Soaring fossil fuel prices are testing the resolve of sustainable investors. But sustainable portfolios will deliver better long-term outcomes, argues Pendal’s MICHAEL BLAYNEY
- Oil prices test resolve of sustainable investors
- Expect better long-run outcomes from sustainable portfolios
- Portfolio construction can smooth the ride
INVESTORS are understandably asking whether there’s a long-term cost to being in a sustainable fund when oil is trading above $US100 a barrel.
“The reality is that sustainable portfolios have had a more difficult time of it recently and people are asking whether investing in a sustainable fund might mean a long-term drag on returns because they can’t get exposure to certain sectors such as fossil fuels,” says Pendal’s Head of Multi-Asset Michael Blayney.
“The short answer is we don’t expect to get worse returns from sustainability over the long term.
“Indeed, we expect to get better long-run outcomes from sustainable portfolios.
“But you will see greater variation relative to a benchmark in certain types of environments.
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“If you want a sustainable strategy — and you screen out fossil fuels and weapons and tobacco and gambling and so on — then you have to accept that sometimes you will outperform and sometimes you will underperform.
“We saw a sustainable strategy work really well during Covid. During that period oil prices collapsed.
“Also, many sustainable portfolios have a slight growth tilt to them. And 2020 was a really great environment for growth investors and much of 2021 was pretty good too.
“But if you look at one-year returns of sustainable funds as a category now, they’re not looking as great. And year-to-date has been very difficult.”
Portfolio construction critical
In this environment portfolio construction takes on even greater importance.
“If you look at other asset classes for economic exposures that you’re lacking in equities, that gives you an extra tool to manage through these periods,” Blayney says.
“While we encourage people to focus on the long term, the reality is people do think about the short term and they do think about peer comparisons.”
Investing across asset classes can smooth the road for sustainable investors.
“If your sustainability strategy gives you a slight growth bias then you might want to look for investments that fit your sustainability strategy but also gives you a value bias, for example in your alternatives.
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“Or you might actively seek out a bit of energy price exposure and inflation hedging via commodity futures or certain types of renewable energy infrastructure.”
Beyond Aussie equities
Looking beyond the local equity market is also attractive.
Oil and gas companies have outperformed this year as oil prices have pushed beyond $US100 a barrel.
But oil and gas companies are less than 4 per cent of the MSCI World Index. So in global equities at least, there are plenty of opportunities for investors outside that sector.
“There is no reason to believe the oil and gas sector is going to outperform in the very long term. If anything, because of the decarbonisation economy it has big structural headwinds,” Blayney says.
All investors — including sustainable investors — need to have realistic expectation from the beginning.
“They need to understand that some equities in their portfolio might trail the market over the short term. But that is okay if they have the right strategy, structurally, for the long term,” Blayney says.
“To help them through some of those periods, they should think about sustainable balanced funds which hold some renewables, for example.
“To the extent that they can, investors should look at what they’re missing from equities and then use other asset classes to identify exposures which are consistent with what they are trying to achieve from a sustainability perspective.”
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.
When equities and bonds sell off at the same time — as has occurred this year — investors need to reconsider portfolio construction norms, says Pendal’s MICHAEL BLAYNEY
- Inflation, rates and the Ukraine war are changing the norms of investing
- Equities and bonds both in negative territory this year
- Alternative assets, commodities provide opportunities
INFLATION, the prospect of higher interest rates and the war in Ukraine have altered the investment landscape this year.
“Russia’s invasion of Ukraine is a human tragedy first and foremost,” says Michael Blayney, Pendal’s Head of Multi-Asset.
“We haven’t seen a major war of this nature in our lifetimes. Many are also struggling to come to terms with how to think about it from a market perspective.”
“We went into the war already experiencing high inflation, and the war adds to those pressures.
“Also, central banks around the world had already thrown a lot of stimuli at economies, because of COVID.”
“We’ve ended up with the situation of central banks needing to tighten in a period of geopolitical uncertainty, and that’s a challenge for portfolio construction.”
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Government bonds and equities, in Australia and overseas, have fallen in value this year. But the Australian dollar has appreciated, contrary to normal practice in times of crisis when the local currency tends to fall against the greenback.
