There’s a relative calm in markets after several years of volatility in inflation, interest rates and markets. Investors should take the opportunity to examine their portfolios, says Pendal’s MICHAEL BLAYNEY
- Aussie equities, bonds relatively attractive
- Less need for alternatives, credit
- Find out about Pendal’s multi-asset funds
FINANCIAL markets have shifted to a “more normal” environment in recent months, meaning investors should think about portfolio allocation in a more traditional way, says Pendal’s Michael Blayney.
“Investors should maintain a balanced mix of equites and bonds and some alternatives,” argues Blayney, who leads Pendal’s multi-asset team.
Here Blayney explains his latest thinking on key asset classes.
Equities
“On Australian equities, we have a fairly constructive view. You have a market that offers pretty good dividend yields and you get franking.
“Also the Australian market tends to be less efficient than some other markets and you can get a better level of alpha from active management,” he says.
Blayney believes Australia equities are now around fair value, so it’s worth maintaining a “good exposure”.
“Aussie equities aren’t an exciting growth market like Wall Street because we don’t have those big technology stocks. But what we do have is a steady-yielding market.”
On a long-term basis, international equites remain attractive because of the diversification benefits around sectors and countries, Blayney argues.
The development of artificial intelligence, and its impact on portfolios, is top of mind for many investors.
“AI has created a lot of excitement – particularly in those ‘Magnificent Seven’ tech stocks – and pushed up their valuations,” Michael says.
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The technology has the potential to transform many businesses and the economy – generating significant improvements in productivity.
But the market has run a bit ahead of itself, Michael argues, with the seven stocks – Apple, Alphabet, Microsoft, Amazon, Meta, Tesla and Nvidia – “priced for perfection”.
Markets have moved into a consensus view of a Goldilocks economy – that the US Fed has moved rates enough to bring inflation under control, but not enough to crash the economy.
“There is a good long-term case for international equities, but in the short term, markets have already priced in all the good news at the mega cap end of the market.
“If anything does go wrong, then that skews the risks towards the downside, so we maintain a small underweight position.”
Bonds
“We still really like bonds,” Blayney says. “There’s a yield cushion in case of further volatility.
“If you’re starting point is 1 per cent then you don’t have much of a cushion. But we’re starting at around 4.5 per cent.
“Bonds are around fair value, or slightly cheap, and they have the potential to give you diversification and liquidity in a risk-off type event.”
Another benefit of bonds and cash is that they provide “dry powder”, Blayney says.
“While markets are calm now – with the VIX (volatility index) low – we know they will be volatile again.
“It’s important to have liquid assets like cash and government bonds to take advantage when that volatility comes.”
Alternatives
Alternatives should still be part of a portfolio, says Blayney. But with bond yields higher, investors don’t need as big an exposure to alternatives to generate returns, compared to a low-yield environment, he says.
“It still makes sense to have some of them because when you do see spikes in inflation.
“Some of the inflation-linked assets like commodities or certain types of listed infrastructure can be really useful.
“But right now in a relative sense, with bonds and cash being more attractive, the need for larger alternative allocations has reduced.”
Blayney believes investors should be cautious on credit.
“I would stay away from high yield because you are just not being paid enough for the downside risk.
“On investment-grade credit we are a bit more neutral.
“Overall we think investors should keep their defensive assets high quality and liquid, to ensure they’re well placed to deal with any volatility that 2024 may bring.”
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.
Institutional investors and super funds have been slowly shifting their asset allocations away from Australian equities for several years. It’s now time to reconsider that drift, argues Pendal’s ALAN POLLEY
- Investors drifted away from Australian equities
- It’s time to come back home
- Find out about Pendal’s multi-asset funds
A DECADES-LONG drift away from Australian equities should come to an end after institutions overshot investing in overseas markets, says Pendal multi-asset PM Alan Polley.
Traditionally, Australian investors had a distinct preference for investing at home. But over the past decade major institutions and superannuation funds shifted their attention overseas.
As a result, the “equity home bias” in the Australian investment industry fell below 50 per cent.
“There were good reasons for that shift, but we think it is now done,” says Polley, who co-manages Pendal’s multi-asset funds.
