Anyone hoping for Australia to join the global rate-cut club is likely to be disappointed in the short term, writes Pendal’s head of cash strategies, STEVE CAMPBELL
AS expected, there was no rate change from the Reserve Bank today.
We believe changes are more likely to happen at RBA meetings where updated forecasts are released in the form of their Statement on Monetary Policy.
Those meetings are held in February, May, August and November.
What did we get out of today’s statement?
There are a lot of known unknowns at the RBA at the moment:
- To what extent are lags from past policy tightening still feeding through to the economy?
- How will consumption growth look after tax cuts, the wealth effect from rising house prices and lower inflation?
- What pricing responses will we see from businesses in light of a tight labour market and slowing demand?
- And what of the external environment? Geopolitical risks remain elevated. The economic outlook for China and the US has improved. Commodity prices have risen.
The central bank rate-cut club has increased its membership in recent months.
The Bank of Canada and the European Central Bank both joined the club this month, easing by 0.25% each.
Existing club members include the Swiss National Bank and Sweden’s Riksbank.
Anyone looking for Australia to join the club soon would be disappointed, however.
The final paragraph from today’s RBA note said: “Inflation is easing but has been doing so more slowly than previously expected and it remains high.
“The Board expects that it will be some time yet before inflation is sustainably in the target range.”
So the RBA is not ruling anything in or out. Rate hikes? We see this as highly unlikely.
What the RBA is looking for
The RBA needs to see inflation moving sustainably towards its target before easing policy.
Instead, right now it sees excess demand in the economy and a tight labour market.
There is now a higher risk of an RBA policy mistake caused by holding policy too tight, for too long.
The RBA is now reactive to past data. Gone are the days of relying on forecasts resulting in policy changes.
That is a scenario they are more comfortable with, however.
Easing policy too soon – without inflation properly contained – is the death knell for any central banker.
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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.
The Reserve Bank seems prepared to look through higher near-term inflation without hitting the panic button. Pendal’s head of cash strategies STEVE CAMPBELL explains the latest numbers
THE Reserve Bank left the cash rate unchanged at 4.35% today – and that’s where it will likely stay this year, based on its accompanying quarterly forecasts.
Bond yields rally following the announcement.
Those looking for a more hawkish tilt following higher-than-expected, first-quarter inflation data were left disappointed.
The RBA’s economic forecasts – contained in its quarterly Statement on Monetary Policy (or SoMP) made for interest reading.
If the SoMP was released prior to the rate announcement, yields may have actually moved higher.
The RBA is now forecasting annual headline inflation to end the year at 3.8% – up from 3.2% in the February statement.
Annual trimmed mean inflation (which filters out extreme price movements) is now forecast to be 3.4% at the end of the year, up from 3.1%.
Upward revisions of 0.6% and 0.3%? It would not have been unreasonable to expect something more hawkish today.
However, the RBA is looking through nearer-term upside inflation. Inflation forecasts for 2025 remain unchanged at 2.8%.
The RBA also revised the quarterly unemployment rate lower by 0.1% to 0.2%. It’s now expected at 4.2% by the end of the year.
Economic growth was forecast to be lower. Part of this is also due to higher rates that have gone into forecasts relative to February.
These are not the RBA’s assumptions on where the cash rate will be.
Rather they use market pricing and economist expectations for the cash rate, which have changed by around 0.5% to 0.6% since the February forecasts.
What’s next
So what do we take out of today?
Should inflation end the year close to the RBA’s forecasts, then rate cuts won’t be happening this year.
Yet the statement reflects patience on the part of the RBA. The central bank seems prepared to look through higher near-term inflation outcomes and is not hitting the panic button.
It will take more to tighten monetary policy. The cash rate is now more likely to end 2024 at 4.35%.
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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.
What does today’s Australian inflation data mean for investors? Pendal’s head of cash strategies STEVE CAMPBELL explains the numbers and what they mean for rate cuts
CALLS for rate cuts in 2024 now appear premature based on first-quarter inflation data.
Headline inflation rose 1% over the first quarter, resulting in annual inflation of 3.6%. Economists had been expecting a quarterly rise of 0.8% and 3.5% over the year.
The RBA’s preferred inflation measures – the trimmed mean and weighted median – also exceeded expectations by 0.2% for the quarter, rising 1% and 1.1%, respectively.
