Market Insights and Education & Resources

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When rates start going up, how far will they go? It's a question Pendal's head of government bond strategies TIM HEXT has been thinking about a lot lately

WE have just released our latest Income and Fixed Interest Quarterly Report (contact a Pendal business manager for a copy) and I have spent my time recently questioning market pricing.

Right now nearly everyone is focused on the timing of RBA rate hikes versus market expectations.

The near-term performance of funds we manage is all about solving that one.

But the issue that's been occupying my mind -- and I write about in the Quarterly -- is the long-term question of the terminal rate of a hiking cycle.

In other words, when rates do start going up, how far will they go?

I think rates will move up to 1.5% in 2023. Inflation will peak around 3% in early 2023 before tapering off back to 2.5%, led by modest goods price deflation kicking in.

This will see the RBA happy to leave cash rates there for at least a year or more.



Consensus is that 1.5% cash rates will see out the rate-hike cycle. The logic is that a 2% rise in mortgage rates would hit the economy hard.

But as the decade unfolds and investment remains strong, real yields could move modestly positive once more.

That would mean cash rates closer to 2.5% than 1.5% and bond rates nearer 3% than 2%.

I doubt markets will factor this in for some time, but it's a risk to consider for long-term asset allocators.

Of course in the meantime -- with cash stuck near zero -- it is expensive to be too underweight fixed interest.

Now rates have backed up, fixed interest is once again playing its part as a defensive asset.

For those of us managing portfolios, we must play the short term while keeping in mind the medium term.

We'll leave long term to the custodians of superannuation funds whose time horizons allow for it.


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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 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.

“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.”


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.

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CHINA’S property-led economic slowdown shows no sign of ending. In this week’s The Point podcast, Pendal portfolio manager Amy Xie Patrick explains what that means for Australian investors:

An excerpt from this podcast

“The market assumes the Chinese government won't let the Chinese economy fall below 5 per cent growth. But I think the pain threshold is lower this time.

“Normally, that’s really bad news for the Australian economy. But Australia’s reliance on resource exports has gotten a lot more muted, especially with respect to China.

“For investors, it means you need to be a lot more region specific when looking at your portfolio construction, especially for a fixed income portfolio.”

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What's the role of fixed income in portfolios right now? Here's a quick snapshot from Pendal's head of income strategies AMY XIE PATRICK

IT'S been a tough year for fixed income.

Fuelled by bouts of inflation tantrum, a rise in yields drove one-year total returns on most major fixed income benchmarks into the red by early November.

Only high-yield benchmarks delivered positive returns — mostly due to the recovery of credit spreads that took place at the start of the year.

Though this doesn’t help the average fixed income allocation much, since the risk-and-return profile of global junk debt is more akin to equities than fixed income.

The market currently out-hawks all central banks, pricing in a steeper path of normalisation than policy makers are willing to concede.

As you can see in the below chart, since the end of September the market has doubled its expectation around the pace of rate hikes in Australia.

That leaves a decent buffer for central banks to get “pulled-to-market” if they are wrong — and a lot of room for yields to fall if they are right.

Such a steep path of rate hike expectations leave little room for error. The latest Omicron Covid variant is a case in point.

Let’s also not forget the efficiency of markets that run ahead of hiking cycles.

From 2004 to 2006, Alan Greenspan’s Fed raised policy rates by 425bps. Over the same period, yields on US 10-year Treasuries rose a mere 33bps.

Any hiking cycle now would be hard pushed to even match half of Greenspan’s pace.

Even with inflation still rising, fixed income has an important role to play.

Its negative correlation to equity markets delivered a poor return outcome for the asset class in 2021.

But overall,  portfolios have benefited from the tear that risk assets have been on.

In times of market stress that negative correlation will prove invaluable.

Compared to a year ago, 10-year government bonds in Australia now provide 85bps more yield.

There is now a fatter cushion to absorb any macro stumbling blocks lurking on the horizon.

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Pendal’s head of equities Crispin Murray and his team have access to Omicron analysis from a variety of leading virologists and epidemiologists. Here are Crispin’s observations so far.

NEAR TERM, the emergence of Omicron is concerning because the sheer number of variations in the virus — notably the spike protein which the vaccines target — are very likely to render vaccines less effective in preventing the spread of the virus.

The Moderna CEO said as much in the Financial Times this week.

The transmissibility of Omicron is likely to be greater than previous variants, but it is still unclear to what extent.

Although the number of reported cases in South Africa has accelerated far faster than Delta, it’s unknown how long the variant was already seeded in the community or subject to super-spreading events.

The datasets are still too small to be more definitive.

We believe comments that Omicron may be less virulent — that it will lead to fewer hospitalisations — are premature.

This view is based on observations in South Africa rather than data from a trial. It can be influenced by a variety of factors such as age and the number of previous infections a patient person has had.