“We think Australian investors have drifted far enough – and we should start to see bias stabilise or even shift back to Australia.
“There are good reasons now to check your home bias and either keep it as it is and stop drifting — or even marginally go the other way and lift the home bias a little bit.”
Why we drifted
The drift away from Australia over the past decade was founded on valid reasons, Polley says.
“You can make the case that the home bias was too strong.
“Most investors had two-thirds of their equity portfolios here, but Australia’s market cap is less than 2 per cent of global equity markets.
“You were not getting diversification because there was risk concentration with one country and two main sectors – resources and banks.
“There was material security concentration as well. This all adds up to a higher level of risk.
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“The Australian market was also not very future forward. To get exposure to tech meant going to the US.
“Another reason for negativity was climate change. The Australian economy and equity market has a very high carbon intensity and that’s a bit of a headwind.”
Change in direction
Now, those arguments are losing their punch.
The ASX has been proactively wooing tech companies to list locally, leading to the emergence of a more material tech presence on the local market.
At the same time, private markets have successfully backed some fast-growing Australian tech companies.
“Five years or so ago, we didn’t really have any unicorns. Now, there are several Australian unicorns such as Canva and Immutable that give credence to the Australian market and business community.
“The number of tech stocks on the ASX300 has grown over the past decade from eight to 20 names, including companies such Xero and SiteMinder.”
Australia is also now better positioned to benefit from the climate transition, Polley says.
“Two years ago, lithium was basically nothing. Now it’s about a third of the value of thermal coal exports.
“So, there’s a shift in our energy export mix from dirty energy to clean energy via lithium.
“There’s also upside potential for critical-minerals mining, given our government’s ambition to become a renewable energy superpower, decarbonise the economy and increase clean energy exports such as green hydrogen.”
Why home bias works
Investing in Australian stocks delivers some genuine benefits over investing overseas, argues Polley.
For starters, investing in your home economy provides better linkages to local inflation because revenues and earnings are tied to domestic pricing.
“That gives you a hedge in your investment portfolio to the domestic inflation rate. That’s an attractive feature to have.”
Investing at home also comes with greater knowledge.
“You’re more likely know your own stocks, you’re more likely to use the products and services of your own stocks.
“Invest in what you know is a common investment adage. That’s another reason it’s less risky to have a home bias.”
Franking credits
Australia can also offer technical advantages over foreign stocks such as fewer friction costs such as tax and fees, argues Polley.
Australia is one of the few countries in the world to offer a franking credit system that ensures investors are only taxed once on dividends.
And we are the only country that refunds unused franking credits, in cash by the ATO! Australia is very generous when it comes to shareholders.
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Because franking credits are not useful to all investors, they are not fully priced by the market, says Polley.
This means they offer a material after-tax return uplift for local investors, especially when compounded over time.
“It’s a nice additional income pickup that you’re not going to get from investing overseas, and especially for retirees.”
Cost differences also make investing at home worthwhile.
Investing overseas means more complexity, dealing with many more securities, tax complications and managing different markets and different currencies.
“There’s more trading, there’s more accounts that need to be opened. These are all additional look-through costs that are associated with investing overseas that are often hidden in the net return.
“It is not as clean as investing in Aussie shares.”
Potential for better returns
Polley’s capital market assumptions for long-term market returns across various asset classes suggest Australian equities could outperform international equities over the next decade.
That would be a reversal of the last decade where Australian equities went into a post-resource-boom coma, while international equities were supported by lower interest rates.
“Long-term forward return expectations are really just a summation of dividend yield and growth rate.
“The dividend yield for the Australian market is around 4.3 per cent — even before franking credits — while international equities are yielding about 2 per cent.
“So just on the dividend alone, there is a 2.3 per cent additional return.
“That’s a lot of return for growth to make up for — and we don’t think international equities will have that much more growth than us, especially given high starting valuations and what’s likely to be a higher interest rate world.”
“The Australian dollar is also on the cheaper side vs the USD, and the Fed is more ahead on its interest rate cycle. That could see the AUD appreciating over the medium term.”
