NAB this week broke the Big Four banks bond drought. Tim Hext explains what it means for investors

WE WROTE last week about Covid and vaccination rates leading to a potential re-opening in late October and November. 

But at the end of this week markets still seemed lost in lockdown gloom as worsening daily headlines continued to drown out positive news about accelerating vaccination rates.

After a snap lockdown in New Zealand, we even saw Reserve Bank governor Adrian Orr change his mind at the last minute, deciding not to hike rates. 

Perhaps he thought it just wasn’t a good look — basing medium-term monetary policy on day-to-day news seems reactionary. 

But enough of that. Onto other issues.

NAB breaks Big Four banks bond drought

This week NAB returned to Senior AUD Term Funding Markets with a new 5-year bond issue. It was the first such deal by one of the Australian majors since January 2020. The deal was $2.75 billion at 41 over. 

Of course the drought was caused by the Term Funding Facility (TFF) — where the RBA gifted some $200 billion of 3-year money to banks at 0.1% to drive down term rates and mortgage rates.

It worked as a public policy driving down mortgage rates. Bank margins crept slightly higher, but most of the savings ended up in lower mortgage rates, supersizing the housing price boom to levels that are nothing short of startling. 

We’ll save the longer-term implications of that for another day.

The extra money from the TFF of course ends up back at the RBA in the Exchange Settlement Account — earning zero since public money given to the private sector is surplus to the private sector. 

It does mean banks want fewer savers but look more aggressively for borrowers. 

Bank treasuries will need to manage the maturity of the TFF, which takes place largely in two blocks in September 2023 and June 2024. Banks will want to begin terming out their private sector debt to dates beyond this well in advance. 

This week’s NAB is the first of many to come. 

For now, pent-up demand for bank paper is experiencing strong support. But we expect spreads to drift wider over time. We see more value for now in the Tier 2 bank market.

Outlook for rates

For those term deposit holders and cash account holders there is little good news on the horizon. 

For the next 12 months at least, interest rates will be next to nothing. 

We see hope of RBA rises in 2023 and by then maybe even strong credit growth in the private sector. 

The bad news is interest rates will be below inflation for years to come, effectively sending the purchasing power of savers backwards. 

Oh well, maybe they own a house to more than offset it.

The Regnan Global Equity Impact Solutions Fund aims to generate positive and measurable impact, alongside a financial return by investing in companies using the United Nations Sustainable Development Goals (SDGs) as an investment lens.

With a background in cash and dealing, Steve brings over 20 years’ financial markets experience to our Institutional Managed Cash portfolio. During his time at Pendal Group, Steve has managed numerous New Zealand cash portfolios and has been active in portfolio positioning while executing domestic and international credit and bond funds. Steve previously worked at Tullett and Tokyo as a corporate bond broker, and holds a Bachelor’s degree in Commerce from the Australian National University.

There are parallels between China’s crackdown on its education and tech industries and similar moves in the US. China investors can learn from this, says Pendal’s Samir Mehta

• July was challenging for investors in Asia and emerging markets
• But there are underlying principles to consider with China’s regulatory crackdown
• Well-managed and resilient businesses adapt and find means to thrive in any situation
• Find out about Pendal Asian Share Fund

CHINA’S recent diktat to private tutors effectively crippled the sector. Ordered to become “non-profit”, desist from raising capital, and shun foreign teachers, the sector became uninvestible overnight.

Several commentators were furious and accused the government of hurting foreign investors.

But was this behavior unique?

A blunt clampdown might be. But what about the underlying principle?

Take a look at the US to witness the state of finances for students and universities.

Over the past decade, one of the single biggest sleeves of debt that has spiralled out of control relates to student debt. There is clamor (mostly from the left) for writing that debt off.

Many politicians demand free education at community colleges. It just goes to buttress the point that in every human activity, there are multiple stakeholders.

In China, 92% of parents enroll their children in extracurricular classes and half of families spend more than 10,000 yuan ($1,500) each year on such classes, according to a survey reported by Chinese news source Caixin.

