Want to understand the outlook for China? Look to Japan’s 1990s stagnation experience, says Pendal Asian equities manager SAMIR MEHTA

• Even in low-growth periods, some companies stand out
• Cashflow, pricing power and market structure the key
• Find out about Samir Mehta’s Pendal Asian Share fund

INVESTORS looking for clues as to how China’s economic future will pan out should examine Japan’s performance after the 1980s boom, says Pendal’s Samir Mehta.

China faces enormous uncertainty about its economic outlook after decades of faster-than-normal growth culminated in a slowdown on the back of Covid-lockdowns, a real estate crunch and regulatory tightening in tech and education.

As the rest of the world wrestles with supply constraints, runaway inflation and rising interest rates in 2022, China instead faces lacklustre growth, rising unemployment and the real prospect of deflation.

“It’s almost diametrically opposite to what the rest of the world is facing,” says Mehta, who manages Pendal’s Asian Share Fund.

“What we are seeing at the moment in China is reminiscent of what happened in the Japanese economy when their bubble burst in the 1990s — for the next three decades Japan’s economy was mostly hobbled.”

Mehta says the key to Japan’s long-term troubles lay in the fact that its banks refused to recognise non-performing loans (NPLs), take write-offs, recapitalise and move on to lubricate economic growth via taking on risks on new projects.

“There are parallels with what we are seeing in Chinese banks. They are unlikely to recognise or write off their NPLs and they are not changing old business models.

“If you do not recognise the problem, then you risk a massive balance sheet recession and deflation.”

Another parallel to Japan is policy mistakes prolonging the downturn.

In the 1990s the Bank of Japan went too far with interest rate rises while increases in indirect taxes were poorly executed.

Similarly, Beijing seems to be making policy mistakes such as its strict zero COVID policy. Just last month authorities locked down a million people in Wuhan.

Mehta says an extended period of low growth should change the way investors approach China.

“Remember that in Japan’s case there were always some very good companies that were globally competitive — Toyota, Sony, Nintendo, some of their speciality chemical and semi-conductor companies.

“It’s not as if there weren’t good businesses but those businesses typically relied on export orientation because the domestic economy was going through a very challenging period of disinflation and deflation.

“I want to keep that precedent in mind for China and look for similar opportunities.”

Mehta cautions that the geopolitical environment is different. While Japan did cause resentment in the US in the 1980s because of its economic power, it was never a military threat.

“So be careful – the same export markets that were open to the Japanese might not be open to the Chinese.”

But the broad characteristics of companies that will thrive in a slow growth, deflationary domestic environment should be similar.

“The companies that stood out had shared characteristics.

“They were companies with high pricing power, they had an industry structure with few irrational competitors, and they were able to generate very strong cash flows.

“When you have a disinflationary or deflationary environment, cash is a fantastic asset to own.

“Inflation is the enemy of holding cash as value, whereas in a deflationary environment, cash is king.

“In my portfolio in China, I am gravitating towards these kinds of businesses – export-oriented champions or domestic champions with pricing power and cash flow.”

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

The investment metrics that worked in a low interest rate world are no longer the right markers for profitable investing. Pendal’s SAMIR MEHTA explains

• Some investing metrics will stop working as rates rise
• Margins, asset turns and net profits are key
• Find out more about Samir Mehta’s Pendal Asian Share fund

HOW do you pick your way through tricky global markets?

As markets adapt to higher interest rates, companies with good margins, a high ratio of sales to assets and strong net profits are best placed to survive and thrive, says Pendal portfolio manager Samir Mehta.

The types of metrics that worked in low interest rate world — measuring total addressable market size; valuing stocks as a multiple of sales; and earnings measures that hide stock-based compensation expenses — are no longer the right markers for profitable investing, he says.

“This is a market with nowhere to hide — bonds, equities, private equity, crypto, whether growth or value,” says Mehta, who manages Pendal’s Asian Share Fund.

“The reasons are evident — the Fed is raising rates and they are going to start the process of quantitative tightening.”

Mehta says the effects of this will play out over the coming years. As interest rates rise, the US dollar strengthens, vulnerabilities in the financial system are exposed.

“The first fatalities are on display — cryptocurrencies, bonds of Chinese property companies and the Sri Lankan economy — but there will be more.

“If you look back in history — the savings and loan crisis, the tech bubble, the housing bubble — as we go through a tightening cycle something big could break.”

Opportunity for investors

The crisis will be challenging but he says the opportunity for investors is to look through the valley and identify the factors that will help companies survive the downturn and then grow as stability returns.

“In the last decade or more of this loose monetary policy environment, every entrepreneur, venture capitalist and most fund managers became focused on the concept of total addressable market.

“How big can this business become? How scalable can it be? Can you become the next Facebook or Google?

“Now, in trying to address a very large market, what became secondary, almost inconsequential, was the question of whether it was a profitable venture.”

