Despite recent volatility the fundamentals of investment in European equities haven’t changed much says Pendal Group’s Clive Beagles

• Investors in Europe must not panic.
• Long term fundamentals remain sound.
• Pricing of some stocks, due to the conflict, is irrational.

Clive Beagles has a message for investors in Europe: don’t panic.

The war in Ukraine is a human tragedy and has immediate implications for many commodities, says the senior fund manager from Pendal’s UK-based J O Hambro asset manager.

But considered long-term investment strategies remain sound.

It’s a particularly pertinent message given the rotation that had been going on since the middle of last year from large, tech-focused growth companies (often on Wall Street) to value stocks.

“For many years people wanted to invest in mega caps and growth stocks and not much else,” Beagles says. “And then late last year and into this year investors got the point of thinking about something else.”

European and UK markets, particularly banks, become attractive to what Beagles describes as “slightly lower conviction” investors. They were prepared to buy into European equities, but not with gusto.

Then came Russia’s unprovoked invasion of Ukraine and those slightly-lower-conviction investors pulled back on European and UK stocks.

Broadly, the more a stock is invested in Europe — or relies on energy, or is a bank or a consumer staple relying on customers that feel the effect of higher gas prices — the more the share prices fall have been, Beagles says.

And the reaction to perceived bad news has triggered big declines.

“Interest rates are still going up and the fundamentals of the story haven’t really changed much. Investors need to remember that,” Beagles says.

“Going back a month, the UK and Europe were much cheaper than their US counterparts in comparable sectors. And that has been accentuated in the past few weeks.

“What’s happening is a human tragedy. In economic terms, outside some commodities like wheat and wool and coal, the main impact is on business confidence. And, of course, there’s more short-term uncertainty.

“While it’s right to think that economic growth across Europe might be 100 basis points lower, the region is still expanding.”

The pricing of some equities in Europe and the UK is now verging on the absurd, Beagles says.

He uses the example of British free-to-air television network ITV. It recently reported 24 per cent growth in revenue to a record level, a 40 per cent jump in earnings per share, and said the current year has started strongly.

It’s share price dropped 27 per cent on the day of the announcement, with investors focused on the costs associated with the acceleration of ITV’s digital transformation strategy.

“Obviously investors are concerned that future economic growth and business confidence may be materially impacted by events in Ukraine. But going through the numbers the share price drop is absurd,” Beagles says.

If you look at the UK specifically the market has a relatively high weighting to oil and mining, and commodity prices are up, Beagles points out.

“Assuming we get a couple of rate rises, many companies in Europe and the UK will get back to getting a return on equity of about 10 per cent. You’d normally expect them to be trading at least at book value, and many, such as UK banks, are not. Absurd.”

About Clive Beagles

Clive Beagles is a senior fund manager with Pendal Group’s UK-based asset manager, J O Hambro Capital Management. Clive is one of the UK’s most highly respected equity income managers. He has 32 years of industry experience and co-manages the JOHCM UK Equity Income Fund.

About Pendal Group

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

Find out about Pendal’s investment strategies

Contact a Pendal key account manager

Greater employee power and digitalisation are two pandemic trends that will endure to shape the investment landscape in 2022. CLIVE BEAGLES explains

• Covid has forced many companies to catch up with digitalisation
• The best have adapted and created new opportunities
• Wage pressures will eat into some earnings in 2022

THE pandemic has breathed new life into some sectors of the economy that otherwise would have been swamped by technological change — and that could open opportunities for investors.

The pandemic forced some old-world industries to ramp up their digitalisation – the use of technology to provide new revenue and value-producing opportunities.

These enhancements will have long lasting benefits says Clive Beagles, a senior fund manager who focuses on equity income at Pendal Group’s UK-based asset manager JO Hambro Capital Management.

“There were some sectors that pre-Covid were structurally compromised, and their outlooks weren’t positive, Beagles says. “But that’s transformed during the pandemic and emerged as part of the vanguard of the recovery.