“The world is a much more difficult place to find diversification and that’s really the theme of the year,” Blayney says. “Normal ways of diversifying aren’t really working at present.”
The critical reason the rules of the past two decades aren’t applying is inflation.
“When you get higher inflation, you tend to see bonds and equities correlate a bit more positively. It means investors need to think about other sources of diversification in portfolios,” Blayney says.
Getting exposure to commodities has been a successful diversification strategy, Blayney says, as has being active in your asset allocation to try and control risk.
“If you are going to move on market conditions, you need to be quite nimble,” Blayney adds.
Pendal’s diversified funds had been overweight growth assets for much of the last couple of years, but have pulled back in the last few months. Pendal’s diversified portfolios are now underweight both bonds and equities.
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“That doesn’t mean you want to be underweight forever. There will come a point when it makes sense to reweight towards bonds in the portfolio.
“When there’s an inflation shock, bonds generally feel the heat and then as things settle down, bonds can become a great buying opportunity. Same for equities. We are not there yet but it’s important to keep it in mind.”
Blayney adds that within sectors and geographies there are buying opportunities, hence the need to be active.
“For example, right now Australian equities have better valuations and are a bit more of a safe haven.
“Looking globally there are expensive assets, there are fairly valued assets and there are also some undervalued markets.”
Corporate debt can also provide opportunities with spreads in the US – the difference between yields on a government bond and a corporate bond – around 1.4 per cent. And Blayney says holding funds in cash to take advantage of opportunities is important.
“Our funds have been running a little more in alternative assets than usual, which includes some listed renewables and risk parity and target return strategies that are able to provide alternative sources of returns.
“The alternative asset portfolios have done a really good job of supporting total portfolio returns at a time when equities and bonds haven’t been great.”
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.
Cash as an asset class is becoming more attractive and investors should be ready to rethink its role in a balanced portfolio, says Pendal’s ALAN POLLEY
- Cash yields should start to rise as inflation increases
- Among defensive assets, cash could outperform
- Find out more about Pendal’s multi-asset funds and cash funds
HOLDING cash in a portfolio hasn’t been very rewarding in recent years.
With interest rates at record lows, real returns have been negative and few investors have been rushing to put their money into cash.
But it might be time to rethink cash in a portfolio says Alan Polley, a portfolio manager in Pendal’s multi-asset team.
“Cash as an asset class has been poor, but with rates normalising due to inflation, cash yields are going to go up,” Polley says. “Cash as an asset class will start to become more attractive.”
“It’s a reflection of inflation expectations and inflation going up. When prices are rising, cash can be a bit of an inflation hedge.
“Looking forward, it should play more of a role in a balanced portfolio because inflation is going up,” Polley says.
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Cash comes in many guises. Generally, it is defined as investments with a term of no longer than 90 days. It might be a three-month bank bill, money in a savings account or a term deposit, or cash management trusts.
It has many attributes, not least it’s among the safest of the defensive assets.
“Cash is a store of wealth which provides protection that other assets don’t always have in times of stress. It provides optionality in a portfolio and provides a medium to longer term link to inflation,” Polley says.
Also, other asset classes are priced relative to cash. So as cash starts to provide higher yields, other alternate investments will look relatively less attractive.
“There are a number of cash-alternative asset classes like crypto-currencies, gold and some collectables, that have performed very well.
“Part of the reason is that investors, in response to the very low returns of cash, have looked elsewhere to put their money,” Polley says.
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“But cash will start to look better relative to those investments.”
He says investors don’t yet need to rush to put their money in a cash-based assets.
“Investors don’t have to do this right now. But over the next year or two cash is going to become relatively more attractive compared to the past few years. People should start thinking about that now and get themselves set up,” Polley says.
“Cash should also outperform other defensive assets as interest rates rise, providing capital protection in particular for investors with a lot of fixed income exposure such as conservative risk profiles.
“Cash is becoming relatively more attractive than other defensive asset classes.”
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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.
Global bond markets might not look attractive, but Aussie bonds could be a good fixed interest component for portfolios right now, says Pendal’s multi-asset chief MICHAEL BLAYNEY
- Inflation a key risk for retirees
- Balanced portfolios need bond exposure
- Inflation, bond outlook in Australia better than elsewhere
INVESTING in bonds is challenging in the current economic environment, with inflation and interest rates rising around the world.