Mehta says this explains the rapid growth of a whole raft of popular but unprofitable global tech companies.

“These companies were selling a $1 for 50c.

“If I was to stand on a street corner and hand out a $1 in exchange for 50c my turnover will go through the roof.

“But now, in the current environment, several of these companies could go bankrupt. Which will inflict pain on consumers accustomed to subsidies.

The reason is twofold.

“Not only is there little capital available for companies to give you those subsidies, but there are massive shortages in everything around us. Problems due to supply chain disruptions; even finding qualified labour has become very difficult.”

The job now for investors is to find those companies, which will survive the shake out and take advantage of the dislocation.

Mehta says investors should turn to time-honoured measures like margins (the ratio of earnings to sales), asset turn (sales to assets) and net profits (after all expenses).

“Let me put in an Australian context: it’s no longer ‘Tim TAM’ for Total Addressable Market.

“Now it’s ‘Tim MAN’ for Margins, Asset turn and Net profit.”

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

‘If you don’t own China today, you’re going to miss out,’ says Samir Mehta, manager of Pendal Asian Share Fund. Here’s why

• Stimulus could turn around faltering Chinese economy
• Policymakers have track record of rapid action
• Find out about Pendal Asian Share Fund

INVESTORS nervous about the outlook for China are not accounting for the fact that Beijing has a track record of rapid policy change — and could move quickly to bolster the faltering economy, says Pendal’s Samir Mehta.

A policy-led resurgence in Chinese growth could spark a rally in Chinese stocks battered by regulatory crackdowns, a slumping property market and the fight to suppress COVID outbreaks.

(Listen to this fast podcast from Pendal’s head of income strategies Amy Xie Patrick for a fixed interest perspective on China).

“When Xi Jinping came to power in 2013, he quickly changed the incentives in the system away from pure GDP growth to what he ultimately termed ‘common prosperity’ — reducing inequality, balancing growth and promoting fairness,” says Mehta, who manages Pendal Asian Share Fund.

“If that meant you had to take down the education sector, the internet sector and the property market, you do it. The incentives changed and society began to re-orient itself.

“Policies can change on a dime in China — and my sense is we are on the cusp of them doing something to ramp up economic growth.”

Under pressure

China’s gross domestic product rose by an annual 4.8% in the first quarter. The economy is under pressure from regulatory constraints on the real estate industry and lock downs as authorities struggle to contain Covid.

A quarter of China’s population lives in cities that are now under some form of pandemic lockdown.

The first clues that Beijing wants to re-start growth have come in reports that Xi is calling for a boost in infrastructure construction and a statement from last week’s Politburo meeting promising stimulus.

“We should waste no time in planning more policy tools and enhance the strength of adjustment in due course,” the Communist Party’s Politburo said Friday, according to a readout of a meeting of the leadership on state broadcaster China Central Television.

There have also been reports that Xi is meeting tech giants this month in a sign of easing regulatory pressures.

And newspapers last week reported Xi had told officials to ensure the country’s economic growth outpaced the US this year.

Expect stimulus

Mehta expects further policy effort to stimulate the economy is on the way.

“During lockdowns in the US, among many other schemes, the government handed out $600 additional monthly payments to households.

“What’s to stop the Chinese from doing something similar?”

Mehta expects fiscal action to dominate because monetary policy is more constrained by the global environment.

“In face of the rapid depreciation of the Japanese Yen, the Chinese renminbi has depreciated by almost 2.5% in the past week.

“The People’s Bank of China needs to be very careful about the externalities. The worst thing that could happen is if they loosen monetary policy in a big bang and are faced with capital outflows, which could result in a further weakening of the currency and have ramifications and unintended consequences.

“Monetary policy cannot be done in isolation, whereas fiscal policy can.”

Risk for investors

The risk for investors is that Chinese policy changes can come “at the drop of a hat”, says Mehta.

He points to the rapid reversal of Beijing’s climate commitments after last year’s UN climate conference.

“Chinese authorities said they were focused on not using fossil fuels and reducing coal consumption — and then the war in Ukraine exacerbated an energy crisis. Restrictions on fossil fuels have been shelved as a result.

“China’s coal consumption is back approaching all-time highs.”

Mehta says a change in policy on economic growth or zero-COVID will have profound impacts for investors.

“Charlie Munger said ‘show me the incentive and I’ll show you the outcome’ and China is all about incentives.

“For 30-plus years, there was just one incentive for everyone in government — GDP growth. What was surprising is that China achieved that GDP growth year-in, year-out.

“But incentives can change on a dime: one thing we know about the Chinese authorities is that when they want to do something, no one can stand in the way because it’s an authoritarian Leninist society, where there is no democratic process. It is rule by law (as defined by President Xi or the CCP), not rule of law.

“When they confront reality, they will have to look it in the eye.