“This potential additional return more than makes up for the additional volatility of Australian equities due the higher sector and stock concentrations,” Polley argues.
Fees may be lower
Another underappreciated feature of the Australian market is that funds management fees for Australian equities can be lower than international equities.
“The Australian funds management industry is very competitive, and it can be cheaper and less resource intensive to manage an Australian shares portfolio.”
Australian equity managers may also benefit from a less efficiently priced domestic market.
“There’s a large portion of retail investors in the Australian market, so they are more likely to be on the losing side of trades — thus professional managers can find mis-priced stocks.”
Also, large global fund managers tend to view Australia as a bit of a rounding error, often buying and holding a couple of big miners and retail banks and forgetting the rest. This results in less price discovery.
It’s not widely understood that our standard market index, the ASX 300, is a broad-cap index that includes large, mid and small-cap stocks.
Global counterparts like the S&P500, FTSE100, DAX and CAC are all large cap indexes.
“We all know that small caps tend to be less efficiently researched, and thus less efficiently priced.
“So that’s a place where excess returns can be found.”
About Alan Polley and Pendal’s Multi-Asset capabilities
Alan is a portfolio manager with Pendal’s multi-asset team.
He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.
Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
While investors expect rate cuts offshore next year, Pendal’s head of cash strategies Steve Campbell sees our cash rate unchanged in 2024.
AUSTRALIAN mortgage-holders were spared further pain this week when the Reserve Bank left the cash rate unchanged at 4.35%.
The decision was in line with market expectations, which had a rate hike at around 5% probability.
In its statement, the RBA retained a tightening bias against a background of much uncertainty.
Domestically, total household consumption has been sluggish, though the distribution is uneven.
Some households have benefitted from rising house prices and interest income, while others have struggled from higher interest costs and negative real wages.
Much like the experience globally, goods inflation is declining while services inflation remains too high and persistent.
The RBA was a reluctant hiker in November, boxing itself into a corner with a low tolerance for higher inflation — which ultimately proved the case following the release of the third-quarter inflation number in late October.
Since the November RBA meeting there’s been no smoking gun to warrant further policy-tightening — in fact, it was quite the opposite if we look at offshore markets.
Bond yields rallied aggressively in November, largely unwinding the carnage that bond investors experienced in preceding months.
In the United States, the short end rallied by around 50 basis points. The market is now looking for the US Federal Reserve to ease monetary policy by more than 1 per cent in 2024.
Market pricing also has the European Central Bank, Bank of England and Bank of Canada easing multiple times.
So, where to from here?
The RBA
The next RBA meeting in early February will be influenced by fourth-quarter inflation data released in late January.
We expect Q4 headline CPI to come in around 0.8%, taking annual headline inflation rate to 4.2%.
The RBA’s forecast for 2023 annual headline inflation is 4.5%.
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We can’t see how the RBA can achieve its 4.5% forecast — and 0.3% would be a considerable miss.
If we’re right, talk about Australian rate cuts in 2024 will gather momentum.
That would be getting ahead of things.
The RBA hasn’t been as aggressive in hiking and was slower than other central banks to move.
Inflation is likely to come down to 3.5% in 2024. But unless we see significant weakness this will remain too high to warrant a rate cut.
We therefore see the central bank leaving the cash rate unchanged over 2024.
Though this won’t stop the market periodically pricing rate cuts in — opening opportunities to trade duration with a long bias into early 2024.
About Steve Campbell and Pendal’s Income and Fixed Interest team
Steve Campbell is Pendal’s head of cash strategies. With a background in cash and dealing, Steve brings more than 20 years of financial markets experience to our institutional managed cash portfolio.
Find out more about Pendal’s cash funds:
Short Term Income Securities Fund
Pendal Stable Cash Plus Fund
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
After the GFC investors generally had to chase greater risk to achieve targeted returns. But that looks to be changing, argues Pendal’s ALAN POLLEY
- Overly austere government budgets have hurt investors over past 15 years
- More normal monetary and fiscal policies good for outlook
- Find out about Pendal’s multi-asset funds
SINCE the global financial crisis, investors have generally had to chase greater risk to achieve returns.