But portfolios need diversification — and for investors putting money into fixed income assets, Australian bonds are an attractive option.
That’s because inflation and the prospect of interest rate rises are lower in Australia than the United States.
“If you are constructing a portfolio right now, bonds have relatively low yields and you’re seeing a spike in inflation,” says Michael Blayney, who heads up Pendal’s multi-asset team.
“In the US it’s 7 per cent year-on-year, it’s about 5 per cent in the UK and it’s 3.5 per cent in Australia. That makes it hard to be positive about bonds.”
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So is there any reason for investors to consider being overweight bonds?
“One big reason is geopolitical risk,” says Blayney (pictured above).
If Russia invades Ukraine — it has more than 100,000 troops amassed near the border — bonds would likely benefit from a “flight to quality”.
“US Treasuries would be a pretty good place to be in that case,” Blayney says. “But that would be a short, sharp event, so if an adviser is thinking more strategically, the bigger issue is inflation.”
Managing inflation
Inflation is among the biggest risk facing retirees.
“It erodes a retiree’s purchasing power, and they are no longer earning wages,” Blayney says.
“Higher inflation is also generally bad for other asset prices, such as equities, because it causes bond yields to rise and that raises questions over the lofty valuations of some stocks.
“But the reality is that in a portfolio today you have to position yourself to have some hedges against inflation,” he says.
Returns on cash are almost zero so most investors still need to hold bonds. The question is how overweight or underweight they want to be in the bond market.
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“Whatever their position, investors need to look at what bonds look more attractive,” he says.
That’s where the Australian bond market stands out because the inflation outlook isn’t as severe as many other economies.
“I can buy a German bund [bond] and for the first time in quite a while get a positive yield, but it’s only 0.2 per cent. I can go to the US and get 1.9 per cent, but inflation is seven per cent and I’m reasonably confident that the Fed will hikes rates this year.
“I can go to Australia where I get about two per cent on a ten-year bond, and the inflation rate is much lower. And when the immigration tap turns on again, I know that will relieve some of the pressure on wages, which feeds through to interest rates.
“So, if you want to hold bonds, and balanced portfolios do even if they are under-weight, Aussie bonds aren’t a bad place to be,” Blayney says.
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.
Investors should prepare for a long-term structural rise in the rate of inflation, regardless of how the current economic cycle plays out, says Pendal’s ALAN POLLEY
- Short-term debates about inflation doing a disservice to investors
- Look through the cycle; higher prices are here to stay
- Inflation-proof portfolios needed to ensure long-term real returns
DEBATE about the transitory nature of the current inflation cycle is just a distraction for genuine long-term investors, who should look beyond the short-term economic cycle, says Pendal portfolio manager Alan Polley.
Over the next decade, many of the big drivers of lower prices from the past — including the globalisation of manufacturing, government fiscal austerity measures and cheap fossil fuels — will start to unwind.
This means investors need to prepare portfolios to weather the return of rising prices.
In the long term, inflation is now more likely to align with central bank targets — rather than fall materially short as it has over the past decade, says Polley.
Going forward, there’s also more risk of inflation spikes compared to the past decade.
“Over the last decade inflation has materially undershot central bank targets, independent of this transitory-or-not debate,” says Polley, a portfolio manager in Pendal’s multi-asset team.
Inflation at a turning point
“Right now, we’re at a flux. The long-term outlook for inflation is at a turning point. The drivers of lower inflation over the last decade are starting to unwind.”
This inflection point for inflation means the dialogue occupying markets at the moment “is quite misguided”, he says.
“Whether the current bout of inflation is transitory or not doesn’t really matter.
“What really matters to long-term investors is not what happens in the short term.
“What investors should really be worrying about is the implications for long term inflation.”
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Polley identifies five drivers of lower inflation over the past decade:
- A higher propensity to save amid stalling economic growth
- Higher rates of globalisation
- Advances in technology
- Low labour bargaining power, and
- Deep underemployment in many western economies
But in the coming decade, a new set of forces will conspire to put upwards pressure on prices.
First among the changes is the unwinding of the rate of globalisation, says Polley.
“Pretty much all the developed economies have been comfortable outsourcing their manufacturing to lower-cost countries like China.