“There seems to be almost universal revulsion at owning stocks in China for good reasons. Yet Chinese stocks today are the equivalent of the “anti-ESG portfolio” of 2021 and 2022.

“Every sector ignored by the market due to ESG compulsions roared back to life — and was in hindsight the only portfolio to own in 2021 and 2022.

“If you don’t own China today, you are going to miss out.”

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

Warren Buffett’s “economic moat” isn’t what it used to be. Investors need to ask new questions about competitive advantage, says Pendal Asian Share Fund manager SAMIR MEHTA

• Old competitive advantages may no longer apply
• Outsourcing, globalisation now a weakness
• Find out about Samir’s Pendal Asian Share Fund

WARREN Buffet popularised the idea of the “economic moat” to describe a company’s competitive advantages.

But with geopolitical conflict, government sanctions, supply chain disruptions and a new sweeping deglobalisation, companies’ economic moats are not what they once were, says Samir Mehta, who manages Pendal Asian Share Fund.

“The years of seamless globalisation are behind us,” says Mehta.

“Disparate systems with built-in redundancies mean higher costs of doing business going forward.

“It is prudent is to assume lower profit margins and much lower returns on capital for most businesses.

“We might need to reassess what we pay for businesses once thought secure due to their moats.”

Rethink competitive advantage

Sustainable competitive advantage has taken many forms — it could be the ability to produce goods cheaper due to sophisticated outsourcing arrangements, the ability to source low-cost raw materials, or access to less-expensive labour.

“But in a deglobalised world where supply chains are disrupted and sanction risk is real, new questions need to be asked,” says Mehta.

“Where are your email servers based? Which cloud computing software do you use?

“Are you dependent on Visa, MasterCard or Amex for your corporate credit cards?”

Some of the fundamental technologies that investors take for granted have geopolitical connections that can make companies that rely on them vulnerable, says Mehta.

The US government owns the GPS (global positioning system) which powers location-based services like maps on smart phones. American and European banks control the SWIFT international payments system.

“These are all things which we just take for granted,” he says.

Mehta says the end of the era of just traditional economic moats is another example of change in some of the core factors that investors have taken for granted for decades.

“These are cyclical changes in a long business cycle,” he says. “From the 1980s, we witnessed falling interest rates and lower inflation – but at some point in time, we know that this economic cycle will likely turn.”

Mehta says investors should look to the past to gain insights into what the new world might look like.

“Cycles last decades; we’ve had many instances in the past where we’ve lived in inflationary environments or seen changes in the way economies are managed.”

He recalls the changes Asian economies went through after the crisis of 1997/98 as the International Monetary Fund and western governments imposed sweeping change across the way economies were managed in return for bailouts.

Look for new clues

With some of the basics of investing under threat, Mehta says investors need to look for new clues to find success over the next decades.

One particularly important change is to watch for the effects of the re-engagement of government in economies.

This is typified by Beijing’s deep intervention into Chinese business to reduce inequalities and help contain cost of living pressures, but it is also noticeable in the west as governments deepen their involvement post-pandemic.

Mehta says this re-engagement of government is something of a return to the past for some Asian economies, where the state has a history of “managed capitalism” and favouritism in service of advancing national goals.

“In the past we looked for markers such as higher returns on capital from competitive advantages, but now I have to reorient myself – are there companies that derive their moats from protectionism?

“Where are the companies that will benefit because a government wants them to benefit? “You have to think hard and reassess the level of vulnerability for companies. In that sense, we are heading back to the future.”

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

Coping with volatility is normal for investors. Here are a few timeworn tips from Pendal’s Asian Equities Fund manager SAMIR MEHTA

• Diversification key to coping with volatility
• Sell-offs can bring opportunities
• Find out about Samir Mehta’s Pendal Asian Share Fund

INFLATION energy prices, interest rates, and now war in Europe: at times it feels like there is nowhere for investors to hide.

Yet coping with volatility and uncertainty is situation normal for experienced investors, who can turn to a few tried and trusted tips to get them through the downturn, says Pendal’s Samir Mehta.

“There are periods of time a portfolio will struggle,” says Mehta, who manages Pendal Asian Shares Fund.

“The cause of volatility and sell-off is global in nature — no geography and very few sectors have been spared.”

Investors can turn to three timeworn strategies when seeking to cope with market uncertainty, Mehta says.

Diversify

First, he says check that your portfolio is appropriately diversified. Even in times of market dislocation, different assets perform differently.

Past few months, the best performers were in the energy sector (oil, gas and coal producers) and miners. A properly diversified portfolio has exposure to these sectors.

This will test ideological convictions, says Mehta.

“But the goal is to identify a few of these areas of strength and have a bit of exposure — even if they are areas where normally you don’t want to participate.”

Diversification includes holding an allocation to cash through the turmoil.