Part of the blame lies with overly austere governments, says Alan Polley, a portfolio manager with Pendal’s multi-asset team.
“For the past decade and a half, government Treasury departments have been nowhere – they’ve been chilling out,” Polley argues.
“The lack of fiscal policy meant monetary policy needed to take up the slack via non-conventional tools such as quantitative easing.
“The resulting wall of money increased valuations, decreased prospective returns and risked asset bubbles.
“Now that’s unwinding, there’s descent prospective returns for equities and bonds – and that makes balanced funds more attractive.”
What happened
In the aftermath of the global financial crisis, many governments implemented austerity measures, which involved cutting spending and raising taxes in an effort to reduce budget deficits and debt levels.
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Austerity policies were controversial. Some argued they were necessary to stabilise the economy and restore financial stability.
Others argued the measures were harmful to economic growth and disproportionately impacted the poor and vulnerable.
The austerity measures were also bad for investors, who generally had to chase greater risk to achieve returns.
“Europeans took it way too far and that killed their economy – which is why they’ve had basically no price returns on the stock market,” Polley says.
Compounding the challenge has been ultra-low interest rates which reflect monetary policy — not fiscal policy — doing the hard work stimulating economies.
A return to fiscal support
But the Covid pandemic was a turning point.
“The pandemic has been a major turning point in many aspects, and one of them is the realisation from governments and finance departments that monetary policy is out of bullets and so fiscal policy needs to fire up,” Polley explains.
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“The transition to fiscal policy is good for investment returns, because governments will now do some of the work to bolster aggregate demand.
“Issuing more debt at a time when central banks are decreasing their balance sheets, creates a more normal supply-demand balance for government bonds – and more normal bond yield levels.”
While governments (notably the US) have spent money in recent years, as a long-term secular trend fiscal policy hasn’t been pulling its weight supporting economies, Alan says.
“Looking forward, we finally have fiscal policy back which means monetary policy can start to normalise, which is what’s happening,” he says.
Normal fiscal policy and normal monetary policy means we can get back to normal investment returns.
“Fiscal and monetary policy are supposed to work together.
Monetary policy is such a blunt instrument but with fiscal policy you can fine tune it a little bit more. You can aim your spending or target you revenue raising to get more productive outcomes,” Alan says.
“The two are designed to work together and we just haven’t had that since the GFC.”
About Alan Polley and Pendal’s Multi-Asset capabilities
Alan is a portfolio manager with Pendal’s multi-asset team.
He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.
Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
A ‘normalisation’ of economic conditions means it’s time for investors to reassess how they think about risk, argues Pendal multi-asset PM ALAN POLLEY
- Expect ‘more normal’ monetary policy in coming years
- Less need for non-traditional assets in portfolios
- Find out about Pendal’s multi-asset funds
AFTER 15 years of the ‘new normal’, the ‘old normal’ appears to be back as central banks return to more conventional monetary policy.
That’s potentially good for investors, argues Alan Polley, portfolio manager with Pendal’s multi-asset team. But it may mean a reassessment of asset allocation.
“Over the past decade and a half we’ve had what was termed the ‘new normal’,” Polley says. “Now we are back to the ‘old normal’. The way things were before the GFC.”
“The last decade and a half, post the global financial crisis, we had global central banks taking non-conventional monetary policy to the extremes.
“They took interest rates close to zero. Some countries went negative,” Polley explains.
“It means we’ve had very low returns from traditional markets like bonds and equities.”
Valuations were pushed artificially high because interest rates were low, and there was relatively little income, he says.
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“Absolute returns were quite low. Inflation was low too — and of course that was part of the reason why central banks were doing this extraordinary monetary policy.
“But nevertheless, absolute returns were unattractive.
“The whole return environment has been challenging over the last decade-and-a-half.”
Changed capital allocation
The ‘new-normal’ environment forced investors to change how they allocated capital.
“Returns were lower, but investors still had the same return objectives – something like CPI plus three or four per cent.
“It meant that the probability of achieving those target returns were much lower,” Polley says.