After moving to a neutral statement in its March meeting, it’s likely the RBA will take a more cautious, hawkish tone in its next statement in May.
That meeting will be accompanied by a monetary policy statement with updated economic forecasts.
From its February forecasts, the RBA sees annual headline and trimmed mean inflation for the year ending June 2024 at 3.3% and 3.6%, respectively.
Headline inflation has risen 2.77% since June 2023 and a trimmed mean of 2.95%. For the RBA’s forecasts to be realised, we need 0.48% and 0.6% for the next quarter.
Inflation forecasting is a tough caper, but if these annual forecasts were to be revised, they would more likely be higher than lower after today’s data.
A closer look at the data
Looking at the key underlying components from the Bureau of Statistics, we can see:
- The rental market remains extremely tight, with rents rising 7.8% over the past year. This is the biggest annual increase since 2009. With population growth of around 2.5%, a housing shortfall and supply lags, there is nothing in the near term to suggest the rental market will turn around soon.
- Insurance costs surged 16.4% over the past year, recording their highest rise since 2001. Natural disasters, higher reinsurance and claims costs were cited as by the Bureau as drivers.
- Electricity prices could cause volatility in the nearer term. Prices fell 1.7% in the March quarter, resulting in prices rising 2% over the past year. This is much lower compared with the 6.9% annual rise over 2023.
The Energy Bill Relief Fund rebates which came into effect in July 2023 have had a significant effect on the annual number.
Since June 2023 electricity prices have risen 3.9%. Excluding the rebates, they would have been up 17%. When the rebates drop out of the number (and unless they are replaced with something else) then annual electricity prices will pick up in the Q3 numbers. - Education has its annual increase recorded in the first quarter of the year. The 5.9% increase in the first quarter was the largest rise since 2012.
Did anything actually fall?
Apart from a decrease in electricity prices, other falls included:
- International travel (down 5.9%)
- Furniture (down 5.6%)
- Clothing and footwear (down 1.1%).
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Where do we see the RBA now?
Prior to today’s data I had thought November was the most likely date for the RBA to ease policy prior. (And as a mortgage holder, I thought this might also be a rare win on Melbourne Cup Day).
The chance of no cuts in 2024 is now closer to 50/50.
The unemployment rate at 3.8% – along with the Stage 3 tax cuts and a fear of cutting before inflation is properly contained – mean the risk for no change in 2024 is now higher now after today’s release.
Along with domestic forces, the RBA is also closely observing the inflationary environment overseas – particularly in the United States.
The chance of no cuts in 2024 is now closer to 50/50.
The unemployment rate at 3.8% – along with the Stage 3 tax cuts and a fear of cutting before inflation is properly contained – mean the risk for no change in 2024 is now higher now after today’s release.
Along with domestic forces, the RBA is also closely observing the inflationary environment overseas – particularly in the United States.
Inflation has remained more stubborn than expected by the US Federal Reserve and economists. The US economy has also been supported by a more accommodative fiscal stance than in Australia.
Neither central bank wants to ease policy until they are comfortable that inflation has been sustainably contained – comfort that may only occur in 2025.
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.
What does the latest commentary from the RBA signal for markets? Pendal’s head of cash strategies STEVE CAMPBELL explains
IT WAS no surprise that the Reserve Bank of Australia left the cash rate unchanged at 4.35% this week.
Though the RBA’s statement was more neutral than February, which prompted a rally in bond yields.
What did we learn from the statement?
What is certain is that there is a lot of uncertainty at the RBA at the moment. In fact “uncertainty” appeared six times in the statement in relation to:
- Economic outlook
- Sustained productivity growth
- Chinese economy and implications of the conflicts in the Middle East and Ukraine
- Lags from past monetary policy tightening
- Household consumption
- The path of interest rates that best ensures inflation returns to target in a reasonable timeframe.
The unemployment rate has risen to 4.1% (following a low of 3.4% in late 2022 and 3.5% in mid-2023).
But the labour market is still seen as too tight to produce inflation outcomes the RBA wants to see.
Productivity gains is the key here. Productivity growth needs to increase to its long-run average for wages growth to be consistent with the inflation target.
The RBA sees signs that productivity has picked up in the past two quarters which resulted in a slight moderation in unit labour costs. Further gains, though, remain uncertain.