“The term often used to describe this situation in China’s education is ‘neijuan’ or involution, which literally means, ‘inside rolling’, a process of incessant competition from which no one benefits,” Caixin reports.

“Chinese parents feel intense pressure to provide the best resources to their children, who in turn must work extra hard to keep up in an educational rat race.”

On Zhihu, a Chinese social website for questions and answers (similar to Quora), almost all comments from parents are against the government’s new regulation of cram schools.

“This is like America’s Prohibition Act. You can ban alcohol, sure, but does that mean that people don’t want alcohol anymore?” posted one commentator.

“Same with banning cram schools. If you close them, does that mean parents do not want to send their kids to these
schools? The demand is still there. It’s just becoming more costly.”

Another posted: “Only half the students graduating from Grade 9 are allowed to go to high schools. The other half have to go to vocational schools. There is a quota now. But what parents want their children to become blue-collar workers?

They’ll do everything possible to make sure their kids score well enough to be the top half.”

Unfortunately, the ban on these education companies does not solve a real problem for parents who want their children to get supplemental education.

In effect, those who can afford to pay will hire personal tutors while the State will pressure existing schools
to provide alternatives, which might be sub-par.

There are no perfect answers. Fair access to quality education at an affordable price are universal problems for almost every society.

Each society has their ways of dealing with pressures from stakeholders.

The one lesson I take away from this episode is that when one stakeholder ‘extracts’ disproportionate benefits, the backlash will be felt over time.

Contractors vs employees

Consider the admonition and regulations dished out by the Chinese authorities to food delivery firm Meituan Dianping on providing fair wages and benefits to its delivery riders.

A stock we own, it suffered a sharp sell-off on news of further tightening of regulations. The authorities had three choices when it came to imposing better pay conditions:

1. Low coverage proposal: classify all the workers under a contractual relationship instead of a labor relationship –
   meaning they are not staff of the company. Companies do not provide social benefits but shift the burden to the individual or the State.
   
2. High coverage proposal: classify all the workers under a labor relationship, meaning full coverage would be provided by the company. This would add significant costs to platforms such as Meituan which would potentially also be passed on to consumers.
   
3. Middle coverage proposal: Only a very small group of workers are classified under contractual or labor relationships.

The majority would be classified under some middle form of labour.

The only insurance that the platforms are required to provide for these workers is occupational injury insurance. The rest are up to the workers themselves to fund.

From what I gather, authorities have agreed upon the middle path, greatly reducing the uncertainty on compensation for labour.

Over time, this might still be subject to change if societal pressures force a rethink. As of now, the cost increase for the platforms will be only a few cents per order.

In my view, that burden is bearable – it will reduce profitability in the near term but not structurally damage
the business.

Markets ignore the bigger and more relevant case for continuing to own the stock. This service is crucial for society –
imagine life without the ability to order food during this pandemic.

Restaurants and delivery riders have fair demands but the platform delivers an essential service. Besides, after stringent regulatory requirements, in my opinion, no startups are likely to raise capital to challenge Meituan’s dominance.

During the worst of the sell down, I added to our holdings.

Contrast this to the US.

In January last year California passed a law Assembly Bill 5 which is supposed to make it harder for companies to hire workers as contractors.

As NPR reported at the time: “Supporters of Assembly Bill 5 say companies have been exploiting contract workers for years because they are not considered employees who get benefits like health coverage and workers’ compensation.

“The law touches many industries, from trucking to tech to certain medical professions. AB5 does include carve outs for professions such as dentists and attorneys.”

California voters later handed Uber and Lyft a big victory when they approved a measure allowing the ride-hailing companies to keep classifying their drivers as independent contractors.

If you are a steward of capital adhering to the principles of Environmental, Social and Governance factors, which of these outcomes is preferable?

China equities: What can go right?

July was challenging for investors in Asia and Emerging markets.

Thankfully, our fund was positioned to shield us from the worst of outcomes. The sell-off was furious and sometimes indiscriminate.