“You need to try to preserve as much capital as possible,” he says.

Bunker down

Second, Mehta says investors should bunker down and wait out the volatility.

“Sometimes you have to just live through these painful periods of underperformance,” he says.

Look for opportunity

And finally, he says it is a good time to look for opportunities to change the portfolio as the price of companies becomes divorced from their fundamentals.

“Sometimes, the selling is indiscriminate,” says Mehta.

Mehta says broad-based market sell offs often throw up opportunities to buy companies at attractive prices.

“To navigate through this, I try to identify companies that will come through this in a much better state than they are today.”

Case study: Meituan

He uses the example of a company in his portfolio, China’s food delivery giant Meituan.

Meituan has been sold off amid concern it could suffer from Beijing’s regulatory actions aimed at improving equality and alleviating cost of living pressures for Chinese families.

“But they are a business that in my view benefits the community – they provide a lot of employment. Their fees for restaurants are among the lowest in the world. And they are very profitable,” he says.

Mehta’s advice: “Be careful not to the use the price of a company to judge its value.”

“These are the decisions that investors have to make with the kind of confluence of events that are taking place.

“Whether it’s geopolitics, Federal Reserve action, Chinese regulatory issues or inflationary pressures — we have to look through this fog and try to understand which are the businesses that genuinely will come through these problems.”

“The unintended consequences of actions in this war will play out over a long while to come. War teaches us why geography matters and why history can’t be ignored.

“No one felt the weight of his actions than the so-called father of the atomic bomb, J. Robert Oppenheimer (as you can see in this video below).

It’s a sober realism worth listening to.

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

As a sharp downturn in world markets shakes confidence, investors should look to the past to identify a path through volatility, says Pendal Group’s Asian Share Fund manager SAMIR MEHTA 

• Volatility in 2022 is following a familiar pattern
• Think ‘VEPL’: Valuations, Earnings Progression and Liquidity
• Find out about Samir Mehta’s Pendal Asian Share Fund

“HODL!” has been the call to arms for a new generation of investors in recent years — an accidental misspelling of “hold” that became a meme and a rallying cry for how crypto investors should behave when faced with market turbulence.

But as a sharp downturn in world markets so far in 2022 shakes confidence, perhaps investors need to adopt a different meme, says Samir Mehta, who manages Pendal’s Asian Share Fund.

“The meme we should be guided by is VEPL! — Valuations, Earnings Progression and Liquidity,” he says.

Market volatility so far in 2022 is showing a familiar pattern to previous downturns and investors can look to the past for a path through, says Mehta.

He recalls a market aphorism that as the tide turns on easy monetary policy. It’s the small fish that die first as those asset prices underpinned by excess liquidity and leverage start to unwind — but ultimately at some point “a whale gets beached”.

This time around, examples of the ‘small fish’ are the collapse in the Turkish lira amid runaway inflation and the rapid retreat of cryptocurrencies.

“We now have to figure out — where is the whale?” says Mehta.

Past ‘whales’ have been the collapse of the US housing market in the GFC, the tech wreck of 2000 and the Asian financial crisis of 1997.

‘Every generation thinks they invented sex’

Mehta recalls a decade ago launching the Asian Share Fund with a presentation titled ‘Every generation thinks they invented sex’.

Little has changed with the latest generation of investors, he says.

“This ‘everything rally’ in 2020 and 2021 was premised on shiny new memes and radical technological blockchain breakthroughs. A new paradigm. Yet what has not changed is human greed and fear.

“Excesses, once created, usually deflate over time.”

Mehta says that, as a result, the key skill for investors in 2022 is going to be patience.

“As of now, it would be foolhardy on my part to opine with confidence that this sell off in January in the US is start of a prolonged bear market.

“[But] the confidence that I do have is to suggest that prudence dictates diversification away from momentum-oriented assets.”

So where should investors turn in 2022?

Mehta says he is becoming more optimistic on the outlook for China and intends to increase portfolio weighting over the course of the year.

While market sentiment towards China is negative, it will be one of the few countries loosening monetary policy in 2022.

“In my view, monetary policy will loosen faster than most expect in China,” he says.

Shares in southeast Asia also remain cheap and out of favour, says Mehta.

“That is why I kept adding to our holdings in that region. I still remain convinced that patience in those names will help us in 2022.”

Mehta says the southeast Asian region — with significant stock markets in Singapore, Thailand, the Philippines, Malaysia and Indonesia — has historically been vulnerable to external shocks, “but today that is all relative”.

Elsewhere, valuations for Indian stocks in 2022 will likely face the headwind of higher oil prices but strong competitive dynamics in many industries by dominant firms is an attraction.

“Ultimately, the test as always is whether the stock I own manages to deliver on earnings.”

And how about that whale?

Mehta suggests investors watch three asset classes for signs of trouble: the Chinese property market, the euro, and the private equity and venture capital sector.

