Damien provides fundamental analysis for our smaller companies strategies, supporting stock selection through valuation, stock data evaluation and building company investment models. Damien was previously an Equity Analyst at Kosmos Asset Management, where he was responsible for fundamental research focused on non-resource ex-ASX 100 Australian and New Zealand stocks. He holds a Bachelor of Business (Finance & Economics) from the University of Technology in Sydney and has completed level three of the CFA program.

 

The Reserve Bank is easing off the accelerator instead of tapping the brakes. Pendal’s Tim Hext explains what investors can expect next

THE RBA this week enacted what they would view as stage three of the great stimulus unwind.

Stage one was the end of new money in the Term Funding Facility (TFF). This concluded in June, with $187 billion taken up. This was 3-year money, so it runs off from June 2023 to June 2024.

Stage two was capping Yield Curve Control at April 2024. This was done in early July.

And now Stage three this week is a gentle taper of Quantitative Easing (QE) purchases from $5 billion a week to $4 billion – hardly impactful but a signal things are improving.

Future stages will likely see more QE tapering. The RBA is signalling the next review in February next year.

By then total QE will be nudging $300 billion.

We expect QE to be finished by August 2022. Then we adopt a wait and see before any actual tightenings.

The RBA has been very clear this can only occur once inflation is sustainably within the 2-3% band.

We think it will be there by late 2022, but the RBA wont tighten until well into 2023. A modest hiking cycle up to 1.25% should then follow.

Why do we think any tightening cycle will be modest? 

Well, it’s important to remember mortgage rates and deposit rates fell by more than 1.5% in early 2020, despite cash rates only falling 0.65%. This was due largely to the TFF flooding the system with cheap term money.

As the TFF unwinds, it is therefore expected mortgage rates will move higher, independent of the RBA.

Hikes of 1.25% by the RBA will look more like 2% in the real economy. This is more than enough to tap the brakes.

Of course all this assumes a world where vaccines do their job. It also assumes a world where inflation edges higher, but largely behaves. 

Time will tell.

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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

Significant Features: The Pendal Active Moderate Fund is an actively managed diversified portfolio that invests in Australian and international shares, Australian and international listed property securities, Australian and international fixed interest, cash and alternative investments.

Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the Fund’s benchmark over the medium to long term.

Brenton manages the Pendal MidCap Fund and natural resources portfolio, drawing on over two decades of expertise across precious metals, derivatives, investment banking, and private equity to invest in large and small cap mining companies.

Brenton has worked with Randfontein Estates Gold Mine & Harmony Gold as a mine geologist and Executive, and at JP Morgan, Deutsche Bank, Craton Capital, Macquarie Funds Group, and Taurus Funds Management in research and asset management roles.

Graduating with honours, he holds a Bachelor’s degree in Science (Geology) and a Master’s degree in Science from the University of Johannesburg. He is a member of the CFA Institute and has previously served on the International Accounting Standards Board.

Risk is a constant theme for investors and is never more front of mind than amid a once-in-a-generation bull market.

• Investors wary of market rally ending
• But risk pricing indicates benign outlook
• Low institutional complacency a good sign

THE S&P 500 has not had a 5 per cent fall since before last year’s US presidential elections, soaring by more than a third since those lows.

In Australia, the S&P/ASX200 is up by a quarter over the same time frame.

Conventional wisdom says the longer markets rise, the more risk of correction must be building in the system.

But this time around the conventional wisdom looks wanting, according to Tom Ciszewski, a volatility analyst with Pendal’s Bonds, Income and Defensive Strategies team.

Risk measures and positioning can often be a contrarian indicator says Ciszewski.

When investors are hedging themselves it often can be supportive of further bullish performance. On the other hand low hedging and bearish positioning can be a sign of complacency and a relative market top.

“The way derivative risk and implied volatility is priced right now in equities globally, it’s actually pricing in for a pretty benign environment,” he says.

Ciszewski says investors should keep a close watch on how big institutions position themselves in derivatives markets as they protect their portfolios against the risk downturn.

Perhaps paradoxically, Ciszewski’s confidence is founded on the fact that institutions have been buying downside protection as the market rises.

This is because in the past over-confidence and complacency among institutional investors is an indicator that markets may be close to topping out.

“You’re always looking for when and how things will blow up. What is the next downturn going to be and how will we make money during it?” says Ciszewski.

“But right now, there’s very little complacency. The institutions are giving up a little upside to buy more downside,” he says.

Measuring institutional sentiment

One way to measure institutional sentiment is the ratio of put and call options being traded.

A high put/call ratio indicates more people are buying puts than are buying calls. It’s an indicator that investors are protecting themselves against potential market falls.

The SPX put/call ratio, which measures options on the S&P500, has risen over the past year to above two. That indicates twice as many put options as call options are trading on some days.

Ciszewski says institutions may be buying downside protection simply because they have had a strong year of gains and feel they can afford to protect themselves, or it could be they see genuine risk on the horizon. 

Corroborating the high level of put buying and lack of complacency by institutional investors is the current level of SPX Index option skew.  The implied volatility of downside strike puts versus upside strike calls is at multi-year highs.