Some clients questioned “should we even bother investing in China?” To which my answer is a resounding yes.

We now have to ask the question – what can go right? If you reflect back to 2015 and 2018, we had sharp sell-offs across Chinese equities in both years.

Once we got past them, what mattered is what still matters today – liquidity, earnings progression and valuations.

In my view, the regulatory risks in China always existed; it’s just that we are now more attuned to them. That should not be an excuse for revulsion.

I am running screens to identify the businesses we can own over the next two to three years or longer.

The timing of recovery in stock prices is difficult to predict. Risks abound. Yet after this sell down and the growing distaste for Chinese equities, I am setting myself up to buy into stocks at much better valuations.

As always, time will tell.

About Samir Mehta and Pendal Asian Share Fund

Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Find out about Pendal Asian Share Fund

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.

When investing with a sustainable tilt, bonds as an asset class needs to be thought of very differently to equities, property and infrastructure. Pendal’s Michael Blayney explains

• Bond investors have several options to get a sustainable tilt
• Sustainable, green and impact bonds have different attributes
• A multi-asset approach provides greatest flexibility

A MULTI-ASSET approach to building a sustainable portfolio provides many more options than a single asset class.

But it also means investors have to understand how to go green within each asset class — and the implications that decisions in one asset class impacts other asset classes.

In Australian equities, where the market is more concentrated, fundamental active management is the optimal approach.

In international equities, the main implication of a sustainable fund is lower energy exposure. To achieve that it might be necessary to invest in correlated assets in other asset classes.

Sustainable investing in property and infrastructure involves fewer exclusions than the broader equities category, but it can be harder to find dedicated sustainable products.

What about fixed income?

“When investing with a sustainable tilt, bonds as an asset class needs to be thought of very differently to equities, property and infrastructure,” says Michael Blayney, head of Pendal’s Head of Multi-Asset.

“It is less about increasing in value, and more about avoiding defaults and impairments.”

In other words, investing in bonds is about much more than returns, as the world learned during the Covid downturn.

Bond markets are not simple, partly because derivatives are often needed across products to achieve interest rate and credit exposure outcomes. That makes bonds far more complicated than buying stocks.

But understanding the complexity allows greater flexibility in creating a sustainable portfolio across asset classes.

Blayney explains that credit spreads — the difference between what a government bond and a corporate bond of the same maturity is yielding — are tighter on sustainable indices.

“That’s because by their nature, they tend to be underweight in the riskier industry sectors, particularly energy,” he says. “ESG [environmental, social and governance] characteristics tend to correlate with higher quality businesses.”

There are also green bonds, where proceeds are earmarked for projects that have a positive impact on the environment. Increasingly there are also impact bonds that target social outcomes.

Comparing the different types of bonds – aggregate, sustainable and green – shows that yield to maturity is lower for the latter two. This is partly due to the country composition, with green bond issuance dominated by Europe.

	Global Aggregate	Global Aggregate Sustainability	Global Green Bond
Rating	AA-	AA-	A+
Yield to maturity (%)	1.05	0.79	0.53
Weighted average spread (basis points)	34	30	58
Duration (years)	7.5	7.6	8.5

Source: Bloomberg. Bloomberg composite rating shown. Data as at 19 July 2021. Global Green Bond Select Index proxied with an index tracking ETF.

“There are tools — futures or interest rate swaps — that allow investors to get access to the desired yield curve without the exposure to the market where the physical capital is allocated,” Blayney says.

The weighted average spread of the securities in the Sustainability Index is lower than the standard index, partly because of the individual securities and partly because of sector differences. While the credit ratings are broadly the same, when one index is rated higher it is always the Sustainability index. All indexes are investment grade.

“In the case of impact bonds, many are issued by banks. So they can have high creditworthiness while allowing capital to be directed to meaningful projects,” Blayney says.

“There’s also a relatively newer, and quite innovative range of credit securities where the coupon paid by the borrower is linked to achievement of various non-financial objectives.”