“Everyone talks about Covid accelerating ten years of change — and that’s helped some of these industries.”

Some old-economy industries will emerge from the pandemic in much stronger shape than where they started.

“They haven’t exactly reinvented themselves, but they have reacted in a meaningful and agile way.

“Yet some of them are still being valued as if they’ll have declining profits and at some point will become terminal.”

Beagles nominates recruitment and advertising-reliant industries as sectors that will emerge from the pandemic in 2022 in better shape than when Covid hit.

Two examples in the United Kingdom are broadcaster ITV and recruiter Michael Page.

“In the case of media and particularly broadcast TV, the ability to provide much greater data on audiences and who is being reached provides the medium with a whole new selling point,” Beagles says.

“In the case of recruiters, they’ve used the pandemic time to go digital, and there’s strong demand for labour.”  

Greater employee power

Another big change for firms and earnings in 2022, Beagles says, is the emergence of employee power. Because of the strong demand for labour, workers can demand more.

“It’s still some way out but it could eventually be one of the biggest changes in the past 20 years, because for the last two decades all the power has been with employers,” Beagles says.

“There will be sectors where the employees will become much more strategic. We know about medical staff but also areas which weren’t considered strategic before like HGV (heavy goods vehicles) drivers.”

Labour pressures – there’s 1.4 million people unemployed in the United Kingdom currently and 1.2 million job vacancies – will put pressure on prices, and that will eat into earnings in some sectors.

“Twenty-twenty-two is only about the second or third innings, to use a baseball analogy, of a longer change period. It has a way to go and the rotation in markets in 2022 should be quite powerful.”

About Clive Beagles

Clive Beagles is a senior fund manager with Pendal Group’s UK-based asset manager, J O Hambro Capital Management. Clive is one of the UK’s most highly respected equity income managers. He has 32 years of industry experience and co-manages the JOHCM UK Equity Income Fund.

About Pendal Group

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

Find out about Pendal’s investment strategies

Contact a Pendal key account manager

There’ll be a lot of talk at this month’s climate change conference in Glasgow. Pendal’s MURRAY ACKMAN explains what Australian investors should pay attention to

IN TWO WEEKS world leaders — maybe even our ScoMo — will fly to Glasgow for the 26th UN Climate Change Conference of the Parties (or “COP26”).

There will be a lot of talk — but Australian investors should watch a few things closely, says Pendal Credit ESG analyst Murray Ackman.

“This is not your typical gab-fest,” says Ackman.

“The pressure on countries to act is very real as we’ve seen recently with the Morrison government’s turnaround on a 2050 emissions target.”

Murray says Aussie investors should pay attention to three things:

1. End to coal power

Coal accounts for about half of energy-related CO2 emissions and will have to be phased out to reach net zero emissions by 2050. Many are pushing for this COP to include a commitment on ending coal power.

Increasing uptake of renewables in Australia is coinciding with reduced coal use — but we still export a lot of coal.

Businesses that produce coal (eg Whitehaven), transport it (eg Aurizon) or ship it (eg Port of Newcastle) would be severely impacted by a global decision to phase out coal, Murray says.

2. Australia as a pariah

New national targets to cut greenhouse emissions by 2030 will be announced at Glasgow — as required under the Paris Agreement.

Many developed countries have already flagged stronger targets.

But Australia has been without a substantial climate policy for nearly a decade — which could start to cause problems for us, says Ackman.

“The carbon intensity of an economy may be a differentiator for future investments.

“We’ve already seen some investors avoid businesses and government bonds due to a perceived weakness in climate policy.

“They’re now known as ‘brown markets’ as opposed to ‘green markets’.

“If Australia’s national targets are not regarded as ambitious enough, this divestment trend may continue.”

3. Investment opportunities

A faster shift away from fossil fuels presents obvious challenges for Australia, since they relate to a quarter of our exports.

But change can also lead to significant opportunities.

“There is a very clear path to reduce Australia’s domestic emissions which will require substantial infrastructure investment,” says Murray.