Household consumption has been weak over the past three quarters, weighed down by falling real income growth and higher interest rates.
The RBA anticipates some reversal here though, with real incomes expected to increase and support economic growth through the remainder of the year.
The Stage 3 tax cuts will also support consumption.
Inflation is falling in line with the RBA’s expectations and is expected to be within the 2-3% target range in 2025 and at the midpoint in 2026.
Inflation within the target range is not a prerequisite for the RBA to ease policy – if inflation is falling sustainably, then the central bank can ease monetary policy despite inflation being above 3%.
Services inflation though remains elevated and is moderating only gradually – something that is also occurring in other economies.
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Where to from here?
In our view, any change from the RBA is more likely to occur at those meetings where its latest set of economic forecasts are released via the Statement on Monetary Policy (SoMP).
The SoMP is released quarterly, with the next set of forecasts due to be released at the next meeting in May.
The forecasts, and changes to prior forecasts, can be used as a justification by the RBA should it look to change the tone of its statement or change monetary policy settings.
However, any change to the cash rate is not going to happen in the nearer term.
November is more likely than August for any policy easing at this stage, in our view.
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.
Beyond the human tragedy in many parts of the world, investors must be ready to manage assets differently in times of geopolitical uncertainty. Here are some tips from Pendal’s multi-asset chief MICHAEL BLAYNEY
- Prepare ahead of time and understand your assets
- Consider a greater home bias
- Browse all Pendal’s multi-asset funds
IT CAN be hard to focus on the health of our investments knowing that many people are struggling for survival in war zones around the world.
Just reading the newspaper or watching TV news reports about Gaza or Ukraine is enough to make most Australians feel extremely fortunate.
Yet amid the global geopolitical uncertainty, our portfolio management responsibilities remain.
How does one consider the impact of geopolitical risk on portfolios?
In this article, Pendal’s head of multi asset Michael Blayney offers some tips for managing investments in times of global turmoil:
Prepare ahead of time
Preparing for geopolitical turmoil starts before geopolitical turmoil happens, points out Blayney.
“World events are unpredictable. We have no idea what could happen with China and Taiwan, for example.
“As investors, we need to live with these risks and think ahead of time: ‘how well diversified am I? where are my assets?’
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“The first thing is to start with a well-diversified portfolio that’s consistent with your risk tolerance – a good blend of equities and bonds and some alternative assets.
“The last thing you want is something bad happens and then you realise you’re invested in a way that is outside your risk tolerance.”
Understand your assets and exposures
Understand your assets and where you are exposed before an event happens, says Blayney.
“When these events happen, you often see investors rushing to ask their fund managers where their assets are invested and how much exposure they have.
“It’s useful to know before the event where you have a lot of exposure.
“For example, if your bond portfolio is heavily exposed to some emerging markets, you might find it’s not as defensive as you thought it would be coming into one of these events.”
As an example, Blayney points to Bloomberg’s Global Aggregate Bond Index, which serves as a global benchmark for measuring the relative performance of fixed-income investments.
“If you use the Global Aggregate Index – which a lot of people do – you can find yourself with up to almost 10 per cent of your bonds invested in Chinese bonds.
“In the event of a major blow-up around Taiwan, you might find the bond portfolio you’re holding for defence is nowhere near as defensive as you’re expecting it to be.
“It’s important to be aware of what’s under the hood.”
Consider some home bias
Once you have a strong understanding of your assets and exposures, you’re better placed to understand your comfort level, points out Blayney.
If you’re watching the TV news and finding you’re not feeling comfortable with the amount of geopolitical uncertainty, consider a bit more “home bias”, says Blayney.
“International diversification has lots of benefits. But this environment may support a bit more Australian equities and a bit more exposure to Aussie bonds.”
Blayney has rebalanced Pendal’s asset allocation towards home in recent times. You can read more about the team’s reasoning here.
“We’ve now got 27% exposure to Australian shares and 34 per cent to global shares in our sustainable balanced fund,” he says.
The local stock market offers Australian investors benefits such as franking credits and a stable dividend yield.
“We also benefit from that ‘friendshoring’ theme (where governments push businesses to restructure supply chains and production away from geopolitical rivals to friendly powers).
“Plus if you have any valuation concerns over the Magnificent Seven tech stocks – and the impact that has on the valuations of global shares – Australia can be a good place to be.
