It’s a promising time for fixed-income investors, but investors should be aware of potential risks around rates, inflation and a Trump presidency. Pendal’s GEORGE BISHAY explains

• Rate cuts still likely due to falling inflation, not recession fears
• Active credit management important
• Find out about Regnan Credit Impact Trust
• Find out about Pendal Sustainable Australian Fixed Interest fund

THE services side of the economy – particularly wages and rental inflation – have held up prices in recent times.

But forward indicators monitored by Pendal’s income and fixed interest team show the drivers of these two factors weakening.

That means inflation in developed markets should continue to fall, allowing central banks globally to start cutting rates, argues Pendal’s head of credit and sustainable strategies, George Bishay.

“That means central banks globally can start cutting rates,” he says.

“My view is that central banks will cut rates because inflation is coming down — not because we are going into recession.”

It’s an important distinction, because when an economy goes into recession, bonds usually perform well, while credit and equity markets can underperform.

“If inflation is falls, that’s a bullish environment for bonds as central banks will cut cash rates and interest rates in general should come down.

“This is also bullish for credit and equity markets.”

What a Trump White House means

The key risks to this view is if oil prices rise or if Donald Trump beats presumptive Democratic nominee Kamala Harris in the US presidential election later in the year, Bishay says.

“If Trump wins the election, will he have the ability to change policy? Will he have a majority in both houses of Congress? 

“If he does, then that’s problematic for bonds because ultimately that’s likely to be inflationary,” Bishay says, nominating tax, immigration and trade as key areas of policy to watch.

The impact of a Trump Presidency is more skewed towards longer-term bonds because his policies would likely have a medium-term impact on inflation, he says.

“The short end continues to perform because central banks will be easing rates as current inflation comes down.”

Active management remains important for fixed income

With so much uncertainty in the market, active management of credit portfolios is critical.

“Most credit managers in Australia are buy-and-hold managers. In periods such as Covid, performance of those strategies can get hammered before eventually recovering.

“Volatility of their returns can be quite high.

“We prefer to actively de-risk and re-risk our credit exposures, based on a top-down process.

“If we have concerns about the macro environment, we will reduce risk across the board on credit exposures. That tends to support outperformance because it minimises downside risk.

“When we have more confidence in the market, we re-risk and participate in the upside benefit.”

The three main pillars of Pendal’s top-down process are a qualitative view, quantitative models and technical analysis.

“When the three pillars line up, we de-risk or re-risk the portfolios and that’s been incredibly powerful.”

Investors have been getting used to good news on inflation. But does the latest data suggest we’re getting ahead of ourselves? Pendal’s head of bond strategies TIM HEXT reviews the evidence

You can also listen to this podcast on Apple or Spotify

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

Is there still opportunity in government bonds, despite US inflation data surprised to the upside?

“People like myself are paid to worry about weekly fluctuations, but I think for investors the trend is still in place,” says Pendal portfolio manager Tim Hext.

“We have higher interest rates than we need given the inflation backdrop now, as opposed to 12 months ago.

“Central banks have recognised that and will deliver on cuts.

“People like me are paid to delve into how many and when. But the theme is still lower rates in the US across the year, and Australia will likely follow towards the back after the year.

“Cash rates in Australia are 4.35%. We think you’ll see them towards 3.6% by the end of this year, possibly a little bit lower into 2025.

“If you think about term deposits, you’re going to face an environment where getting in the high 4s and even in some cases low 5s won’t be there in the second half of the year.

“You’ll start to see more in the low 4s and possibly high 3s.

“When you look at bonds at this point in time – depending on whether you buy a government bond, a state government bond, or a bank bond – you’re still getting 4 point-something or 5 point-something as your yield.

“That’s going to out-do term deposits in the medium term. “So there is a bit of juice left.”

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

Reckon you’ve got 2024 figured out? Stay on your toes, because markets could go in any direction this year. Pendal’s head of income strategies AMY XIE PATRICK explains her thinking in our latest podcast

You can also listen to this podcast on Apple or Spotify

An excerpt from this podcast

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Amy Xie Patrick, Pendal’s head of income strategies:

At the start of 2023, the investment base case was a US recession, an inverting yield curve and an end to the inflation fight.

There was optimism about China reopening after the end of zero-Covid restriction policies.

Now, at the beginning of 2024, it couldn’t be more different, says Pendal’s head of income strategies Amy Xie Patrick in our new podcast.

Recession is now nobody’s base case, says Amy. China is the last place people are optimistic about in their world views.

It’s all evidence that investors will need many levers to pull when navigating this cycle, she says.