“There will be a lot of spending on the electricity supply of the future with transmission lines, interconnectors and energy storage.

“There are also opportunities for export, whether that’s green hydrogen (produced by renewables), minerals required for electric vehicle batteries and even copper.”

The RBA’s Melbourne Cup day meeting will be closely watched after Wednesday’s inflation numbers. TIM HEXT explains why.

IN AUSTRALIA we only get inflation data quarterly, so the number is keenly anticipated.

For the inflation hawks Wednesday didn’t disappoint. For the RBA it looks like a decade of over-estimating inflation has now moved to a new decade of under-estimating.

The headline inflation number was on forecast at 0.8% for the quarter and 3% annually. However it was the underlying number that shows a more concerning picture.

Underlying inflation strips out the top and bottom 15% of moves, usually including fuel and food. Here the number was 0.7% for the quarter.  This is the highest since 2014.

While that is only 2.1% annually, markets will usually annualise the latest quarter to get a more current read.

Of course 0.7% means 2.8% — above the RBA target.

Looking under the hood a number of factors were at play.

Fuel prices were up 7%.  We knew that already but  they have gone up further in October.

New dwelling purchase prices, or building costs, are losing the dampening effect of Homebuilder subsidies. These costs had risen around 5% over the last year but until now this was offset by the subsidy.

Property rates were also up 3%.  Household items, usually flat or down, were up 3 to 4%. Maybe its transitory but time will tell.

The RBA next meets on Melbourne Cup day. What could have been a “nothing to see here” pre-race statement will be keenly watched.

Three days later the Statement on Monetary Policy comes out which will provide their updated forecasts.

No doubt the RBA will play down the impact of one number but inflation is already above their forecast for 2022.

Some upgrades will be required. The confidence in their “no rate rise till 2024” outlook will either be toned down or removed. It will be a step too far for now for 2022 to be in play for rate rises but surely 2023 should be.

In terms of their current policy actions there will be no changes for now. However Quantitative Easing is reviewed in February, before which we will have the Q4 CPI print.

Also, whether they keep the April 2024 bond at Yield Curve Control at 0.1% is debateable. They can change that any time and given they actually have to put their money where their mouth is with that policy, it may be reviewed sooner.

Overall we continue to hold inflation bonds in portfolios where we can and will continue to do so until the market prices in 2.5% inflation.

After these numbers that day is getting closer.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

It looks like investors believe the RBA is wrong on its inflation outlook — and they could be right, says Pendal’s Tim Hext

MARKETS and most central banks have spent most of October talking about higher inflation and potential or actual rate hikes.

The RBNZ hiked in early October (delayed from August). The Bank of England looks like moving soon. The US Fed have signalled likely hikes in H2 2022.

Only the RBA is holding their line from earlier in the year — they see no need to hike until 2024. Inflation may creep higher but they don’t see it hitting their 2.5 per cent target until 2024.

Usually on the hawkish end of the spectrum, the new RBA is firmly down the dovish end.

So which market has seen the biggest move higher in five-year bond yields over the last month?   

Australia.

Even this week the RBA did not change sentiment in their minutes. I suspect they are even more perplexed by recent moves than us.

Whenever things like this happen we try and find a rational explanation. Often it isn’t rational but here goes.

The first one is duration positioning, which was longer in Australia than others because of RBA rhetoric. Painful stops have been apparent.

The second one is the market thinks the RBA will revert to previous modus operandi and hike before inflation reaches its target.

This would be wrong. The RBA knows its credibility is on the line and Governor Lowe has been at pains to say there will be nothing pre-emptive this cycle.

For economic reasons the only explanation may be that the market thinks the RBA is wrong on its inflation outlook.

On this one I agree. I think inflation will hit their target in 2022 and hikes will follow in early 2023.

On our portfolios we remain overweight inflation bonds where we can.

We have covered duration shorts and current levels leave us considering whether there is value in short-end yields.

Long-end yields however will need to see 2% before we ask the same question.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

AT THE END of September we were trying to understand market pricing versus what the Reserve Bank was saying.