“It forced investors to chase risk and go out the risk curve. They shifted out of the traditional markets and put money into higher risk assets and hoped the world didn’t turn against them.
“Investors pushed out into small caps, into high yield credit, into emerging markets, into less liquid investments.
“They sold optionality for income. Private markets became very popular. They took on additional risk in some form, whether it be liquidity risk or market related risk or even complexity risk,” he says.
Style bias
Alan explains low interest rates also introduced style bias – investors started chasing growth.
“Growth stocks with longer duration outperformed value style investing for 15 years. People started using the term TINA – there is no alternative,” Alan says.
“People were changing their asset allocation, drifting away from defensive assets such as bonds and putting more into growth assets such as equities than they probably should have.”
But the world has changed over the past two years. Interest rates are back to long-term, historical averages. The ‘old-normal’, which was the world before the GFC, is back.
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“We think bond rates are now close to normal type levels. Likewise equities valuations have adjusted. Our concern around high absolute valuations for equity markets aren’t as prevalent anymore,” Alan says.
Positive outlook
The good news for investors is the outlook is pretty positive over the next decade.
“There is less need to chase risk with non-traditional assets. There’s less need to shift out the risk spectrum. Chasing of liquidity premiums is less necessary now.
“Investors need to ask themselves: do they need to chase risk when bonds have again yields of around five per cent, and equities have reasonable dividend yields?
“Investors can also start thinking of de-risking their portfolios out of equites, because they had piled into equities out of bonds. Bonds are more attractive,” Alan says.
“Investors can be in quality equities and bonds and have a greater likelihood of achieving their return targets. That’s a great environment for investors versus where we’ve been,” he says.
“So investors should be thinking about leaning back into traditional asset classes out of non-traditional asset classes, de-risking their portfolios and start running a more ‘old normal’ portfolio for this ‘old normal’ environment.”
This is especially important for those in or approaching retirement, having the benefit of de-risking into lower risk and less complex assets but still getting an attractive return and income, Polley argues.
About Alan Polley and Pendal’s Multi-Asset capabilities
Alan is a portfolio manager with Pendal’s multi-asset team.
He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.
Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
Australian bonds are looking attractive, particularly if inflation can be brought under control, says Pendal’s head of multi-asset MICHAEL BLAYNEY
- Aussie bonds attractive against peers
- Low cash rate weighing on A$
- Find out about Pendal’s multi-asset funds
AUSSIE bonds are “somewhat unique in the world” right now, argues Pendal’s head of multi-asset Michael Blayney.
“Our 10-year bonds are yielding more than the cash rate — whereas most other major markets have a strongly inverted yield curve,” he says.
An inverted yield curve is when short-term rates are higher than long-term rates. It’s historically associated with expectations of an economic contraction.
Given the possibility of a slowdown in the global economy, the Aussie bond market is relatively attractive.
“In addition, markets are pricing in inflation in the US and Australia to come back under control.
“And last night’s inflation print in the US was very encouraging, noting of course that it’s still likely we’ll see bumps along the way,” says Blayney.
“From a valuation perspective that makes Australian government bonds attractive.”
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“If the Reserve Bank can get inflation down to 2.5 per cent and you’re getting around 4.5 per cent on ten-year bonds, then that’s a pretty attractive low-risk rate,” Blayney says.
Why it’s happening
The difference in yield curves between Australia and the US is partly due to the transmission mechanism of monetary policy, Blayney explains.
“In the United States, lots of corporates have fixed-rate debt and home-owners have fixed-rate mortgages.
“In Australia there is more variable rate debt, and the monetary policy transmission mechanism is much faster.
“That’s one reason why the Reserve Bank hasn’t been as aggressive as the US Federal Reserve in this tightening cycle.”
That’s meant the local benchmark rate — the cash rate — is now below the US’s Fed Funds Target Rate.
“That’s unusual. It doesn’t happen that often,” Blayney says.
“And it has other consequences. It’s one of the reasons the Aussie dollar is trading at 65 US cents.
“If a global investor can get a higher rate in US dollars than Aussie dollars, and the US is a safe haven, then that’s where they’ll put their money.”
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.