“Ultimately investors have a range of ways to express ESG preferences or insights within the bonds component of portfolios. We believe a blend of green bonds — sovereign and non-sovereign, other impact bonds, and sustainable corporates — can represent a solid core to a portfolio,” Blayney says.

Is it worth thinking green across your portfolio?

Yes, says Blayney.

“A broad universe of securities allows investors to give effect to a variety of ESG tilts within their portfolios,” Blayney says. “Generally, we expect less tail risk and a quality bias in moving to a more sustainable portfolio.”

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About Michael Blayney and Pendal’s Multi-Asset capabilities

Michael Blayney leads Pendal’s multi-asset team.

Michael has more than 20 years of investment management and consulting experience. He was previously Head of Investment Strategy at First State Super and head of Diversified Strategies at Perpetual.

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

The team manages our multi-asset portfolios with a focus on strategic asset allocation, active management and tactical asset allocation.

Browse Pendal’s multi asset funds here

Find out about Pendal Sustainable Australian Fixed Interest Fund here

Contact a Pendal key account manager here

The net-zero movement is driving a ‘circular economy’ which presents opportunities for investors to make money and make the world better, argues Regnan’s MOHSIN AHMAD

• Circular economy crucial to net zero
• Companies with a technology edge are favoured
• Reverse-vending machine maker TOMRA aims to convert trash to cash
• Find out about Regnan Global Equity Impact Solutions fund

BY NOW most people know they need to understand the impact of the “net zero” movement on their investments.

Countries including Australia are pressuring companies to help reduce emissions to zero by 2050 – in order to limit a global temperature rise to 1.5 degrees Celsius above pre-industrial levels.

Science shows that’s the level needed to avert the worst impacts of climate change.

But “impact investors” also believe many activities needed to achieve net zero are an investing opportunity.

“In terms of getting to net zero, energy efficiency and switching to renewables is only going to solve half the problem,” says Mohsin Ahmad, a fund manager with sustainable investing leader Regnan.

“To get the rest of the way, we need to look closely at how we make and use products, and that’s where the circular economy comes in.”

What is the circular economy?

The circular economy is all about moving away from a linear model that we have known since the dawn of the industrial revolution, whereby we extract, we produce and we discard.

“It’s about producing more efficiently, repurposing waste, using more renewable inputs and ultimately that leads to less greenhouse gas emissions” Ahmad says.

It is also an investable trend.

From a portfolio perspective, there are three different angles, says Ahmad:

1. “One is to invest in companies that facilitate a more efficient production of goods and services
2. “Then there are companies that are enabling recycled inputs, renewables and biodegradable type solutions.
3. “And then there are companies that leave the ecosystem in better shape.”

Ahmad says one of the lessons from recent years is that companies that can help reduce natural resource intensity will be winners in the short term.

“These are companies that help others to minimise their input requirements and deal with some of the inflationary pressures currently prevalent.

“They will also be winners longer term because of their contribution to lowering greenhouse gas emissions.

“If we are going to speed up the transition to net zero, these companies play an important role in addressing the systemic challenge of climate change we face,” he says.

Stock story: Dürr

An example of one such company is German engineering firm Dürr, argues Ahmad.

Dürr is held in Regnan Global Equity Impact Solutions fund.

“They provide solutions to automotive and other industrial customers to improve their resource efficiency of production,” Ahmad says.

“One of the main areas they are focused on is paint application in the automotive space which is very energy and water intensive.

“About 70 per cent of the total energy consumption at an automotive assembly facility takes place in the paint shop. What Dürr has done is to significantly reduce the environmental impact of paint shops.

“They’ve been able to achieve a 67 per cent reduction in energy input in paint shops, a 71 per cent reduction in water, a 73 per cent reduction in volatile organic compounds and a 36 per cent reduction in the amount of paint being used,” he says.  

Watch this video to find out more:

Where to start

Investing in circular economy companies starts with understanding the United Nations Sustainable Development Goals, and then finding a company that addresses at least one of the underlying targets in a meaningful way, says Ahmad.