Governor Lowe had been at pains to say the RBA would not hike rates until inflation was sustainably at its 2.5% target.

Yet markets were pricing for higher rates, while expecting inflation at only 2%.

Unless your view is Governor Lowe will change his mind, something must be wrong. Given his term is up in September 2023, an about-face is not likely.

The question is whether rate rise expectations are too high or inflation expectations too low?

How will the circle be squared?

As mentioned many times before, our view is inflation will rise to 2.5% in late 2022 and into 2023 — so we expect higher rates in 2023.

We also own inflation bonds against being underweight in nominal bonds (in portfolios where they are allowed).

Of course it pays to remind investors that a nominal yield is made up of a real yield and inflation.

A fixed rate bond “fixes” a level on both of these. An inflation bond fixes the real yield but the inflation component is floating — that is, actual inflation.

So the higher inflation goes, the more inflation bonds outperform nominal bonds.

This past week has seen bonds continue their sell-off on global inflation fears.

Expectations are now for cash rates to hit 1% in 2023, consistent with our view. We have closed underweight duration positions but will be leaving our inflation bond position on for now.

Equity markets and credit markets continue to adjust to a world of lower monetary support. So far moves have been modest and largely well behaved, consistent with a relatively smooth transition.

If we are right and inflation moves modestly higher it won’t upset the overall positive outlook for risk markets.

Maybe what’s happening is markets are beginning to price a risk, albeit a low one, for a world where inflation pushes far higher than 3%.

Stagflation always gets wheeled out at these times.

There is a chance of short-term stagflation on supply issues, but it is certainly not our medium-term base case.

Just don’t expect double-digit returns on risk assets going forward.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

Here are the main factors driving the ASX this week according to Pendal investment analyst GRAEME PETRONI. Reported by investment specialist Chris Adams

• The Fed and BoE cut rates by 25bps, the RBA remains unchanged
• Economists modelling various scenarios for Trump’s policies
• Find out about Pendal Focus Australian Share Fund

IT was a big week for markets following the US election.

The S&P 500 rose 4.69% on pro-growth policies around tax cuts and deregulation.

Bond markets stabilised after sharp moves higher in the lead up to the election, with the outcome suggesting a lower trajectory for US rates.

Trade tensions dragged on Europe, while China benefited from optimism in the lead up to the NPC meeting, which ultimately failed to deliver on expectations.

The Australian market echoed the US with respect to financials, tech and cyclical industrials outperforming, while taking a more cautious approach to resources – with the S&P/ASX 300 closing the week up 2.23%.

While macro moves dominated, there was a fair amount of news flow, particularly from bank reporting season.

Banks reported solid results but without any further follow through on the positive thematics that had been building around margins and balance sheet.

US election

The US election is widely regarded as having been won on the economy. The catch cry “are you better off than you were four years ago?” clearly resonated.

It looks likely to be a clean sweep of the popular vote, electoral college, Senate and House, potentially giving Trump a mandate for reform. However, the House is close and the Senate lead is slim, which may put some constraints on passing legislation.

Trump talked about some big policies throughout his campaign, like a significant lift in tariffs (50-60% on China, 10-20% rest of world), tight immigration controls (15-20 million deportations) and lower taxes (extend 2017 cuts, no taxes on social security, overtime and tips).

But in his post-election speech, there was no mention of tariffs or China and references to immigration were dialled down (“we’re going to have to let people come into our country… but they have to come in legally”).

This illustrates significant uncertainty on the extent to which Trump’s campaign policies are implemented.

Economists have modelled various scenarios.

If tariffs are limited to 20% for China and 5% for the rest of world, and if net migration only moderates to 500,000 per annum, the inflationary impact is contained to 0.5 percentage points (ppt).

There is also a negative growth impact, but this would potentially be offset by taxes and deregulation.

The end outcome for the Federal Reserve (the Fed) is estimated to be two to three fewer cuts in 2025, potentially implying US cash rates don’t fall much below 4%.