“But geopolitical and national security concerns mean the rate of outsourcing is going to diminish — or at least become less efficient.
“World governments are starting to understand the risk as China starts to flex its muscle.
“And increased income inequality in developed nations — resulting from a hollowed-out and unhappy middle class with zero real income growth — will need to be politically and practically addressed.
“Onshoring manufacturing and finding alternative suppliers to China will drive a reduction in the rate of globalisation and thus the global supply of labour.”
At the same time, the world’s move away from fossil fuels will impose new costs through the global economy, from the expense of building a new renewable energy system to an increasing carbon price on emitters.
“We won’t be able to rely on cheap fossil fuels going forward — that means energy prices will go up.”
Government policies are another new driver of higher price pressures as the post-GFC austerity policies give way to a political willingness to run higher deficits and monetary policymakers allow inflation to run higher than previously.
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“In the past, when inflation gets to the US Fed’s 2 per cent target, they start to raise rates,” says Polley.
“That biases inflation low because they never let inflation get above the target.
“Now, they are saying they are going to let inflation run hot, which by definition means inflation will be higher on average than it was in the past.”
Policymakers also have an incentive to allow inflation to run higher because it is the most effective way to reduce the value of high government debt.
“The monetary policy punchbowl won’t be removed when the party starts to warm-up — and it may be further spiked with fiscal policy.”
How to position portfolios now?
So, how should genuine long-term investors position their portfolios for the end of low inflation?
Polley advises focusing on assets that have long proved to be protective against higher prices: commodities, inflation-linked bonds, real assets and equities, especially value-based stockmarket strategies.
“You could also look for investment products that have the objective of delivering a real return after inflation,” he says.
Ultimately, Polley suggests investors leave the debate over the immediate inflation outlook to their fund managers.
“As an investor, focusing on short-term market gyrations just gets you distracted from the main game which is your real long-term investment returns.”
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.
Clients asking about falling equity markets? Here Pendal’s head of multi-asset MICHAEL BLAYNEY puts the recent volatility into perspective, outlining the risks and opportunities
- Recent fall in equity markets is not a surprise
- Opportunity to sell expensive and buy cheap
- Aussie bond market looks better value than most
“IF I’M AN ADVISER, and clients are walking in asking about the headlines saying the market is down, and I’ve got to show them losses in their equity and bond allocations, there’s a few things I need to explain,” says Michael Blayney, who heads up Pendal’s multi-asset investment team.
“The first is the context of the recent fall in equity markets. Second, I need to talk about relative valuations. And finally clients need to know there’s very different behaviour going on compared to March 2020, at the beginning of the pandemic.”
Equity markets around the global have fallen sharply in recent weeks. In the week ending January 21, the five-day drop in the S&P500 was the largest since March 2020 — the beginning of the pandemic. In Australia it was the biggest weekly fall since October.
“Investors must keep in mind the broader context,” Blayney says. “It’s been a very strong period for equities, and Wall Street has only fallen back to levels of August last year.
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“If you think of it in terms of the long bull market we’ve been in, that’s more of a pull-back. And it’s to be expected.
“The other thing that’s happening is bond yields are rising. So, if you buy bonds to protect your portfolio, then in the short term that hasn’t been working.”
The common factor for both bonds and equities over the past two years has been liquidity, Blayney says. But with inflation rising and interest rates in the US set to increase, the era of easy money is coming to an end.
“As we move to a more normal environment, there will be more volatility because ultimately, easy money tends to suppress volatility.
When it comes to relative valuations, Blayney says last year his team was more bullish and happier to take on riskier assets.
“Now we are just a little more cautious. As the bull market has matured, more and more markets have crossed through fair value, and US large cap equities look particularly expensive.”
Blayney also points out that January 2022 looks very different to March 2020, at the beginning of the pandemic. This time around, investors are selling off some of the high growth, popular stocks, particularly tech companies.
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“In a relative sense, you are seeing value stocks doing much better,” Blayney says. “Also, some of the frothiness around high-risk assets – notably crypto-currencies – has started to come out of the market.”
While all equity markets tend to rise and fall together, over three to five years disparities in cumulative performance between different regions and styles become evident, making diversification within growth assets very valuable to longer term investors.
