analyst with Hermes where he helped launch and manage the Hermes Impact Opportunities Equity Fund.