“I am not a macro-economist and I have been wrong before, but I’m trying to look back through history and identify where today’s biggest vulnerabilities may lie,” he says.

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

Omicron is adding uncertainty to investing at the moment. Here Pendal portfolio manager Samir Mehta discusses how to approach investing in periods of doubt

• Investors face weeks of uncertainty with Omicron
• Barbell strategy a way of approaching investment uncertainty
• Find out about Samir Mehta’s Pendal Asian Share Fund

INVESTORS expect weeks of uncertainty as lab technicians probe the Omicron variant.

How to tailor portfolio construction in such times?

It is an apt question in a week where unexpected Covid variants have roiled markets. But the important thing to remember is that uncertainty has always been a feature of investing, says Samir Mehta, who manages Pendal Asian Share Fund.

It’s not just the big unforeseen events that are difficult to predict, he says.

Mehta points to records of Treasury bond yield forecasts from the Society of Professional Forecasters — the oldest quarterly survey of macroeconomic forecasts in the United States conducted by the Federal Reserve Bank of Philadelphia.

Year in, year out for the past two decades, America’s top economists have predicted that bond yields will rise.

As you can see below from this analysis by Bianco Research, year in, year out they have been by-and-large wrong.

Bond bearishness has been a constant for decades, and horribly wrong for decades. pic.twitter.com/noSV4aN23r

— Jim Bianco biancoresearch.eth (@biancoresearch) November 19, 2021

“Humans by nature — especially in our industry — need to appear knowledgeable. And to appear knowledgeable you have to come across as if you know a few things,” says Mehta.

“At the moment, it seems like the rational thing to do is to consider the possibility of interest rates going up because that’s what everyone is saying.

“But there have been so many instances where we’ve been in similar positions like this, and the forecasts have been consistent for rising rates, and they just have not panned out as expected.

“There’s this big tug of war and I have no clue as to which way it will go.”

How to manage uncertainty

So, what do you do when you don’t know what will happen next?

“The question is how do you make decisions in an uncertain environment,” says Mehta.

“And that’s the job. Not just for people like myself, but so many professions involve decision making under uncertainty.”

Mehta says a simple way to construct a portfolio in uncertain times is to use a “barbell strategy” where a portfolio is weighted to opposing outcomes.

“If you do not have conviction on outcomes, you want to hedge your bets. That’s what a barbell is,” he says.

“You have enough on both sides so that you don’t get caught on the wrong end of either of them and as evidence start to accumulate, and you get more conviction, you move towards where the evidence is taking you.”

Mehta says the biggest unknown in markets remains whether inflationary pressures are transitory or here to stay.

“Let’s say the forecasters are right, that inflation is likely to be trenchant and not transient.

“That means 10-year bond yields and interest rates around the world have to rise.

“The question becomes which countries, sectors and companies are likely to be uncorrelated to the effects of rising inflation and rising interest rates?

Investing in Asia

Mehta says investors could look to Southeast Asia for this exposure.

“Southeast Asia is neglected, completely out of favour and cheap. But countries like Indonesia and even the Philippines are benefiting from the reflation due to commodities.”

And China should also be back on the list in a barbell approach.

“China is completely out of favour — but it is the one country that has acted diametrically opposite from all others from a central bank action perspective.

“The People’s Bank of China has tightened monetary policy, not allowed lending to get out of hand, the property bubble is coming under strain, GDP growth is affected.

“If the Western world goes into a rising interest rate, rising inflation environment, could we anticipate China doing the opposite? Should we be alive to the fact that liquidity conditions in China could start to become benign at a time when the rest of the world is quite negative on China?”

And what’s on the other side of the barbell?

Here, Mehta says a well-structured portfolio should own the companies that will continue to thrive should inflation prove transitory.

“I want to have some part of my portfolio in structural winners and growth in case forecasts of rising interest rates based on rising inflation turns out to be wrong.”

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About Samir Mehta and Pendal Asian Share Fund

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

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

Find out about Pendal Asian Share Fund

About Pendal Group

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

Contact a Pendal key account manager.

In all the investor excitement about AI equities, investors may be missing a crucial factor. Pendal equities analyst ELISE MCKAY explains

• Generative AI capturing investor imagination
• But high electricity costs could hinder usage
• Find out about Pendal Horizon Sustainable Australian Share Fund
• Find out about Pendal Focus Australian Share Fund

Big US tech stocks are soaring on a wave of new, advanced AI applications.

But similar to Bitcoin’s early days, excited AI investors may be overlooking the technology’s extremely high power costs and potential associated sustainability issues, argues Pendal Aussie equities analyst Elise McKay.

While the remarkable progress of AI promises to revolutionise industries, the sheer cost of the electricity needed to train and run the systems puts a question mark over the long-term prospects of adoption.

“There’s three key components of power usage required for running a generative AI model,” says McKay.