Bond markets believe the RBA will join other central banks in an extended pause after this week’s rate rise. Pendal’s STEVE CAMPBELL explains
IF THE Melbourne Cup was not already a tough experience for some, the Reserve Bank added further pain for mortgage holders when tightening monetary policy by a further 0.25% on Tuesday, taking the cash rate to 4.35%.
When third-quarter inflation exceeded RBA forecasts, it was too much for the central bank to bear.
The RBA acknowledged “the risk of inflation remaining higher for longer has increased”.
In their statement the Reserve Bank revealed some updated economic forecasts, which will be fully revealed on Friday with the next monetary policy statement.
The RBA now forecasts inflation to be around 3.5% at the end of next year (up from 3.3%) and in the high twos by the end of 2025.
Economic growth is expected to remain below trend, which should see unemployment rise (though more slowly than previously forecast).
And a key line in the statement remains: wages growth is consistent with the inflation target “provided that productivity growth picks up”.
I would be hopeful, more than confident on that.
Where to from here?
The RBA retains a tightening bias, though there is nothing in its statement to suggest a follow-up hike will occur in December.
Fourth-quarter inflation is released in late January and will determine if a move to 4.6% is required at the first meeting of the year in February.
We expect a better-behaved inflation number for Q4 – below 1% – which should take pressure off the RBA.
The RBA is a reluctant hiker. They are aware of the lagging impact of monetary policy and they don’t want to overtighten.
They will also be the standout central bank if they continue to raise the cash rate.
The US Federal Reserve, European Central Bank and other developed market central banks are all expected to remain on hold in the near term.
Inflation is expected to remain above the band into 2024, so the RBA is not likely to bring relief to mortgage holders anytime soon.
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It simply isn’t going down without a fight.
What it means for bond investors
Bond markets certainly believe we will join other central banks on an extended pause.
After Tuesday’s announcement three-year and 10-year bonds finished lower in yield, reflecting a more neutral stance in the RBA statement.
We expect a further modest rally in the near term – led by offshore factors more than domestic factors for now.
A more significant rally would require labour market weakness – something we have yet to see.
About Steve Campbell and Pendal’s Income and Fixed Interest team
Steve Campbell is Pendal’s head of cash strategies. With a background in cash and dealing, Steve brings more than 20 years of financial markets experience to our institutional managed cash portfolio.
Find out more about Pendal’s cash funds:
Short Term Income Securities Fund
Pendal Stable Cash Plus Fund
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Investors should be taking the time to review portfolios amid geopolitical tensions and economic uncertainty, says Pendal’s head of multi-asset, MICHAEL BLAYNEY
- Neutral stance on bonds
- Opportunities in equities and real assets
- Find out about Pendal Sustainable Balanced Fund
- Browse all Pendal’s multi-asset funds
HOW should investors be thinking about asset allocation right now, amid Middle East tension and economic uncertainty?
Pendal’s multi-asset chief Michael Blayney is neutral on bonds and slightly underweight equities.
But in both asset classes there are opportunities in selected markets, he says.
And there are opportunities in real assets such as listed infrastructure and property, Blayney believes.
“We’ve seen weakness in equities, though there has been a small bounce back.
“Bond yields have marched upwards as investors price in the likelihood of higher interest rates for longer – but they now provide good compensation for inflation risk.
“Bonds should also fulfil their traditional role as a safe haven asset in the event that the crisis in the Middle East broadens.”
No panic
Blayney says a noticeable feature of the market response to the crisis in the Middle East, is a lack of panic.
“The human toll is tragic, but it hasn’t triggered massive volatility in markets.
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“So far, oil prices have risen but remain below last year’s peak.
“Bonds yields initially fell, but have since risen again. Equities — aside from a modest move down on Wednesday night — have been pretty relaxed.”
Bonds
Pockets of value are emerging in some bond markets, Blayney says.
“Canadian bonds have started to become quite cheap. Australian and US bonds have also been heading into cheaper territory.
“For investors looking to add defensiveness to a portfolio, current government bond pricing is pretty attractive.”
Global equities
Blayney’s multi-asset funds are still underweight US equities.