However, this will depend on the degree to which campaign policies are pursued.

The directional impact of Trump policies is clear: bad for bonds, supportive for equities (at least in the near term), some volatility risks, positive for financials, and negative for property, resources and US homebuilders.

Markets have moved a long way in a short space of time and there are still a lot of unknowns to play out.

US interest rates

The Fed played a straight bat, continuing with a 25-basis-point (bp) rate cut (4.50%-4.75%) and making only minor changes to statement wording.

In response to questions about post-election policy impacts, Chairman Powell made it clear that the Fed would not pre-empt changes, saying “we don’t guess, we don’t speculate, and we don’t assume”.

On the outlook, Powell noted that the labour market had cooled and that the Fed was alert to any further deterioration.

There was also confidence expressed that inflation would reduce to target.

Against this, economic growth has been stronger than expected, and Powell said the Fed was starting to think about when to slow the pace of cuts.

This suggests consecutive cuts for now, slowing into 2025.

US economic data

US economic data remains reasonably strong, though there are some mixed signals for the labour market:

Initial jobless claims were benign, with 221k per consensus, continuing to moderate.

• The Michigan Consumer Sentiment Survey was published, covering the two weeks before the election. The index resumed its uptrend, lifting from 70.5 to 73.0 over the month (above consensus of 71.0). This was despite a 0.5 ppt dip in current conditions to 64.4 – more than offset by a surge in expectations to 78.5.

• The ISM Services Index lifted from 54.9 in September to 56.0 in October, which was above consensus of 53.8 and could suggest a pickup in the economy. However, the index appears more consistent with stability in Services spend rather than an acceleration. And within the ISM Services data, the price paid index remains supportive of a moderation in inflation.

• Non-farm productivity increased 2.2% (annualised) in the third quarter. This slightly missed consensus of 2.5% but the prior history was revised up, pointing to strong post-Covid productivity gains. Within the data, unit labour costs increased 1.9% (annualised) in the quarter, which is a potential concern for inflation. But the index has tended to be heavily revised over time and other indicators point to a softening of the labour market.

• Initial jobless claims were benign, with 221k per consensus, continuing to moderate.

UK interest rates

As widely expected, the Bank of England Monetary Policy Committee cut the official rate 25bp to 4.75%.

Growth and inflation forecasts for 2025 lifted sharply following the UK Budget.

While guidance was retained for a gradual approach to policy easing, this is now subject to “evolving data” rather than “absent material developments”.

This suggests a pause in December and modest pace of cuts through 2025.

However, trade tensions could pose a risk to growth and increase the case for cuts over the course of 2025.

Australian interest rates

The RBA left the cash rate unchanged at 4.35% (in line with consensus) and made minimal changes to its outlook.

From the RBA’s perspective, restrictive policy settings are having their intended effect, with inflation moderating.

Household consumption has slowed, but with an offset from public spend.

The RBA made the point that local rates had never risen as much as in other developed countries, and even with cuts offshore (from the US, UK, EU, Canada, New Zealand), rates here remain less restrictive.

Reflecting this, it noted that inflation hasn’t moderated as sharply as offshore and labour markets remained relatively tight.

The market continues to debate when the local rate-cutting cycle will begin – whether early or mid-2025.

The RBA is not expecting inflation to reach the top of its band until late 2025, with the middle to be reached in late 2026.

But there is potential for US tariffs on China to have a negative flow through domestically, depending on China’s response.

China policy

If the US imposed the full 60% tariff on China, the impact to China is estimated at -2ppt of GDP.

This would fall to sub -0.5ppt in the event of a 20% tariff, with the potential for this to be offset by currency depreciation and fiscal policies. However, we have yet to see a fiscal response.

On Friday, the National People’s Congress (NPC) Standing Committee announced a RMB 10 trillion increase in the local government debt resolution over the next four years.

This should reduce local government interest costs and gradually improve infrastructure investment.