“Either way, it has this kind of circular effect and allows the market to continue to grind higher.”

When will the outlook change?

So, what will change the benign outlook? And what risks should investors be keeping an eye out for?

Ciszewski says inflation is the biggest potential threat, saying that if markets are wrong and the inflation showing up now around the world is not transitory, that could end the equities rally.

The other risk is if the COVID pandemic manages to outmanoeuvre vaccines and triggers new lockdowns and border closures.

Right now, neither scenario looks likely, he says.

Institutional investors are confident inflation is a temporary effect of reopening.

And markets are looking through the COVID pandemic to a time when life returns to normal.

“There’s more American cases of COVID this Labor Day than there were last Labor Day,” says Ciszewski.

“It doesn’t mean they’re going to lock down. We all have to be careful about merely reading the headlines.”

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About Tom Ciszewski and Pendal’s Income and Fixed Interest boutique

Thomas Ciszewski manages Pendal’s volatility fund, implements defensive derivative structures and develops multi-asset class strategies. He has 24 years of experience in managing derivative portfolios and producing positive uncorrelated returns for investors.

Pendal’s BIDS boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s Income and Fixed Interest strategies here

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About Pendal Group

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

George’s investment management career spans over 30 years with Pendal and its predecessor firms. He is responsible for management of credit, fixed interest and short term income portfolios, including Pendal’s highly regarded Sustainable Australian Fixed Interest Fund, Short Term Income Securities Fund and Credit Impact Trust.

George holds a wealth of experience in portfolio management and credit analysis. He has also worked across numerous fixed income, credit and money market portfolios in portfolio management, credit analysis and dealing roles for 27 years. Prior to this George worked in an accounting role for three years.

In 2019 George was awarded the Alpha Manager status by Money Management’s parent, FE fundinfo, in recognition of his career-long performance in the asset management industry. George was one out of 11 Australia-based investment professionals included in this list of esteemed professionals across multiple asset classes, after being assessed on his ability to create risk-adjusted alpha (outperformance) over his entire track record.

George obtained a Master’s degree in Business (Finance), a Bachelor’s degree in Business (Accounting & Finance) and a Graduate Diploma in Applied Finance and Investment.

Debate about inflation as transitory or structural misses the point. It’s about building a portfolio that’s robust to a range of outcomes, says Pendal’s Michael Blayney.

• Portfolio construction must allow for all inflation scenarios
• A dynamic approach to investing may be required
• Liquid alternatives, property, infrastructure may be solutions

THE MAJOR global economic debate right now is whether the recent jump in prices in the US, Europe and other parts of the world including Australia, is transitory or structural.

Central banks remain convinced it’s transitory, though a few around the globe have taken steps to taper bond-buying programs. More than 25 central banks — mostly in emerging markets — have raised interest rates so far this year.

It remains to be seen whether we look back on the “inflation is transitory” line as we do now on the Fed’s “sub prime is likely contained” line in 2007.

“You can go through both sides of the argument, but in portfolio construction, that’s not the main point,” says Michael Blayney, head of Pendal’s multi-asset team.

“As an investor you are faced with a huge amount of uncertainty as to the inflation outlook … and it’s about building a portfolio that’s robust to a range of outcomes.

“Portfolio construction has to link back to a client’s objectives and make sure it can handle different scenarios.”

The difference now, compared to the global financial crisis in 2007-08, is the amount of money in the system thanks to government spending, support payments and money creation, Blayney says.

Back then monetary policy was loosened — just as it is today — but fiscal policy was much tighter.

“There’s an awful lot of money sitting in people’s bank accounts — I’d say an unprecedented amount. It’s hard to imagine it’s never going to get spent. Also, fiscal policies are considerably looser around the world. And we’re starting to see price pressures.

“Last week’s US employment data disappointed with fewer new jobs being created last month, but wages still rose. You also have businesses wanting to de-globalise and bring supply chains closer, which might mean having to accept higher prices.

A portfolio construction approach to inflation

“If you think about all these things, it might mean you sit in the structural camp or the transitory camp. But what you need to think about is balancing portfolio construction risks over range of scenarios,” Blayney says.

Bonds don’t do as well as a portfolio diversifier in an environment where you see unexpected increases in inflation, he says. And if authorities need to tighten monetary policy you could very conceivably see a period where equities and bonds suffer together.

“When the inflation genie gets out of the bottle, traditional bonds become more of a problematic asset, at least initially. It means you have to be dynamic in your asset allocation.

“For example, if bonds sell off a bit because of inflation that might be a good entry point. Once inflation is priced in, it allows you to buy bonds at higher yields. Of course, it means you have to be comfortable not always holding lots of bonds in your portfolio.”

Alternate asset strategies

“You can hold cash, but that’s yielding virtually zero (which is around -2% real). So, you need to look at alternate asset strategies,” Blayney says.

At their broadest, such strategies included everything that isn’t bonds or equities. These strategies can also get access to inflation-linked assets such as commodities and other “inflation-hedging” strategies that are difficult for investors to implement directly themselves.