“First of all, there’s the power needed to simply build the equipment that it runs on.

“Then there is the enormous power required to train the model.

“And then every time you ask it a question it requires new computations — and that means more power.”

Even before generative AI became widely available, demand for data was expected to increase at a compound annual growth rate of 40 per cent per year.

The data centre industry is already estimated to account for about 1 per cent of global energy demand, says McKay.

“Just because it’s on your phone doesn’t mean it’s not in a data centre somewhere — and data centres need electricity. Any new technology just increases demand for power.”

McKay uses the example of bitcoin mining, which rapidly increased its share of global energy consumption from next to nothing to an estimated 0.5 per cent in 2021.

“Emerging technologies like bitcoin mining can see very rapid adoption and dramatic increases in demand for power,” says McKay.

“We are now seeing the broad take up of generative AI, which is significantly more power hungry than existing technologies.”

A study by Stanford found that training the popular GPT-3 generative AI system contributed almost 10 times the emissions that the average car consumes in its lifetime, says McKay.

Estimates are the newer GPT-4 model was eight times more power intensive again, she says.

“And you don’t just do this once, you do it regularly.”

OpenAI — the company behind ChatGPT — says it continuously improves its AI model by “training on the conversations people have with it”.

“And each model can only do one search at a time,” says McKay. “So, if 100,000 people search for something at the exact same time you need 100,000 copies of the model otherwise queries will be queued.

“Estimates are that every time you query ChatGPT, it is 300 times more expensive than a Google search.”

High power usage has also raised question marks over the carbon footprint of the technology industry, with many providers shifting to renewable energy to minimise their impact on the environment.

“The high cost of providing AI will hinder its adoption,” says McKay.

“It may mean that only companies willing to pay a high price will be able to use it. There’s a good use case for companies willing to pay for it because it improves productivity, but will we see broad adoption for low-paying use cases?”

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About Elise McKay and Pendal Australian share funds

Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

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

Contact a Pendal key account manager here

Here are the main factors driving the ASX this week according to Pendal Australian equities analyst ELISE MCKAY. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share fund

WE remain in a stock-picker’s market, after emerging from the largely macro-driven environment of the pandemic.

This is emphasised by the still-clouded outlook for the economic cycle and interest rates on one hand — and the extraordinary AI-driven uplift in revenue guidance from chip-maker NVIDIA on the other. 

The outlook for US rates remains uncertain. Fed-speak remains mixed.

Last week Christopher Waller — a member of the rate-setting Federal Open Market Committee (FOMC) — suggested a pause may be appropriate while tighter credit conditions continued to dampen inflation.

But April’s Personal Consumption Expenditure (PCE) index — a measure of US inflation — came in hotter than expected, increasing the chance of another hike in June.

Other economic data from last week suggests the US outlook is stronger than expected, while much of the rest of the world looks weaker. China is not contributing as much as expected and Germany is now in technical recession.

We saw a positive development on the US debt ceiling. The Biden administration and House speaker Kevin McCarthy over the weekend agreed to raise the debt limit and cap federal spending until after the 2024 election.

A lack of visibility in the macro narrative compares with high levels of market conviction in the emerging micro-narrative of AI.

NVIDIA reported a blow-out quarter. Its second-quarter revenue guidance was more than 50% ahead of consensus expectations on the back of AI-related demand for its GPU (graphics processing unit) chips, driving huge bottom-line upgrades. 

This drove a 2.5% gain in the NASDAQ, despite two-year US bond yields rising 30bps.

The S&P500 rose a more subdued 0.35%, while the S&P/ASX 300 was down 1.74%.

Fed speak

We continued to receive mixed communications from the Fed, with no clear direction. This overshadowed the release of May’s FOMC meeting minutes. 

While inflation remains too high, concerns continue over the impact from tightening credit conditions due to stress in the banking system.

The question is whether this will do some of the work that further rate hikes would otherwise do.

Governor Waller gave a “Hike, Skip or Pause” speech on Wednesday, focusing on the case for “skipping” a rate-hike in June and increasing the odds for another rise in July.

“If lending does slow, this can obviate the need for at least some monetary policy tightening,” he said. “It is important to account for this other form of tightening in setting the stance of monetary policy.

“If not considered appropriately, the Fed could tighten too much and needlessly raise the risk of a recession.”

The market saw this as a more hawkish signal than Chair Powell’s comments from the previous week.  

Fed-fund futures are pricing a 69% probability of a June-rate hike and markets are shifting expectations to rates remaining higher for longer.

US inflation and economic data

The PCE — the Fed’s preferred inflation indicator — was released on Friday, with core PCE prices rising 0.38% in April versus 0.30% consensus expectations. It is running at 4.7% year-on-year, up from 4.6% in March. 

This print was higher than expected and represents a stall from its downward trajectory, further complicating the debate regarding a rate rise in June. 