Blayney says it’s time to look at reducing exposure to assets which have become overly expensive and using the opportunity presented by the current pull-back to buy things that are a bit cheaper.
“For example, we like Japanese and UK equities at the moment and value-style stocks. They are reasonable value.
“In terms of bonds, while we are underweight, we are more cautious on markets away from Australia. For example, in the shorter term, the US Federal Reserve will have to tighten more than the Reserve Bank of Australia because the US has more of an inflation problem.
“So, we prefer Australian bonds to most global bonds.”
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.
Rising inflation, full equity valuations and volatility will provide opportunities for active investment managers in 2022, says Pendal’s head of multi-asset, Michael Blayney.
- Active investors should benefit in 2022
- Volatility throws up opportunities
- Conviction important as is ability to re-position.
CONDITIONS will suit active investment management in 2022 says Michael Blayney, head of Pendal’s Multi-Asset investment team.
“If your starting point is that inflation is rising, that tends to reduce the diversification benefits in a portfolio,” says Blayney.
“And 2022 is starting off with equity valuations being very full around the world. In these circumstances you don’t necessarily want to be a passive investor.”
Active investing looks even more attractive when you add the fact that volatility generally provides more opportunities.
“During the period of stimulus and easy monetary policy, it’s been okay to be a passive investor from an asset allocation and a stock perspective,” Blayney says.
“You have had asset classes that have had a steady trajectory upwards.
“When there’s been bouts of volatility, central banks have generally come to the rescue and people have been able to buy the dip.”
But what about the next five years, when interest rates are more likely to be rising, than falling?
“If we have a more volatile environment going forward — because central banks can’t be as accommodating due to higher inflation, and you start to see bonds and equities correlating positively — bonds won’t be as good at providing defensive qualities as in the past.
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“That’s an environment where it will be more important to adopt an active approach to asset allocation.”
Volatility throws up opportunities for active asset allocators and active stock pickers.
“Active stock picking in Aussie equities has always been pretty fertile ground for local money managers.
“In Australian equities, the average manager has consistently been able to add value in the order of magnitude of 1% per annum.
“So Australia has been a pretty good place to be an active investor,” he says.
“Stock picking globally has been more challenging, in part because there’s been a handful of FAANG stocks that have dominated and become a larger part of the index.
“When you have a narrow part of the market running, it’s difficult for active investors to outperform.”
But when a period of excessive valuation in a narrow part of the market unwinds, that can be a great time for active management.
Active investors globally outperformed significantly after the tech bubble burst in the early 2000s, Blayney points out.
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“It was one of the best periods for active investing in global equities.
“Passive has been good strategy to ride the rising markets of the past decade. But rising inflation and a steady reduction in stimulus means we are now at a potential turning point where a more difficult market regime is likely to need a more active approach.
“To be an active investor you need to have conviction and be willing to back yourself,” Blayney says. “But you also need to be able to re-visit your thinking when things change,” Blayney says.
An investment strategy that adapts as the facts change?
That recalls a famous quote often attributed to legendary economist John Maynard Keynes (though some say it was another economist, Paul Samuelson).
When accused by a rival of inconsistent views, Keynes is said to have replied: “when the facts change, I change my mind. What do you do, sir?”
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.
Omicron may strengthen the re-opening trade if it turns out to be mild. But investors need to be ready to move quickly as data comes through says MICHAEL BLAYNEY
INFLATION is the critical issue in financial markets — and consequently how the US Federal Reserve and other central banks respond.
But the Omicron variant of Covid-19 in the short term has created greater uncertainty.
Still, it may not be a negative for markets says Michael Blayney, who heads up Pendal’s multi-asset funds.
Omicron introduces uncertainty because it widens the potential range of outcomes — but there’s also a chance it will strengthen the re-opening trade.
Already on Wednesday we saw a bounce in markets on the back of subsiding Omicron fears.
The risks of Omicron are balanced, Blayney says.
“There’s an outcome in which Omicron is more contagious, but milder and outcompetes Delta.
“That’s the one we all hope for. It would be good for the reopening trade.
“Or there’s the outcome where there’s many mutations and the efficacy of vaccines isn’t as good.”