But there was nothing on the RMB 2 trillion worth of fiscal initiatives that had been speculated on in the press to cover bank recapitalisation and stimulate consumption.

Perhaps this is not surprising; the NPC is designed to approve pre-proposed policies – not launch new ones.

Policymakers will review fiscal budgets at the Economic Work Conference in December. Any announcement would then be communicated at the Two Sessions meetings in March 2025.

Given domestic weakness, in addition to any export threats, there is clear pressure to act.

US reporting season

Some 84% of S&P 500 companies have reported, with the largest stock – Nvidia – yet to come.

The frequency of beats returned to a more normal 51%, down on recent quarters.

Consensus EPS revisions are also back to a more normal trend.

Typically, consensus is downgraded as the year progresses, which we’re starting to see again for the “S&P 493”, excluding the Mag 7 stocks.

By sector, tech and financials were among the better performers while real estate, materials and energy struggled.

Markets

Australian non-bank financials reacted more positively than banks to the US election result, given more direct earnings leverage.

Effectively, the election helped solidify a 60-80bp move in bonds, which had yet to be reflected in share prices.

Among the banks, ANZ and CBA fared slightly better as they previously had more to lose from a fall in cash rates, given ANZ’s unhedged exposure to US institutional deposits and CBA’s very profitable domestic deposit book.

As a sector, banks could yet benefit from a rotation away from resources given disappointment on China stimulus, but reporting season was not particularly inspiring.

Bank reporting

Heading into results, the market was looking for upside on margins and/or the balance sheet, but neither came through.

Core margins were flat to down slightly, with guidance for similar outcomes given the ongoing mix shift in business deposits and emerging mortgage competition.

Credit quality deteriorated, most notably for NAB, where provisions are now being released to offset problem loans instead of being released to profits, as was hoped.

Capital initiatives were piecemeal, with sizeable buybacks appearing a 50/50 proposition given stretched payout ratios and the limit now being reached on optimisation initiatives.

Overall, there was nothing untoward, but no bottom-up catalysts for further sector outperformance.

 

Some Chinese stocks are looking good value. But you need to think differently about value investing in emerging markets explains PAUL WIMBORNE

• Important catalysts to realise value are missing in China
• Value in emerging markets should be assessed differently
• Find out about Pendal Global Emerging Markets Opportunities fund

ARE Chinese stocks good value?

“It’s a question we’re getting asked by a lot of clients,” says Pendal’s Paul Wimborne.

The MSCI China index has halved since its peak in February 2021. Falls of that magnitude in developed markets soon attract bargain hunting buyers that sow the seeds of the next bull market.

But does the same thesis hold for China?

“The answer to that question at the moment is no,” says Wimborne, co-manager of Pendal Global Emerging Market Opportunities Fund.

“The reason for that is we think value in emerging markets should be assessed very differently than in the developed world.”

A value stock is one that trades at an attractive price relative to fundamentals like its earnings, dividends or assets.

Many Chinese stocks appear to fit the bill, including internet leader Alibaba and telecommunications giant China Mobile.

Both are trading at single-digit price earnings ratios with strong balance sheets and good quality earnings.

But the appearance of value is only part of the investment story, says Wimborne says. Investors also need to be able to realise that value.

Three catalysts for realising value

“In the developed world, you have three strong catalysts for the realisation of shareholder value:

• Strong corporate governance
• Minority shareholder rights, and
• Entrenched culture of merger and acquisition activity

“These catalysts ensure the realisation of value when a company’s shares are not doing well.

“In the emerging world, we think these catalysts are often lacking.”

Alibaba — once a popular and strongly performing stock for western investors — is a prime example of how value can be illusive, says Wimborne.

“For starters, foreign entities are not allowed to own Chinese internet businesses, so Alibaba has to have this strange ownership structure — a variable interest entity, where shareholders have economic but not legal control.

“Management can decide what they want to do with the business and minority shareholders have no way of exerting any control or influence over what management does with free cash flow.

“The business throws off a lot of free cash flow, but we struggle to see how minorities will actually get hold of any of it.”