PCE Core services ex-rent rose 0.42%, the biggest increase in 3 months, suggesting stickiness and disappointingly limiting the break to the downside.  This measure has shown no meaningful improvement since Fed officials started to highlight it late last year.  Consumer spending rose 0.8% in April, up from 0.1% increases in both February and March.

This was largely driven by vehicles and financial services.  Motor vehicle consumption surged 3.8% and remains a lumpy category with pent-up demand and low inventories supporting pricing. Used car prices have rolled over again, which should be supportive to the downside in future months. 

Elsewhere economic data in the US has been coming in stronger than expected, including the Purchasing Manager’s Index (PMI) last week where the Composite index is at 54.5 versus consensus at 53.0 and the Services index at 55.1 versus 52.5 expected.

US debt ceiling

President Biden and House Speaker McCarthy reached an “in-principle” agreement over the weekend to raise the US debt ceiling and increase the borrowing limit for two years.

US equities rallied on Friday on the expectation this would eventuate, ending fears of a default on US government debt and any potential flow-through impact on the global economy. 

Spending levels should remain roughly flat for the next two years, which should minimise fiscal headwinds to the economy. 

Republican demands for tightened handouts were met through a temporary increase to the top-age threshold for the Supplemental Nutrition Assistance Program (“SNAP”). 

This now means that low-income adults without dependents or disabilities between ages of 18-54 (previously 18-49) can only receive benefits for up to three months in a three year period unless they are working or enrolled in a work program. 

Internal Revenue Service (IRS) funding will also be reduced, which was intended to boost tax enforcement and modernise technology. 

The agreement still needs to move through the House and Senate by the 5^th of June to ensure the government does not run out of money to pay its bills. 

Rest of the world

UK inflation surprised to the upside at 8.7% year-on-year, 50bps above consensus and with core inflation 60bps higher than expected at 6.8% YoY.  There is pressure on the Bank of England, with the market pricing 90bps of tightening over the next three meetings. 

Germany officially entered recession with GDP -0.3% in 1Q23, following a 0.5% decline in 4Q22. 

The Reserve Bank of New Zealand (RBNZ) hiked interest rates for the twelfth consecutive time, this time raising by 25bps to 5.50% – the highest level since 2008. 

The Board also suggested that the interest rate hiking cycle is done, with the view that rates are sufficiently contractionary to lower demand, but may stay higher for longer.

The market had been expecting one further hike to 5.75%

Generative AI and accelerated computing

The NVIDIA result was a standout, adding US$200bn of market cap (+28%) following a blow-out guidance upgrade for 2Q23. 

This was followed up by Marvell Technology, which was up +32% after signalling a strong outlook.

This underpinned by rapid adoption of accelerated computing to support generative AI.

NVIDIA’s guidance for revenue gains of 53% quarter-on-quarter to $11bn was well above consensus expectations of $7.2bn.

It implies sales of graphics processing unit (GPU) microchips to data centres almost doubling quarter-on-quarter as they rapidly gain share over central processing units (CPU) chips.

GPUs process data several orders of magnitude faster than CPUs, making them better suited to generative AI applications. 

Marvell Technology also guided for AI revenue to more than double in FY24 (from ~$200m in FY23) and more than double again in FY25. 

The question is whether recent market moves reflect the start of a multi-year bull-cycle on the back of AI-driven efficiency gains.

Or are we reaching bubble territory with just seven US mega cap tech names (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta and Tesla) up 70% in 2023 and driving the majority of the 24% NASDAQ rally YTD, leaving us at risk of a pullback?

We do note that valuation metrics for this group do not seem stretched given they are growing, are making efficiency gains, have strong balance sheets and are buying back stock, and may be moving into a more favourable macro / interest rate backdrop.

There is a bigger conversation around what generative AI means for the economy in terms of productivity, jobs, and wages.

Politicians and the business community must also grapple with the implications in terms of accuracy, regulation, ethical considerations, privacy issues, IP protection and data ownership – with no straightforward answers apparent.

Accelerated computing and storage infrastructure also still needs to be built to support mass usage of generative AI at scale. 

Markets

Commodities continued to weaken over the week and have been the worst performing asset class in 2023, after topping the charts in both 2021 and 2022. Oil bucked the trend last week, with Brent crude up 1.8%. 

The US dollar (measured by the DXY) bounced with US economic strength relative to weakening China and Europe data. 

In Australia, technology stocks tended to outperform.

While Technology One (TNE, +9.90%) delivered a decent result and was the best performer in the ASX 100, the other leaders such as Altium (ALU, +7.91%), NextDC (NXT, +6.8%) and Wisetech (WTC, +5.20%) were largely driven by the broader tech thematic. 