“That’s not to say we’re giving up on global. But at the margin when reviewing our strategic asset allocation – and increasing equity exposure – we have been increasing Aussie rather than global.
The same goes for Aussie bonds.
“I think you’d apply that almost doubly to bonds, where Australia does have that safe haven affect. US government bonds are generally also a good place to be if things go badly.“
Other safe-haven options
Besides a home bias, investors looking for greater comfort might also consider a greater allocation to defensive assets.
“The best way to think about defence is nothing ever works perfectly,” says Blayney. “You want to have a few different strategies.
“Bonds are a good hedge against economic weakness. They benefit from a flight to quality if something really bad happens in the world.
“But they won’t work as well when you get inflation shock, as we saw in 2022.
“It also makes sense to have some cash. For one thing you don’t want to have to dip into market-linked investments to pay for your living expenses.
“And it does give you that dry powder to buy.”
Beyond cash and bonds, assets such as foreign currency and alternatives can be useful defensives assets, says Blayney.
Don’t over-react
Investors typically focus on the first-order effects of a geopolitical event.
But it’s also important to think about what the second-order effects might be, points out Blayney.
“In 2022 when Russia invaded Ukraine, most of the damage done to people’s portfolios had little to do with their direct exposure to Russia.
“You had the interest rate cycle and inflation fueled by the geopolitical events.
“Israel’s invasion of Gaza was a terrible human tragedy on both sides of that conflict. But it hasn’t moved markets to any great degree.”
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.
A surprise rebound in the economic outlook is defying expectations of recession. Pendal portfolio manager ALAN POLLEY explains why we’re withstanding higher interest rates
- Global economy showing resilience
- Soft-landing more likely, hard landing less likely
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GLOBAL economic growth remains resilient despite the most significant monetary policy tightening cycle in four decades — diminishing the chances of a hard landing.
That’s what Pendal multi-asset portfolio manager Alan Polley sees in his team’s economic cycle model.
“Last year we were concerned the services sector — which was holding everything together — might turn down and join the manufacturing sector in contraction,” says Polley.
“It appears that isn’t happening.”
Pendal’s economic cycle model is signalling continued economic growth to start 2024 due to:
- An end to the decline in services activity
- A turnaround in manufacturing activity
- Positive economic surprises
- Economic activity breadth expanding beyond the US to include Europe and emerging markets
The robust start to 2024 comes despite last year’s widespread expectations of a significant downturn in economic activity on the back of rapid rate rises, says Polley.
“No one told the American consumer that 550 basis points of interest rate increases is supposed to lead to recession,” says Polley.
“Consumers just haven’t let up the way everyone thought they would.
“Unemployment is still low. Everyone’s still spending, everyone is still comfortable for now.
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“Consumers and companies appear to be learning to live with the heightened cost and interest rate environment.”
The outlook for economic growth is an important input into the prospects for markets and relief at the fading prospects of recession has powered markets higher in recent months.
Hard landing less likely
Markets have been mulling three potential scenarios for the global economy:
- A hard landing, where rate rises trigger recession
- A soft landing, where growth slows and inflation cools
- No landing, where economic growth continues unabated by higher rates
“The probability of a soft-landing scenario has increased,” says Polley.
“Last year, no landing was near zero probability and there was a significant hard landing probability.
“Now, the base case is still the soft landing, but the probability of a hard landing has materially decreased.
“The whole economic distribution appears to have shifted to the right and that is what is providing support to the market.”
How the model works
Pendal’s economic cycle model analyses the level and rate of change of leading economic indicators such as consumer and business surveys.
It also examines how economic data surprises either positively or negatively.
The model is one of three key indicators which inform the multi-asset team’s active asset allocation process – alongside a valuation model and a model that analyses market trends and technicals.
It has a long-term track record of picking turning points in the economic cycle, Polley says.
Broad global turnaround
The turnaround in the economic outlook is founded on a rebound in services activity and improvements in the outlook for manufacturing.
“Manufacturing was in contractionary territory all throughout last year – and still is – but we’re now seeing some positive movement,” says Polley.
“In the last month, the services sector has also bounced off the fence between expansion and contraction and is now back into expansionary territory.”
There has also been a broadening in the number of countries with positive outlooks, says Polley.