The emergence of the new Covid variant has complicated the global economic outlook. The most recent inflation reading in the United States shows price rises of 6.2 per cent in the 12 months to October 2021. That’s the highest in more than 30 years.
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Newly re-appointed US Fed chair Jerome Powell has indicated the central bank will taper its bond purchases. Market watchers now expect interest rate increases next year.
“It’s interesting that Chair Powell wants to drop the transitory label from inflation. The Fed is targeting average inflation and now it’s had a bit of inflation, the average shifts up.”
Time to re-evaluate
The change in tack on inflation and the emergence of Omicron should trigger a re-evaluation of portfolio positioning.
“We’ve been a bit more pro-growth for the last 12 months,” Blayney says. “But we have been bringing that back.
“That doesn’t mean going underweight equities. Instead, it’s about looking for relative value opportunities. We like UK equities but don’t like French equities, for example.”
Blayney also argues the benefits of being exposed to higher volatility.
“Part of our investment process enables us to trade instruments on volatility. When you start to see a bit more financial market stress and an uptick in volatility, you can buy instruments that tap into that. We are essentially long volatility exposure.
Underweight bonds
“We are still underweight bonds,” says Blayney. “Bond yields have fallen a bit with some flight to safety as a result of the Omicron variant. But the reality is we’ve got high inflation, tapering and the potential for interest rate rises next year in the US.
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“That creates a backdrop which is quite negative for bonds, and you’re starting off with pretty low yields to begin with.
“Add in the idea that Omicron is actually part of the lessening of the pandemic, there could potentially be big trouble for bonds.”
What’s most important right now is to be vigilant and able to move your portfolio quickly, he says.
“You’ve got to be active and prepared to shift your views and positioning quickly.
“There will be more information on the Fed tapering and Omicron in coming weeks.
“Whatever you position, you need to be willing and ready to move those around as the situation changes.”
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.
What’s the outlook for cash, bonds and credit after the RBA’s final meeting of the year? Pendal’s head of cash strategies STEVE CAMPBELL explains
- Cash remains a viable alternative for investors
- Environment is right for enhanced cash products
- Find out about Pendal’s cash funds
THE Reserve Bank of Australia held its final 2021 board meeting this week, sticking to its view that a rise in the official cash rate is some time away.
But there’s enough in the RBA commentary, and the response of financial markets in recent months, for investors to consider cash and short-term fixed income assets, says Steve Campbell, head of cash strategies at Pendal Group.
And the credit market is creating opportunities.
“Margins are moving wider on credit securities. For those worried about the rising interest rate environment, we are starting to get higher margins through longer-dated credit securities.
“Enhanced cash products benefit from that type of environment. You are getting better returns without taking more interest rate risk on.
“If you think we’re in for a more benign economic recovery, and too much upside has already been priced in, then shorter-dated bonds can rally from here even though we are looking at an environment where cash rates will eventually move higher,” Campbell says. “There are too many hikes priced in here over the next two years.
“There’s a fair amount of shape coming into the shorter part of the curve and bonds can provide defensiveness for investors who want to look at short-dated cash funds and bond funds.
“They can provide a degree of protection that we didn’t see at the beginning of 2021.”
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Will the RBA be last to move?
For cash and short-term securities investors, the Reserve Bank commented this week that it would keep a watch on what was happening overseas.
“We’ve had the Federal Reserve in November starting to taper the purchase of Treasuries and agencies,” Campbell says. “And we expect that could go further in December. “
The Fed has also noted greater concerns around inflation.
“That could mean rate rises happening in the US sooner rather than later,” Campbell says.
“The Bank of Canada is looking at lifting interest rates early next year. The Reserve Bank of New Zealand has already hiked by 50 basis points. It’s a situation where a rising tide might lift all boats,” Campbell says.
There’s a risk that if the Reserve Bank of Australia decides to stay on hold and be one of the last central banks to move, it may have to eventually lift rates more quickly.
“They may have to play catch up, and hit the brakes harder,” Campbell says.
Variable and fixed mortgages to move higher
Another factor affecting the bond market is the cessation of the Reserve Bank’s term funding facility for the banks, which ended in June.
As lenders start to replace the facility with longer-dated debt, the cost of accessing funds will be higher.
“Where they were accessing funding at 10 basis points, a major bank issuing five-year debt would be paying closer to 65 to 70 basis points over swap currently.