“Then we look for additionality.

“Is the company doing something that’s differentiated? Have they got a technology edge? Are they doing something innovative?

“We also like companies that are in the relatively early stages of adoption of the new technology with large addressable markets.

“Companies where penetration rates are just starting to kick off and there’s a long path of growth ahead.”

Find out more about Regnan Global Equity Impact Solutions fund.

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About Mohsin Ahmad

Mohsin is a fund manager with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Before joining Regnan, Mohsin was a senior analyst working on the Hermes Impact Opportunities Equity Fund. He has worked on thematic equity funds such as water, clean energy and agriculture.

Understanding the downstream impact of a business’s actions is key to sustainable investing. Regnan’s MOHSIN AHMAD explains why

• Watch out for second-order effects of sustainable solutions
• A system-wide view required
• Find out about Regnan Global Equity Impact Solutions fund

YOU may have heard sustainable investors refer to the second or third-order effects associated with a business.

Understanding a business’s downstream impacts — sometimes referred to as “externalities” — is a key concept in sustainable investing. (Pendal CEO Richard Brandweiner explains the idea here).

Sustainability proponents can often fail to account for these effects when promoting a new solution.

That means responsible investors need to take a wide, system-level view when considering challenges like climate change and food security, says Regnan’s Mohsin Ahmad (pictured below).

“It’s not just farm-to-fork,” says Ahmad, who co-manage’s Regnan Global Equity Impact Solutions fund.

“It’s what happens before the farm — with a farm’s suppliers — and what happens after the fork — how a consumer manages recycling and food waste.”

This week London-based Ahmad was in Sydney to address Regnan’s Director Roundtable on Sustainable Agriculture, a meeting of top executives and directors seeking to improve agricultural and food production practices.

Second-order impact

Ahmad uses the example of biodiesel — a renewable and biodegradeable fuel — to illustrate how second-order effects can play out.

“Biodiesel reduces greenhouse gas emissions by 72 per cent versus conventional diesel,” he says.

“On the face of it, that sounds great.

“But when you look at the system-wide effect of everyone moving to biodiesel, there’s a lot more that’s going on when you scratch the surface.”

Land needs to be diverted from food production to produce biodiesel. Often, this requires deforestation and reduces biodiversity.

Forests are often replaced with monoculture which reduces the soil’s ability to sequester carbon. There are also knock-on effects in terms of chemical usage which generates run-off that pollutes waterways.

The net, system-wide result is that climate change is exacerbated, biodiversity reduced and food security risks rise as a result of wide biodiesel adoption, says Ahmad.

Positive impact

Second-order effects are not always negative, however.

Regenerative farming is often criticised as a high-cost approach with lower yields than industrial farming methods.

“That may well be true near-term. But what it doesn’t take into consideration is the system-wide positive effects of regenerative farming practices,” says Ahmad.

“The fact that you’re not using chemicals or you’re using less chemicals means there’s less pollution going into the waterways and less fossil fuel for fuel usage because many of these chemicals are produced based on hydrocarbons.

“There are benefits from a climate mitigation perspective and a biodiversity perspective… but also from the perspective of the soil health as well.

“Those practices, the evidence shows, improve the organic content of the soil which means there’s greater potential for carbon sequestration.

“It also means that there’s more water retention, your crops are healthier and as a result yields over time over the long run will actually improve based on regenerative farming practices.

“So, you can have this positive feedback loop as well.”

Ahmad says this means investors need to take a wide approach and pick solutions that are genuinely going to have a positive effect on whole system.

Read more about sustainable agriculture investing in Regnan’s Catalysing Sustainable Agriculture and Food Production report.

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About Mohsin Ahmad

Mohsin is a fund manager with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Before joining Regnan, Mohsin was a senior analyst working on the Hermes Impact Opportunities Equity Fund. He has worked on thematic equity funds such as water, clean energy and agriculture.