“Last year we had very poor country-breadth – most places were contractionary or weak except for the US. Last month, we started to see increased breadth from a regional perspective.”
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Polley says the model shows the US has maintained and improved its positive score, Europe is improving from deep contraction, and emerging markets are starting to gain a little strength.
“We measure the percentage of economies that are showing positive economic scores. Last year we got down to 31 per cent positive and 69 per cent negative. Now, it has moved to 77 per cent of countries on the positive side.
“All of this is suggesting that despite the high level of accumulated interest rates, what we’re actually seeing in the data is the economic environment getting some more support.”
Monetary policy transmission mechanism blunted
Historically, rapid interest rate rises have often led to recession. However, despite the fastest rate hikes in four decades, the expected economic downturn has not eventuated.
Polley says this is likely due to a blunting of the monetary policy transmission mechanism.
“We all expected the effect of 550 basis points rates rises on economic activity to be significant, but it hasn’t happened yet.
“So, why has the transmission mechanism been blunted? There were very large saving buffers that were built up during the pandemic. There were significant fiscal excesses as well. And there was the pent-up demand for services post-pandemic lockdowns.
“But a big part of the reason that rate rises have not permeated through to the physical economy is because everyone took advantage of low rates and termed out their borrowings. Consumers fixed mortgages; businesses refinanced at very low levels.
“They were able to do that because we had rates so low for such a long period of time.”
Soft landing priced in
Still, the rising chance of a benign economic outcome provides little immediate opportunity for investors as markets have largely priced in the soft-landing scenario by pushing equity valuations higher, says Polley.
“There’s no real bull market gains to come from thinking about a soft landing from here,” says Polley.
“If you think there’s more market gains ahead, then you really need to be of the view that the no landing scenario is increasingly likely – and we think it’s a bit hard right now to increase that probability given the concern around the lagging effects of substantial cumulative global interest rate hikes.”
Instead, the recent strength in markets is an excellent opportunity to rebalance away from the best performers in a portfolio, he says.
“While we are neutral on the outlook, it’s important to take advantage of this strong market rally. We certainly advocate the rebalancing and selling some of the gains and going back to neutral positions.”
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 Reserve Bank played a straight bat on rates, as expected. Here’s what it means for investors, according to our head of cash strategies STEVE CAMPBELL
No change to the cash rate from the Reserve Bank (RBA) today, as was widely expected.
The RBA did retain a tightening bias, stating that “a further increase in interest rates cannot be ruled out”.
Yields spiked following the RBA’s decision, before recovering into the close – with three-year bond yields ending unchanged.
What was also released today were the latest set of economic forecasts in the RBA’s Statement on Monetary Policy (SoMP).
Previously, this would have been released on the Friday following the meetings held in February, May, August and November and provided a useful justification for any change to policy at the preceding meeting a few days prior.
It also helped that the quarterly inflation data was fresh off the press leading into those meetings.
Forecasts revised down
So, what were the main takeaways from the latest set of forecasts?
Economic growth was revised down by 0.2% to 1.8% for 2024, with both household consumption (-0.4%) and dwelling investment (-1.5%) key drivers behind the downward revision.
Inflation is forecast to be back within the target range by the end of 2025 and back to around the mid-point by mid-2026.
Nearer term, however, inflation is forecast to be lower than previously expected, with trimmed mean for the year ending June 2024 and December 2024 revised down by -0.3% and 0.2%.
These were cut by more than we thought and leave risks symmetric in terms of whether they are missed to up or downside.
Post-meeting media conference
Today also marked the start of a new era, with Governor Bullock holding a press conference following the announcement.
Inflation misses relative to November’s inflation forecast was one question that came up.
Goods inflation was pointed to as the reason for the miss, with elevated services inflation remaining a concern.
It is clear that the RBA is not comfortable with where inflation currently sits.
There have been some solid misses and revisions to the RBA’s forecasts in previous quarters that understandably weigh on their confidence.
August’s forecasts were too low – and coupled with the line that the RBA had a low tolerance for higher-than-expected inflation at the October meeting, the central bank left itself with little room other than to hike the cash rate in November.
The November forecasts saw a large upward revision to inflation forecasts and subsequently undershot.
Inflation forecasting is difficult – we are not questioning that.