“That’s a lot more expensive so it’s not unreasonable to expect that both variable and fixed rate mortgages will move higher.
“When that happens, the market will be doing some of the Reserve Bank’s work for it.
“Also, we have a bond purchase program going on. That expires in February. The next big decision is whether the Reserve Bank extends the program or just calls time on it.”
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.
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Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
It looks like we’re approaching peak pessimism on China — which could mean it’s time to lift portfolio exposure to Asian shares, argues Pendal’s SAMIR MEHTA
- China’s economy drives Asia’s markets
- Maximum pessimism reached
- Find out about Pendal Asian Share Fund
SIGNS that investors are approaching maximum pessimism on the Chinese economy could indicate it’s time to lift portfolio exposure to Asian shares, argues Pendal’s Samir Mehta.
Most of Asia’s sharemarkets have fallen heavily over the past 12 months on a combination of rising interest rates, higher inflation and escalating geopolitical concerns.
China’s economic outlook has also been a key cause of the declines across the region, as Beijing takes steps to strengthen regulations governing the property sector and lift oversight of the operations of its big technology companies, says Mehta, who manages Pendal’s Asian Shares Fund.
“Pessimism is now embedded in stock prices, and that’s why I’m turning a little bit more positive on Asia, because if China does well, you could start to see things turn up for the region,”
Mehta says this kind of contrarian view on Asia has the potential to deliver gains even if global markets fall, echoing this year’s sudden reversal of fortunes for coal and gas companies as the rest of markets struggled.
“The simple tagline is that China is like another ‘anti-ESG’ portfolio. Back in 2021, ESG was so entrenched that ‘anti-ESG’ stocks like fossil fuels became very cheap and investors were bidding up anything ESG compliant no matter the valuation and no matter the future risks.
“Those risks became manifest in 2022 — everything that was ‘anti ESG’ had a really big bounce, energy and commodities in particular.
“My sense is that China is at a similar stage with negativity now manifest.”
Three positive signs for China
Mehta says three signs indicate China’s economic prospects may be on the mend.
First, the recent profit season saw improving fortunes for bellwether companies. Food delivery giant Meituan posted better than expected earnings while results at gaming giant Netease were good.
On the other hand, poor results are not being treated with big sell-offs — restaurant chain Haidilao has suffered from COVID lockdowns, but its stock rose after weak results on a plan to reorganise the business and reduce restaurants and staffing.
“So, we have results that are not meeting expectations, yet the stocks are higher. And we have some results that are better than expected. These are the initial stages of what looks like sellers’ fatigue.”
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Pendal Asian Share Fund
Mehta says there are also hints that President Xi Jinping might loosen up on COVID restrictions once he is confirmed for another term in October, using Hong Kong as a test case.
“I don’t have a crystal ball but there are rumblings around Hong Kong where leaders are talking to the neighbouring provinces as to how do they work with opening up a little bit more.”
Mehta says a signal for investors will be if Xi personally attends November’s G20 meeting in Indonesia.
“Xi leaving the country would be a big statement,” he says.
Mehta says a third positive for investors could be a shift in government policy to stimulate the economy.
“There’s a big rise in youth unemployment in China and social stability for the Chinese is going to be a very important point for Xi after he becomes president for a third term.
“There are real issues that the economy is facing, and therefore his motivation will turn away from cementing power to trying to make sure that they don’t have to deal with social problems.”
And finally, investors’ concerns about tension in Taiwan might be overstated, at least in the short term, says Mehta.
“The experts think that the Chinese navy is just not ready for an invasion by sea that would be multiples of the complexity of the Normandy landing — the Taiwan strait is significantly larger than the English channel.”
Instead, Mehta says investors should consider the prospect of Xi biding his time for a decade or more.
So, what are the risks?
Mehta says the US dollar will remain strong as the US Federal Reserve battles inflation, creating capital outflows that put pressure on Asia’s economies. High commodity and oil prices are also a structural headwind for Asia.
“But barring a real accident, which is possible, the negativity is now manifest in China and the rest of Asia. That means it makes strategic sense to start to allocate capital to Asia.”
About Samir Mehta and Pendal Asian Share Fund
Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.
Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.
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Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.