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About Elise McKay and Pendal Australian share funds

Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

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

Contact a Pendal key account manager here

As ESG interest grows, investors are becoming aware of the threat ‘greenwashing’. Here are some tips from Pendal senior risk and compliance manager Diana Zhou and investment analyst Elise McKay

• Five tips for choosing a high-quality sustainable investment manager
• Find out about Pendal Horizon Sustainable Australian Share Fund
• Find out about Pendal Focus Australian Share Fund

AS DEMAND for sustainable investing grows, Australians are becoming more attuned to the threat of “greenwashing”.

What is greenwashing?

Australian investments regulator ASIC defines it as “the practice of misrepresenting the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical”.

The value of Australian assets managed using a “rigorous, leading approach to responsible investment” passed $1.5 trillion last year — 43% of the total market, the Responsible Investment Association Australasia reported earlier this month.

RIAA last year certified 225 products in Australia and New Zealand, representing $74 billion of assets under management — up $18 billion in a single year. (Pendal is named by RIAA as one of 74 responsible investment leaders in Australia.)

But not all investment managers are as green as they may seem. So what steps can you take to avoid greenwashing?

“It can be a real challenge to spot whether a product you’ve invested in is truly green versus one that’s just claiming to be green,” says Pendal senior risk and compliance manager Diana Zhou.

In June, Australian Securities and Investments Commission published guidelines to help product issuers self-evaluate their sustainability-related products.

But investors can still find it problematic separating financial products that are sustainable from the ones that just say they are.

Elise McKay, an investment analyst with Pendal’s Australian equities team, says there are broad global questions on what exactly represents best practice in ESG.

Right now European regulators are leading the way with explicit regulations on disclosures, reporting and metrics.

“My view is that ultimately Australia will head down a similar path towards greater regulation — but we are not there yet.

“From an investor perspective, people are selecting these funds because they have an ethical desire to invest aligned with their beliefs.

“Product issuers have an obligation to be ‘true to label’ and deliver them the solution they are after.”

How can investors be sure that the products they are investing in are delivering what they promise?

McKay and Zhou offer these five steps for investors and advisers to avoid falling victim to greenwashing:

1. Dig deeper than the glossy marketing material

Investment opportunities often come with glossy brochures, but behind the marketing material is a product disclosure statement (PDS), usually available on the product issuer’s website.

Zhou says “the PDS, by law, must disclose the extent to which ESG practices are taken into account in selecting, retaining or realising an investment.

“Investors should read the offer documents (PDS and Additional Information Booklet) in detail rather than relying only on marketing. These documents should provide details on a manager’s ESG practices.

“A PDS needs to be submitted to ASIC and needs to comply with certain rules in the Corporations Act — so there is regulatory oversight.”

2. Check up on a product issuer’s governance

Companies with strong governance frameworks are more likely to be in compliance with rules and regulations, says Zhou.

“You’re looking for a dedicated responsible investment page on the an issuer’s website.

“There will usually be policies and statements about responsible investing, climate change, human rights, modern slavery and stewardship. ”

“The proxy voting process is important for transparency. There should be a record of how the manager voted at the annual meetings of its portfolio companies. Investors should be able to see which resolutions were voted on and which way the investor voted.

“Investors can also look at whether the manager is a signatory to the Principles for Responsible Investment (PRI) which gives an indication of the level of commitment a manager has on implementing its responsible investing strategies”

3. Understand how sustainability is integrated into the investment framework

There are a number of ways a manager can integrate ESG factors into the investment process – but some are more effective than others, says McKay.

Some managers may simply screen out investments while others conduct detailed benchmarking of a portfolio company’s ESG targets.

“Look for detailed benchmarking on areas like climate change, diversity, biodiversity and natural resources, the circular economy and so on to identify who are really leading sustainability and ESG targets.”

4. Look for evidence of stewardship activity.

A fund manager that genuinely cares about making a difference will be actively engaged with portfolio companies.

This goes beyond proxy voting, says McKay.

“Spend time understanding what stewardship activities are done — what are the areas that a manager is working on with companies.”

You can read more here about what to expect from a modern investment manager’s engagement activities.

5. Spend time with the investment team

Finally, and potentially most importantly, McKay urges investors to get to know their fund managers and get into a direct discussion with them to go behind the written word.

“Go and talk to the fund manager — get them to explain the framework to you,” says McKay.

“Go beyond disclosure and get into a discussion to find out if they are really doing what they say they are doing.”

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About Diana Zhou

Diana joined Pendal in 2022 as Pendal’s senior risk and compliance manager. She is responsible for the design, implementation and monitoring of risk and compliance frameworks across Pendal Australia.  

Diana has a strong interest in ESG and Responsible Investment. She represents Pendal in the FSC ESG and Risk & Compliance working groups.  Diana is a chartered accountant and a Level II candidate in the CFA program.

About Elise McKay and Pendal Australian share funds

Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

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

Contact a Pendal key account manager here