“Risk number one is that a soft-landing narrative led by the US economic story may not end up being the case,” says Amy.

“The biggest risk is always what’s outside of consensus. It’s not to say that consensus can’t happen, but if the consensus is the case, markets tend to be priced for it. “

Another risk is markets pricing in six Fed cuts, despite data showing resilient growth.

In her new podcast, Amy explains how she is preparing for risks – and opportunities – the market may not be considering.

With interest rates peaking, and depressed valuations, small and mid-cap stocks could be poised to outperform, argues Regnan’s TIM CROCKFORD

• Small, mid cap valuations depressed
• Europe, Japan, Indonesia, Brazil best opportunities
• Find out about Regnan Global Equity Impact Solutions Fund

VALUATIONS of smaller and mid-cap stocks have reached an extreme level in some parts of the world, believes Regnan portfolio manager Tim Crockford.

Global equities investors should be starting to consider allocating to smaller and mid-cap stocks or “SMIDs”, Crockford, who leads the equity impact solutions team at Regnan.

“People have taken money out of equities and much of that has gone from passive investments and systematic strategies, points out Crockford.

“So the $1 billion and $3 billion companies are disproportionately affected compared to the $100 billion or $300 billion company,” he says.

“Our macro view is that it’s going to get worse before it gets better. But financial conditions are likely to start loosening on account of the market speculating that we’ve seen peak rates.

“What the macro environment does is remove a major headwind SMIDs have faced for three years and gives them a bit of a tailwind going into next year, albeit with elevated volatility initially.

“That’s because when liquidity comes back into the market, we should get the opposite effect of what started when financial conditions started to tighten in 2021.

“We expect that to close the relative valuation gap.”

Where to look for SMIDs

There are tens of thousands of “SMIDs” stocks in developed and emerging markets.

So where to look?

Start by looking outside the United States, says Crockford.

“In terms of developed markets, Europe and Japan offers opportunities.

“In terms of emerging markets, it’s places like Indonesia and Brazil.

“In those economies, valuations are still very attractive given where they are in the cycle. There is clear opportunity there.

“We are still looking at interesting companies in the US — and perhaps some companies there will make their way into our portfolio at some point.

“But on a stock-specific basis, the ones we like are still trading on valuations that are a bit less forgiving if we do go into an economic downturn in 2024.”

Look for growth

Beyond geography, Crockford’s team is looking for companies that will show growth over the next 12 months — or where a valuation is so depressed it’s priced for a highly negative drop in growth in 2024.

“We are looking for companies that are able to generate organic cash flows to fund at least part of their growth.

“And the remainder of the funding needs to be covered by debt that isn’t going to burden, or reverse, the positive effects of potential future cash flow growth.”

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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.

Have investors missed the boat on bonds after they touched 5 per cent in October? No, says Pendal’s head of bond strategies Tim Hext. In this latest fast podcast he explains why.

You can also listen to this podcast on Apple or Spotify

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

For the first time in a number of years, it’s a pretty favourable environment for bonds.

Although they’ve rallied this month, 10-year bonds are roughly around 4.5% in Australia now.

They did briefly touch 5% at the end of October. People may look at that and say, “Oh, I’ve kind of missed it”.

But 4.5% is still very attractive if you believe inflation is going below 3%.

I think we’re still in the territory where if you lock your investments in from a fixed-rate point of view —in other words you buy bonds — you’re likely to do pretty well out of it.

4.5% should turn out to be a pretty good return, because term deposits are creeping up around 5% now.

When I look across the spectrum of what you can buy in bonds, government bonds are around 4.5%, state government bonds 5.25% and bank debt around 6%.

On term deposits, my question to investors would be: Okay, let’s assume term deposits are at 5% and you’re locking yourself into those with no liquidity.

Where do you think on average they’re going to be over the next five or 10 years?”

I think most people would assume they’re going to be a little bit lower, not higher; and that cash rates will come down rather than go up a lot more.

And yet, right now you can lock in, for five or 10 years, rates above 5% in bonds.

The other advantage of bonds is that they’re liquid.

You can sell them anytime. You’re not locked up like you are in a term deposit.

That’s particularly important, that if you saw a sudden sharp sell-off in equities and you’re wanting to buy them — but your money’s locked up in term deposits.

What does worry me is that central banks are driving in a rear-view vision mirror — they’re relying on inflation, and inflation is a very lagging indicator.

So they’re probably going to be a bit too slow to cut rates, because they’ll still be looking at inflation not coming down fast enough in Australia particularly.

That does open the door a little bit for some economic weakness. It’s not a core view, but there’s a higher danger of that.