By cutting the inflation forecasts again in February, what the RBA does not need to follow up with is another line about a low tolerance – had it not cut its February forecasts by as much, it would have given itself a bit more leeway should inflation overshoot in the coming quarters.
On a side note, one line of questioning that seems to have been misunderstood from the SoMP relates to the path for the cash rate.
The SoMP contained an assumptions table, including the cash rate. The assumptions had the cash rate at 3.9% by the end of 2024 and 3.4% by the end of 2025.
These are not the RBA’s cash rate forecast.
As per notes to the statement, the cash rate expectations in the SoMP are derived from financial market pricing and surveys from professional economists.
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What does this mean for investors?
Those looking for the RBA to cut in the near term will be disappointed.
The RBA is responding to inflation, a backward-looking view of where the economy is at.
Indeed, if it wasn’t for elevated inflation, the case from other forecasts out of today’s SoMP would be for monetary policy easing to occur sooner rather than later.
This is what the market is looking at when it is pricing in the cash rate to be cut in Australia this year – that, and offshore markets that have priced in aggressive policy easing in the United States, Europe and England over the course of 2024.
However, we still view any backup in yields as a buying opportunity.
The US is still likely to start cutting in May, and if it cuts at every meeting after, will hit 4% Fed Funds by the end of year. This would open up potential cuts later in the year for the RBA.
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.
Rebalancing is a critical part of portfolio management, and after a strong 2023 investors should take a moment to consider their asset allocation, says Pendal’s head of multi-asset MICHAEL BLAYNEY
- Rebalancing is a natural sell-high, buy-low strategy
- It better controls exposures, keeping risk at desired levels
- Browse all Pendal’s multi-asset funds
RIGHT now many investors will be chewing over whether to let high-performing investment settings ride in 2024.
It’s tempting. But Pendal’s head of multi-asset Michael Blayney believes it’s important to rebalance portfolios after a period of strong performance.
“It is very hard to do emotionally, because you’re rewarding the losers and penalising the winners,” Blayney says.
“But in the long term, markets do exert a degree of mean-reverting behaviour.
“After a period of strong performance it makes sense to take some profits — and that’s what rebalancing is.
“Rebalancing helps you make a bit of money out of that volatility. So if a market is down heavily you will be buying at that point — and selling when the market is rallying.
“You won’t time it perfectly, but over the long term you should make money.”
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Benefits of rebalancing monthly
Rebalancing each month can provide about 30 basis points of excess return per annum over the weighted average assets that make up a portfolio in the long run, argues Blayney.
“And that’s after transaction costs. It is well worth doing because over time these small amounts compound,” he says.
Rebalancing also reduces risk because it keeps a portfolio within tolerances.
“If an investor had not rebalanced all last year, they’d be sitting on a portfolio that’s overweight equities and underweight bonds.
“They’d be running more risk now than they were at the start of the year, when equities were cheaper than what they are now.
“Rebalancing helps keep your assets in line with your desired risk profile,” Blayney says.
Remove emotion
Another benefit of rebalancing is that it takes some of the emotion out of investing.
“It helps avoid behavioural problems, like wanting to bail from a stock or strategy that’s suffered a bit of short-term underperformance or wanting to load up on tech stocks given the extraordinary year they have just had.
“People start to believe that certain parts of the market will never do well, and certain parts are impregnable. But over long periods, these tend to even out and rebalancing helps address that sentiment.”
Technology stocks are a good example of why rebalancing matters.
The technology-heavy Nasdaq on Wall Street returned 55 per cent last year, which super-charged global equity returns. But that doesn’t mean it will happen again this year.
“You always get technological change. People tend to underestimate how much that happens over the long term.
“Faced with high uncertainty it makes sense to both diversify and trim parts of a portfolio which have risen strongly.”
Prepare a good defence
Coupled with a disciplined approach to rebalancing, investors should be careful to ensure the defensive part of their portfolio is high quality and liquid, Blayney says.
This should allow enough liquidity for expenses while taking advantage of opportunities as they arise.
“When markets do eventually have a downturn and a period of volatility, you don’t want to be sitting on a position where you came into the downturn running more risk than what your long-term strategy called for.
“For an adviser, it’s important to set the long-term strategy with the client.
“Review regularly – perhaps once a year. And if you do nothing else, rebalance because then you will naturally buy low and sell-high.”
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.
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.