“It’s a very small underweight in our balanced fund. Equities are priced based on a soft-landing scenario in the US.
“Equities will be sensitive to any bad news, and there’s downside risk associated with that.
“Outside the US, valuations on equities aren’t egregious, and even within the US it’s the large caps that are really expensive.
“There are a few markets in Europe which are a bit expensive, but places like the UK and Japan are relatively cheap.”
Real assets
There are opportunities in real asset classes, Blayney believes.
“Right now you can buy on a 20 to 25 per cent discount to net asset value, things like operating renewables. That gives you quite a bit of margin if discount rates go up.”
Part of the reason for the discount is rising interest rates, but Blayney points out that some of the assets have inflation indexed cash flows.
“In those assets, rising rates haven’t been as bad for net asset values as what otherwise would have been.
“Also, last time we saw a spike in energy prices, assets with a linkage to those prices did well. However there is always a risk of government interference in the market.”
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.
Sustainable investors often exclude commodities because of their ESG-unfriendly reputation. But there are ways to hold them sustainably, argues ALAN POLLEY
- Commodities play an important diversification role
- Commodities can be consistent with ESG
- Find out more about Pendal’s multi-asset funds
INVESTORS who exclude commodities from sustainable portfolios are missing out on an important source of diversification, argues Pendal PM Alan Polley.
Commodities — typically metals, energy or agriculture materials — are highly correlated with inflation and can hedge geopolitical and environmental risks, making them an important part of a balanced portfolio.
But many are inconsistent with ESG principles. A nuanced approach may be necessary to screen out unsustainable holdings while still including those that are consistent with the low-carbon energy transition.
“A sustainable portfolio needs to have diversification just as much as a non-sustainable portfolio — so it’s important to think about non-traditional asset classes,” says Polley, a portfolio manager with Pendal’s multi-asset team.
“We hold commodities in our sustainable multi-asset funds and have done for quite some time.”
Inflation hedge
Commodities tend to be highly correlated with inflation and have a return distribution with a positive skew, meaning returns on the upside tend to be bigger than returns on the downside.
“That’s because commodities are sensitive to supply shocks which can cause the prices to shoot up. That can be useful to hedge geopolitical and environmental risks.”
These features are particularly useful in the current market.
“We think inflation is going to be higher than in the past. We think there’s going to be more inflation spikes. We also think geopolitical and weather-related risk is going to be higher,” says Polley.
“That suggests commodities have more of a role to play in a balanced portfolio going forward than they had in the past last decade or two.”
The problem for sustainable investors is that many commodities look questionable through an ESG lens.
“If you’re a sustainable investor, you can’t just go and invest in all the commodities that make up the standard commodity indexes — energy, base and precious metals, agriculture, livestock.
“That leaves sustainable portfolios not being as broadly diversified as they should be.”
Positive screening
So, how can commodities be included in a sustainable portfolio?
Polley says investors should not only screen out commodities that do not meet ESG criteria, but also actively seek out commodities that do support ESG goals.
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“In terms of negative screening, we don’t want to invest in commodities that are inconsistent with the transition to a low carbon economy. In practice that means we won’t invest in fossil fuel-related commodities in our sustainable funds.
“We also screen animal welfare issues. Livestock is not consistent with the ethics of sustainable investing. In addition, cattle is highly carbon emissions intensive.”
But plenty of commodities are consistent with sustainable investing, he says.
“There are two considerations to be balanced — the utility of a particular commodity in terms of helping to transition to a low-carbon economy versus the externalities like the carbon-emission intensity of production.
“There’s no right or wrong answer, but they do need to be considered and balanced.”
Polley says three considerations are important:
1. Demand tailwinds
The first factor to be considered is whether there is a demand tailwind for the commodity.
“The world needs to transition to a low carbon economy and there’s some commodities that have a positive demand tailwind to that transition. We want to include those future facing commodities.
“Good examples are copper and nickel, which are critical to the to the energy transition.”
2. Hedging factor bias
The second consideration is finding commodities that can complement the factor biases in screened equity portfolios.
“Sustainable equity funds often screen out fossil fuels — and there’s not a whole lot you can do about that within your equities portfolio.