This is exacerbated by China’s closed capital account that stops money moving freely in and out of the country.

“Alibaba would need the permission of the Chinese government to be able to send that money offshore to foreign shareholders.

“We think it’s extremely unlikely that the Chinese government would approve significant dividend payments that would catalyse value for Alibaba.”

Wimborne says these concerns hold true for other emerging markets as well.

Take care in South Korea

“South Korea is another example where value has not worked well.

“Corporate governance is not well entrenched in South Korea.

“The family-run chaebol industrial conglomerates have had little consideration for other stakeholders — such as minority shareholders — in order to develop the economy over the past 60 or 70 years.

“It’s starting to improve at the margin, but minorities do not get treated as well as they should, relative to developed markets. As a result Korea trades at big discount to other emerging markets.”

Investors in emerging markets need to be aware of these kinds of local specifics and not simply apply western ideas to developing countries.

“The way we run our portfolios is very top-down, country-specific — looking at the country’s history, its economic outlook and its equity culture to determine where we think the potential returns will come from.

“Part of that is assessing each country’s corporate governance, its treatment of minority shareholders in general, and the culture of rewarding equity holders.”

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About Paul Wimborne and Pendal Global Emerging Markets Opportunities Fund

Paul Wimborne is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with James Syme and Ada Chan.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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

Indonesia seems to have the right natural resource endowment and policy mix to prosper, argues Pendal’s JAMES SYME

• Indonesia looks promising for EM investors
• Strong demographics support confidence
• Find out about Pendal Global Emerging Markets Opportunities fund

INDONESIAN equities could outperform over the next 18 months on the back of high commodity prices, strong domestic demographics and supportive monetary policy, says Pendal’s James Syme.

Emerging markets (EM) investors have faced tough going in 2022 as the once-booming Chinese economy slows and a rising US dollar draws capital away from developing economies.

But commodity-exporting economies have prospered.

Brazil, Mexico and the oil-rich Middle East have been this year’s standouts — and Indonesia is well-placed to join that list says Syme, who co-manages Pendal Global Emerging Markets Opportunities fund.

Pendal’s EM team follows a top-down, country-driven allocation strategy, analysing factors such as a country’s economic growth, monetary policy, market liquidity, currency, governance, politics and equity market valuation.

“Energy balance is a huge determinant of what happens to countries in 2022, says Syme.

“Indonesia is a very significant coal exporter. Coal was 17 per cent of all exports in the first half and coal prices have been extremely well bid globally.

“There’s been a shortfall of production and it’s a major substitute for oil and natural gas in electricity generation around the world, so Indonesia has benefited from both volumes and prices of coal.

“Indonesia is also a major oil and gas producer. A lot of that gets consumed domestically, but at the margin it’s an exporter as well.”

And it’s not just energy. Indonesia is a leading exporter of palm oil, which is in demand due to disruptions to the edible oil trade from the Russia-Ukraine war.

The south-east Asian nation is also a significant exporter of metal ores, principally nickel.

“So really across the board, we’ve seen strong drivers for Indonesian exports,” says Syme.

“As in Brazil, as in South Africa, as in Mexico, that underpins the terms of trade, it underpins the current account balance, and it enables growth to be stronger.”

An urbanising nation

Terms of trade — the ratio of export prices to import prices — is crucial to emerging markets where economic growth is chiefly funded through exports or foreign capital flows.

The higher US dollar in 2022 has made capital flows harder to come by but strong commodity prices have supported exporters.

Syme says Indonesia’s attractiveness goes beyond its status as a commodity exporter.

It is world’s fourth most populous country with 270 million people and is rapidly urbanising with a burgeoning middle class.

“Productivity and disposable incomes increase when people move from the countryside to the city,” says Syme.

“Indonesia has extremely attractive demographics in terms of both labour supply but also domestic demand.”

Policy is also supporting investment confidence.

Bank Indonesia, the country’s central bank, has considerable foreign exchange reserves and has successfully intervened to support the rupiah, which has kept a lid on inflation.