“There’s liquid alternatives strategies, which rely very much on the manager’s skill and more dynamic management of the fund,” he says. “They tend to be more active and use a lot of relative value type trades with the goal of providing diversification and returns.”

Liquid alternatives involve assets that are easy to buy and sell (liquid) and typically exhibit a lower correlation with traditional stock and bond investments.

Infrastructure and property are other options.

While both are sensitive to rising bond yields they are real assets. Underlying cash flows for many of these assets are linked in some way to inflation through rents (in the case of property), power prices (in renewable energy) or other long-term, contracted inflation-linked revenue streams.

“If you’re worried about sustained, long-term inflation, property, infrastructure and listed alternatives are all good assets to have in your portfolio,” Blayney says.

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About Pendal’s multi-asset capabilities

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

These include Australian and international shares, property securities, fixed interest, cash investments and alternatives.

In March 2024, Perpetual Group brought together the Pendal and Perpetual multi-asset teams under the leadership of Michael O’Dea.

The newly expanded nine-strong team will manage more than $6 billion in AUM and create a platform with the scale and resources to deliver leading multi-asset solutions for clients.  

Michael is a highly experienced investor with more than 23 years industry experience, including almost a decade leading the team at Perpetual.

Find out more about Pendal’s multi asset funds

Contact a Pendal account manager here

Self storage is an under-appreciated part of the real estate industry that could be a big winner from Australia’s growing population. JULIA FORREST explains the investment opportunity

• Population and demographics underpin growth
• Built-in inflation protection
• Find out about Pendal Property Securities Fund

SELF-STORAGE is not the first place many investors would think of as a place to stash some cash.

But Aussie equities investors looking for opportunities should take a closer look at the industry, says Pendal PM Julia Forrest.

“The world of self-storage is not something you often hear about, but it’s an asset class we like,” says Forrest, who co-manages property investing in Pendal’s Aussie equities team.

Record high immigration and a downsizing trend towards apartment-living will fuel ongoing strength in the self storage industry, says Pendal’s Julia Forrest.

ASX-listed National Storage REIT (ASX: NSR) — which operates 230 centres across Australia and New Zealand — offers exposure to the sector.

NSR is the biggest active position in Pendal’s property strategy, Forrest says.

The opportunity explained

High inflation and rising interest rates have seen a somewhat muted investor appetite for real estate over the past twelve months.

Office assets are trading as much as 30 per cent below book value and the retail and logistics sectors are both under some pressure.

But self-storage assets are defying that trend, underpinned by strong demographics, low maintenance costs and inbuilt inflation protection, says Forrest.

“Occupancy was supercharged during COVID — and is now returning to normal — but the underlying metrics remain very strong, linked largely to Australia’s strong population growth.”

Self-storage assets were in strong demand during the COVID lockdowns period as young people returned to the family home, expats were forced to return at short notice, and many households had to clear space for working from home.

Now immigration and an ageing population are underpinning the industry’s growth.

Forrest says 70 per cent of self storage clients are individuals looking for somewhere to store their possessions, often prompted by a life event.

The remaining 30 per cent are businesses needing somewhere to store their inventory, building materials, and tools.

Low costs, strong prices

One of self storage’s key attractions is very low maintenance costs compared to other types of real estate.

“It costs very little to maintain — you’re replacing lighting, there’s a minor amount of depreciation. That means you get strong, resilient cash flows.”

As a result, valuations are holding up well as other real estate sectors come under pressure.

Retail real estate faces structural headwinds from the move to online shopping and infinite supply of virtual alternatives to physical store space, says Forrest.

Office is also facing structural change in the way people work and has risks ahead as the economy slows.

“But self storage is not a discretionary purchase — a lot of it is needs based because of those life events, which makes it a little more resilient than the other sectors.

“Self storage is still transacting at book value. Office is 20 to 30 per cent below book value. Retail and even industrial are beginning to see a bit of pressure on book values, but self storage continues to transact at book values.”

Self-storage sites also have the potential for transformation into high value industrial and logistics space, she says.

“Industrial vacancy is incredibly low. For self storage, one of the higher and better uses is as industrial. You don’t get that with office because of zoning.”

Inflation protection

Forrest says self storage offers a level of inflation protection in a portfolio because of the short duration of leases.

“Because you’re leasing month to month, if there is a big inflationary spike you can just lift your rate. You are not locked into a long-term lease. This provides quite a lot of inflationary resilience.”

She says the Australian market is quite immature relative to other markets.

“Self storage space in Australia represents 2.1 square feet per capita. In the US, it’s closer to 6.1 square feet per capita. So, in terms of available space, Australia is relatively under serviced, although the US is a much more mobile market.”

Real estate sentiment shifts

Sentiment towards real estate has shifted markedly in the last few weeks after a tough year amid signs that inflation is coming under control, Forrest says.

“Until very recently, people were very concerned about interest rates and inflation.

“But with a couple of lower CPI readings here and in the US, the market’s pricing of future rate hikes has come way back and that has led to a real estate rally.”

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

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

Contact a Pendal key account manager here