Apart from that, the soft-landing scenario does look favourable for credit as well, and even for equities — which I think the markets started to factor in a little bit in the last month.

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

---

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

Bond yields are hitting multi-year highs. Why is it happening and what’s next? Pendal’s head of government bond strategies TIM HEXT explains in our latest fast podcast

You can also listen to this podcast on Apple or Spotify

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

US and local bond yields are hitting multi-year highs. Why is it happening and what’s next?

Resilience in the US economy is the main factor, says Pendal’s head of bond strategies Tim Hext.

That’s due to the dominance of fixed-rate loans there and Joe Biden’s big-spending government.

Meanwhile the Australian economy is holding up better than expected and the fixed-rate cliff hasn’t impacted as much as people thought.

“I think it’s a good time to be buying bonds,” says Tim. “At the moment you can buy state government debt at 6% yields.

“The cash rate is likely going to 4.35, but I don’t expect it to be well above 5% for the next decade or two.”

Bond investors are rewarding in two ways, argues Tim: the return and thei insurance role.

“If things were to get out of hand, if you get a collapse in equities, if you see major geopolitical disruptions in this heightened risk environment, then bonds should perform their defensive role.

“I do think they’re cheap insurance.”

Listen to the full podcast above

---

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

---

About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

A drug designed for diabetes — and increasingly used in weight control — has the potential to change the economics of not just healthcare, but many other sectors. Regnan’s MAXIME LE FLOCH explains

• GLP-1 diabetes and weight-loss drugs could have broad economic impact
• Find out about Regnan Global Equity Impact Solutions Fund
• Making Money and Making Change: Watch a webinar with Regnan’s Tim Crockford and former RBA deputy governor Guy Debelle

OBESITY has been a major medical problem for decades, and is fast turning into a crisis with forecasts that half the global population will be significantly overweight by 2035.

The US Center for Disease Control and Prevention says one in five children and one-third of adults already struggle with obesity.

Obesity triggers a range of ailments, from diabetes, high blood pressure and heart disease, to sleep apnoea, psychological issues and musculoskeletal conditions. 

The development of GLP-1 drugs — initially for treating type-2 diabetes and now for obesity and weight loss — has the potential to change not just outcomes for patients, but the economics of healthcare, argues Maxime Le Floch, an analyst with Regnan’s impact investment team.

Regnan is a global responsible investing asset manager distributed in Australia through Pendal and Perpetual Group.

It’s very early days, but there is the potential for demand among medical practitioners such as heart surgeons and orthopaedists, he says.

That means investors in healthcare, and beyond, should consider the impact of GLP-1.

“GLP-1 drugs could have a market-wide impact because they have the potential to lower patient populations for a range of conditions.”

Le Floch adds that most of the impact though won’t be seen for several years.

How they work

Danish company Novo Nordisk (which Regnan invests in) and global pharmaceutical giant Eli Lilly are the two dominant manufacturers of GLP-1 drugs. 

They mimic glucagon like peptide-1 (GLP-1), an incretin hormone that’s released after eating.

“GLP-1 drugs slow gastric emptying, increases satiety and reduces appetite,” Le Floch says.

“They also reduce glucagon and increase insulin secretion, at the level of the pancreas, which underpins glycaemic benefits in diabetics. It’s essentially a key regulator of the body’s response to eating.”

New studies

Demand for GLP-1 is strong and keeping up supply is already a challenge.

The health benefits from recent studies could further exacerbate the supply challenge.

“There was a recent study on cardiovascular risk using NovoNordisk’s GLP-1, and the results were far better than expected. The reduction in cardiovascular risks were in line with cardiovascular drugs.

“There was also a recent trial on chronic kidney disease. The trial was stopped early because of the success of GLP-1.

“Does this mean we will need less kidney dialysis?” Le Floch asks.

The health benefits, if proven, are obvious.

The impact on the healthcare industry — and everyone operating in it from clinicians to suppliers of medical devices and artificial joints — could also be enormous, Le Floch argues.

Beyond healthcare

And it goes beyond healthcare.

US retail giant Walmart recently said it saw “a slight pullback in overall basket” due to GLP-1 drugs slowing food-shopping demand.

“And that comment comes very early in the GLP-1 lifecycle,” Le Floch says. “Less than one per cent of the US population has been on some kind of GLP-1 drug.”

Some food categories are particularly exposed to the impact of GLP-1.

For example, 20 per cent of US adults account for 70 per cent of ice cream consumption, and 9 per cent account for more than a third of confectionary consumption.

“We are still in the early days of obesity treatment getting widely adopted.