“It means that inflation is still below 6 per cent and although the central bank has been hiking, they haven’t had to do the big rate hikes that we’ve seen in some other parts of the world.

“It has been a difficult year for a lot of countries, but Indonesia seems to have the right natural resource endowment and policy mix to relatively prosper.”

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About James Syme and Pendal Global Emerging Markets Opportunities Fund

James Syme is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with Paul Wimborne.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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

Declines in emerging market stocks offer the potential for strong gains once the US rate rise cycle peaks, argues Pendal’s JAMES SYME

• Long-term Emerging Markets story remains intact
• Look to Latin America, South Africa, Southeast Asia, India
• Find out about Pendal Global Emerging Markets Opportunities fund

DECLINES in emerging market stocks over 2022 offer the potential for strong gains once the US Federal Reserve’s rate rise cycle peaks, says Pendal’s James Syme.

Emerging markets are down from their 2021 peak as tighter US monetary policy drives the US dollar higher, while a weak Chinese economy dampens global growth and geopolitical instability roils growth assets.

But investors that keep an eye out for signs the sell-off is ending could be rewarded with a strong rally, argues Syme, who co-manages Pendal’s Global Emerging Markets Opportunities fund.

“Over the long run, in US dollars, emerging markets equities return a significant premium to the developed markets,” says Syme.

“In pure financial theory terms, that’s the reward for the extra volatility it brings – excess return compensates for increased risk or reduced liquidity. Emerging markets are more volatile, but tend to have a higher reward over the longer run.”

This year’s decline, while significant, is smaller than past sell-offs in emerging markets, says Syme.

In the GFC of 2007-08 emerging market stocks fell 60 per cent, while the 1997-98 Asian financial crisis saw EM decline 58pc.

What’s driving Emerging Markets

Three main factors have driven this year’s declines, says Syme.

“The big one has been tightening of global liquidity and the end of quantatitive easing by central banks.

“Related to that is the huge rally in the US dollar. That means other currencies have been weaker, which causes a weaker price performance for EM shares in US dollars, but it’s also reflective of where capital is flowing.

“A strong dollar is an indicator of money flowing out of the rest of the world and into the US and that’s always going to be challenging for emerging markets.”

The second factor is weak Chinese growth amid Beijing’s zero-COVID policy and crackdown on the real estate sector.

“And the last part is a perception of increased global geopolitical risk with the Russia-Ukraine conflict and the colder China-US conflict.

“Those factors create the perception of a riskier environment for international investing in high-risk countries – it’s much easier to own some US treasuries.”

Signs to watch

Investors are watching for signs these three factors may be easing.

“What’s it going to take to end the sell-off and make EM equity attractive as an asset class again?

“One thing would be a change in direction from the US Federal Reserve and a weaker dollar.”

Faltering rallies in recent weeks indicate markets have been looking for that change in direction from the Fed and any suggestion the US economy is softening.

“We have certainly seen in other developed markets that central banks are starting to move away from tightening – we had a super-dovish quarter point hike from the RBA and emergency bond-buying from the Bank of England.”

An improvement in China’s economy could also mark the turning point for emerging markets.

“We’ve seen signs of shifts in China – credit growth is improving, and we’ve seen corporate borrowing starting to pick up.”

Ending the zero-COVID policy would also be a good sign.

“I don’t think that’s likely to come as a single announcement. But they are letting the Beijing marathon go ahead with 30,000 runners – that’s an interesting step forward.”

And finally, any signs of a change in the Russia-Ukraine war would be a potential positive.

EM countries to watch

When things turn around, investors should stick with the markets that have best weathered the downturn.

These include Latin America, South Africa, Southeast Asia and India, says Syme.

“Right now, there are parts of the asset class that are doing OK.

“The things you’d want to own when we get to the turn are the ones already winning.”

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About James Syme and Pendal Global Emerging Markets Opportunities Fund

James Syme is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with Paul Wimborne.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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