The Point

What the Reserve Bank’s 0.5% rate rise means for investors

After this week’s higher-than-expected rate rise, will we see a cash rate close to 3% by the end of 2022?

“The cash rate has been held too low for too long and the RBA is behind the curve,” says Pendal’s head of cash strategies Steve Campbell.

“They are moving more quickly to get closer to neutral. I view 50 basis points next month as more probable than 25.”

Are markets right about a cash rate closer to 3% by year’s end? “Market pricing is aggressive, but at the moment I wouldn’t rule anything out,” Steve says.

Markets are looking for another 3% of rate hikes in the next 12 months — but is the economy ready?

“The RBA tried to imply the economy would be resilient. But the tide is now going out.

“The first 1.5% of hikes will see belt-tightening, but probably no more. However the next 1.5% could see actual stress, especially in housing.

“This is an experiment the RBA hasn’t undertaken for more than a decade — and risks of a policy error are rising.”

Michael Blayney: which asset classes look good now

It isn’t an easy market to invest in, but there are opportunities if you know where to look. We asked Pendal’s Multi-Asset chief Michael Blayney for his view on different asset classes.

Many key equity markets remain overvalued despite the recent sell-off, says Michael. Rising bond yields are also weighing on equity valuation.

Michael likes good value markets such as the UK and Japan “and rotational themes such as value/small cap”.

High yield debt offers limited reward for risk though the recent increase in investment grade spreads mean decent returns on a medium-term basis.

Government bond yields now are better value, but bonds face a significant headwind from inflation.

The maturing cycle and event risks suggest a defensive risk stance, Michael says.

“Cash and alternatives with inflation linkage such as commodities and ‘value exposures’ are preferred.”

Michael Blayney: Three investing rules for turbulent times

Emotion can overwhelm strategy when markets are volatile. Pendal’s multi-asset chief Michael Blayney has three simple rules to remember in times like these:

1. Don’t Panic: A well thought-out and documented philosophy and process is crucial to any active decision making during volatility. This helps you stay disciplined despite the noise. It’s easy to get swayed by emotion, or worse still, enter a crisis at a risk level that wasn’t right for you to begin with.
2. Look for opportunities, but at least rebalance: Disciplined rebalancing adds to returns and reduces risk over time, compared to letting a portfolio run.
3. Diversification Matters: Diversified investors know there’s always going to be some part of their portfolio that’s not working as well as others. Then the cycle turns and they need that part of the portfolio. That cycle can take a decade so an investor must be able to cope emotionally with an underperforming asset for a period. Always include enough liquidity (cash) for your short-term needs. You never want to be a forced seller.

What this week’s rate rise means for cash investors

The cash rate now looks like it will be closer to 1.75% by the end of 2022 after this week’s jump to 0.35%.

“It’s better times ahead for cash investors, though the speed of the move has not been without some pain,” says our head of cash strategies Steve Campbell.

Six-month yields are now likely to sit closer to 1.65%, up from 1.48%, says Steve.

“Those sitting in term deposits may enjoy having their deposits valued at par — but they are accruing at a much lower rate than other opportunities in the market.”

Investors should be wary of short-dated TDs.

“First and foremost cash should be there to provide liquidity while preserving capital. TDs are great at preserving capital. But liquidity? It’s almost quicker to sell a house than wait for TDs to mature.

“I expect we’ll see more volatility, even by cash fund standards in the coming months.

“Short-dated, highly liquid assets will quickly reflect the changes that the RBA will deliver in the coming months. It’s why I think our Pendal Stable Cash Plus Fund is well placed in this environment.”

How to talk to sustainable investors about high oil and gas prices

Investors are understandably asking if there’s a long-term cost to sustainable investing when oil is trading above $US100 a barrel.

But sustainable portfolios will deliver better outcomes in the long term, argues Pendal’s Head of Multi-Asset Michael Blayney.

“The short answer is we don’t expect to get worse returns from sustainability over the long term.

“Indeed, we expect to get better long-run outcomes from sustainable portfolios. But you will see greater variation relative to a benchmark in certain types of environments.”

In environments like these, portfolio construction takes on even greater importance, says Michael.

“If your sustainability strategy gives you a slight growth bias then you might want to look for investments that also give you a value bias, for example in your alternatives.

“You might also actively seek out a bit of energy price exposure and inflation hedging via commodity futures or certain types of renewable energy infrastructure.”

What to do when traditional diversification doesn’t work

How to diversify when equities and bonds sell off at the same time?

“The world is now a much more difficult place to find diversification and that’s really the theme of the year,” says Pendal’s Head of Multi-Asset Michael Blayney.

“Normal ways of diversifying aren’t really working at present.

“When you get higher inflation, you tend to see bonds and equities correlate more positively. While bonds still have an important role in portfolios, investors need to think about other sources of diversification,” Michael says.

Getting exposure to commodities has been a successful diversification strategy, he says. Be active in your asset allocation to try to control risk and improve overall return outcomes.

Corporate debt can also provide opportunities with spreads in the US (the difference between yields on government and corporate bonds) around 1.4%.

And holding funds in cash to take advantage of opportunities is important.

Alan Polley: Time to rethink the role of cash in portfolios

It’s time to rethink the role of cash says Alan Polley, a manager with Pendal’s multi-asset team.

“Cash as an asset class has been poor, but with rates expected to normalise due to inflation, cash yields are going to go up,” Alan says.

“Cash as an asset class will start to become more attractive than in the recent past. It’s a reflection of inflation expectations and inflation going up. When prices are rising, cash can be a bit of an inflation hedge.

“Looking forward, it should play more of a role in a balanced portfolio because inflation is going up.”

When to move?

“Investors don’t have to do this right now. But over the next year or two cash is going to become relatively more attractive compared to the past few years. People should start thinking about that now and get themselves set up.”