“But if people take the drug, change their eating habits, and decrease their risk of developing medical conditions associated with obesity, that could have a real impact on the wider economy.”

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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.

China’s political and economic policies have a huge impact on Australia. In this new podcast, Pendal’s head of income strategies AMY XIE PATRICK explains the latest factors affecting investors

You can also listen to this podcast on Apple or Spotify

An excerpt from this podcast

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Amy Xie Patrick, Pendal’s head of income strategies:

Why doesn’t Beijing pump stimulus into the Chinese economy as other countries do?

“We have to remember that the Chinese political system is not a democratic system, and its principles are very socialist at heart,” says pendal’s head of income strategies, Amy Xie Patrick

“A very classic characterisation of the Chinese style of socialism is they don’t believe in ‘helicopter money’.

They believe money going directly into people’s pockets isn’t the way to common prosperity. Instead, everyone should toil in order to achieve that prosperity.

However, now we’re reaching a point where the drag from the Chinese property story is so severe that they kind of have to choose a lesser of two evils.

Lately you’ve been hearing that some of the government bodies have been proposing a larger fiscal deficit in 2024. The amounts being thrown about are not that large, but I think it’s a signal that the government is on the cusp of considering more direct-to-consumer stimulus, at least just to keep the current positive momentum going for China.

AI developers need power-hungry computer chips. Companies developing more energy-efficient chips are poised for strong growth. MAXIME LE FLOCH explains

• Climate concerns from AI energy use
• New tech can improve efficiency
• Find out about Regnan Global Equity Impact Solutions Fund

SELLING shovels in a gold rush has become a bit of an investing cliche, but it’s an apt description of German-listed Aixtron SE, which makes equipment for the semiconductor industry.

The rapid growth of artificial intelligence technology is driving demand for semiconductors, the fundamental components of all computing devices.

Fast-growing AI chip-maker Nvidia is a prime example.

However, soaring demand for computing power is also causing the problem of high energy consumption and growing carbon emissions.

Aixtron is at the forefront of trying to solve this problem.

“Artificial intelligence doesn’t exist in the ether — it requires computing power from a vast infrastructure of data centres,” says Maxime Le Floch, an analyst with the Regnan Global Equity Impact Solutions fund.

“So there has been a boom in the demand for data centres, and one of the derivatives of that growth is the need for more semiconductors.

“One of the technologies that can help solve the issue of high energy consumption and carbon emissions in the semiconductor industry is the use of compound semiconductors like gallium nitride, where Aixtron is a market leader.

“Gallium nitride chips have a much better energy efficiency than traditional silicon.

“It’s 10 times the voltage of traditional silicon — that’s a huge improvement in energy efficiency.”

This improvement in energy efficiency can reduce the energy consumption of a data centre by 20 per cent, leading to a 10 per cent reduction in data centre operating expenditure, says Le Floch.

These are important advances.

A single prompt in chatGPT consumes hundreds of times more energy than a single google search.

Training the underlying AI model for ChatPGT3 generated 550 tonnes of carbon emissions.

Aixtron is a supplier of “deposition” machines which “deposit” thin layers of high-tech material on computer chips during their manufacture process.

Traditionally made of pure silicon, semiconductors are now increasingly made with two or more elements to improve performance and efficiency.

Aixtron has a 90 per cent market share of the systems that make these so-called compound semiconductors.

“It makes a lot of economic sense for the industry to move to compound semiconductors and Aixtron is dominant,” says Le Floch.

Use in electric vehicles

The firm is also a leader in silicon carbide used in power electronics that manage electrical energy in electric vehicles.

“There’s a move in electric vehicles to silicon carbide inverters that can withstand much higher voltage and temperature than traditional silicon and Aixtron is the leader in this,” says Le Floch.

“Hyundai reported they were able to improve the range of their EVs by 5 per cent just because of the efficiency gains of silicon carbide inverters.

“That’s a big improvement that can either be used to increase range or reduce the size of the battery, which means a lower cost vehicle that uses fewer materials and has better energy efficiency.”

Market drivers

Le Floch says Aixtron is benefiting from the confluence of multiple adoption curves — the rapid growth of AI, the search for more energy-efficient semiconductors, the adoption of EVs and the car industry’s migration to silicon carbide.

Gallium nitride semiconductor demand is growing at 50 per cent per annum, while silicon carbide growth is 30 per cent, he says.

Powerful structural trends like AI and EVs create their own environmental challenges and require changes in the value chain to solve problems like energy efficiency, says Le Floch.

“Companies that can provide compelling solutions for these kinds of problems typically experience very strong growth and long term, compounding earnings.”

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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.