“But within your commodities portfolio, you can hedge some of those factor biases. Underweight oil stocks can be hedged by taking an exposure to commodities that have a positive correlation to energy like corn and sugar beets, which are two of the main feedstocks into biofuels.”
An underweight equities position in the materials sector can be similarly hedged by exposure to the industrial metals complex.
“We want to try and hedge those equity screens induced factor biases, as well as bias towards those critical minerals consistent with the transition to a low carbon economy.”
3. Protection from climate change
A third factor to consider is how to use commodities to protect a portfolio from the effects of climate change like higher temperatures and increased weather volatility.
“If we believe we’ll have heightened weather volatility, that will affect agricultural supply, so it makes sense to own a basket of agricultural commodities — wheat, soy bean, corn, etc.
“We already have warnings of a potential El Nino later this year.”
Nuanced approach
Investors should avoid simplistic, binary thinking about commodities and instead take a more nuanced approach, argues Polley.
“Many just buy the broad commodity index which has all the fossil fuels and livestock and is not consistent with ESG. Others think ‘commodities is mining, and mining is bad’.
“But you have to think beyond that because the world’s transition to net zero is materials and resources intensive.
“And if we don’t enhance the supply of those commodities that facilitate the green transition, then we’re just not going to transition.”
About Alan Polley and Pendal’s Multi-Asset capabilities
Alan is a portfolio manager with Pendal’s multi-asset team.
He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.
Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
The RBA has again left the cash rate unchanged at 4.1% — which is where it’s likely to remain for the rest of the year, argues Pendal’s head of cash strategies, STEVE CAMPBELL
PHIL LOWE spared mortgage holders any further pain at his final meeting as RBA boss, leaving the cash rate unchanged at 4.1%.
The decision wasn’t unexpected after rates were left on hold last month.
Apart from adding uncertainty to recent credit concerns in the Chinese property market, there was little change to the accompanying statement.
The RBA believes further policy tightening might still be required — but this will depend on the data and how risks evolve.
No catalyst
There was no clear catalyst that would have caused the RBA to tighten at this meeting.
A glance at key data released since the August meeting shows unemployment rising from 3.5% to 3.7% in July.
The Australian Bureau of Statistics cautioned against reading too much into that.
The last time unemployment rose was in April, which happened to coincide with school holidays.
The bureau also “continued to see some changes around when people take their leave and start or leave a job. It’s important to consider this when looking at month-to-month changes.”
Meanwhile annual inflation fell from 5.4% to 4.9% — weaker than the expected 5.2%.
Taking a deeper dive on the numbers and excluding volatile items (fruit and vegetables, automotive fuel, and holiday travel and accommodation) annual inflation rose 5.8%, down from 6.1%.
Annual rent inflation continued to reflect the tight state of the market and strong demand, rising from 7.3% to 7.6%.
Electricity prices rose 6% in July and 15.7% over the past year. A surge in July was due to annual price reviews that occur each July, though these were partially offset by the introduction of rebates from the Energy Bill Relief Fund.
In all it was a mixed bag, as is often the case.
What it means for investors
Inflation is moving in the right direction and it’s likely the RBA will end the year with the cash rate still on hold at 4.1%.
But any talk of rate cuts in the first half of next year should be discarded (barring a big, external shock).
Inflation has peaked and the move lower will provide comfort for the RBA. But services inflation remains uncomfortably high.
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It’s where the sticky level of inflation sits that is key and that will only become apparent in time.
The RBA’s forecasts do not have inflation back within the 2-3% target band until mid-2025.
This is predicated on slowing economic growth, resulting in higher unemployment and easing wage inflation.
Further policy tightening most likely requires these factors to not play out as quickly as the RBA expects.
About Steve Campbell and Pendal’s Income and Fixed Interest team
Steve Campbell is Pendal’s head of cash strategies. With a background in cash and dealing, Steve brings more than 20 years of financial markets experience to our institutional managed cash portfolio.
Find out more about Pendal’s cash funds:
Short Term Income Securities Fund
Pendal Stable Cash Plus Fund
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.