Mitigating this uncertainty are a number of observations:

1.  Thanks to South African scientists we've identified this variant at an earlier phase than Delta. This limits the level of seeding in other countries, containing the spread and buying time for a scientific response

2.  While vaccines may no longer be as effective in stopping transmissibility, there is a reasonable expectation they will continue to be effective in lessening the effects of the virus through the response of B and T cells — which play an important role in our body’s Covid defence system

3.  The advent of anti-viral medicines should reduce the health consequences of those infected

4.  The impact of each subsequent wave has been less material on the economy as responses become more targeted and people become more attuned to the risks

5.  We are seeing accelerating economic momentum globally. This is different to what we saw when the Delta wave began to emerge in May and June.

Corporate responses to date have been along similar lines: they will wait until we have more data and a better understanding before taking any potential responses to the new variant.

What if current vaccines prove to be ineffective against Omicron?

The mRNA suppliers say they have already been working on new versions of the vaccine.

They indicate it could take 100 days to develop an Omicron vaccine -- and about six months to become available at a mass level, subject to regulatory approvals.


About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

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

Find out more about Pendal Focus Australian Share Fund here.  

Contact a Pendal key account manager here.

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The tight labour market demonstrates how ESG-related policies such as diversity and inclusion impact “real-world” business functions. Regnan's ALISON EWINGS explains

WHETHER it’s a Great Resignation, a reaction to pandemic lockdowns or the product of border closures and low migration, one thing is true: it is harder than ever to find staff.

If that sounds familiar, you've probably been considering a variety of ways to improve your success in recruitment.

You may not have considered how an Environmental, Social and Governance lens can help.

Earlier this year responsible investing leader Regnan published an investor’s guide to diversity, equity and inclusion (DEI) -- an ESG-related issue that's especially relevant right now for employers battling to attract candidates.

Consider, for example, that more than two-thirds of Australian financial planners are men -- but 60 per cent of graduates coming into the industry are women.

“The future of financial advice is absolutely female-led,” says Benjamin Marshan, Head of Policy, Strategy and Innovation at the Financial Planners Association.

DEI can help recruitment

What are recruitment’s best practices post-pandemic? How can you ensure you’re not inadvertently putting off potential candidates? How can you benefit from what a truly diverse workforce can offer?

A well-considered diversity, equity and inclusion program can help, says Regnan's Alison Ewings, a co-author of the Beyond Diversity report.

Employers can improve their hiring practices by rethinking the process end to end -- from job descriptions and competencies through to the advertising process, candidate selection and interview, says Ewings, who leads Regnan's program of ESG engagement with ASX-listed companies.

“Minor tweaks can change the pipeline of applicants dramatically.”

Diversity in hiring matters. It widens the pool of candidates available for a role and so can help avoid inflating labour costs by artificially narrowing the number of applicants.

And when coupled with an inclusive and equitable work environment, it also drives improved business performance by harnessing new ideas and perspectives.

But much of the traditional hiring process can get in the way of hiring for diversity.

Take care with language

“The starting point is the job description and advertisement itself. You need to think quite carefully about what competencies are really required to do the job well,” Ewings says.

“Even in our own team, we drafted a job advertisement recently where we initially included a requirement for ‘superior project management’.

“That sounds like they need a formal qualification or have done major projects -- but what we were really looking for was someone who’s highly organised.”

Careful use of language can broaden the pool of applicants.

A study of 4000 job ads found that women were put off from applying for jobs that used wording associated with masculine stereotypes such as ‘aggressive’, ‘ambitious’ or ‘persistent’,” she says.

Significantly, women did not consciously note the language or realise it was having this impact and when asked why they did not apply for a role, they cited personal reasons.

“It’s similar with imagery. Who you show in photos of your workforce can be a natural screen for people that they aren't even aware of.”

Rethink the interview process

Ewings also suggests rethinking the interview process itself.

“Not many job roles require someone to be good at being interviewed,” she says, saying some employers are now using a task-based approach for hiring that checks whether people can actually perform a role’s functions rather than whether they can perform well in an interview.

“It often started as a diversity, equity and inclusion initiative, for instance to recruit people on the autism spectrum who may not interview well. But in fact, they discovered it’s a better predictor of job performance in many roles across all hires,” she says.

Where interviews are the best way to screen people or as used as a final check in the process, Ewings suggests ensuring the same questions are used in the same order and that interview panels themselves are diverse.

“You’re trying to sell the job and build rapport, so you don’t want to be too dogmatic about it, but there’s a balance — you need to be able to look back and evaluate each candidate against what you’re looking for.”

She also says the interview question themselves need to be linked to the role’s competencies.

“You’ve got to benchmark the questions you ask back to the requirements of the job. It’s not just a matter of going for coffee with someone for a general chat.”

And what about de-identifying resumes to avoid bias in the recruiting process?

That can be a good idea, says Ewings, but it depends on your objective.

“If you set a target of having shortlists with a specific percentage of, say, women or people from multi-cultural backgrounds, then de-identification won’t help.”

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When rates start going up, how far will they go? It's a question Pendal's head of government bond strategies TIM HEXT has been thinking about a lot lately

WE have just released our latest Income and Fixed Interest Quarterly Report (contact a Pendal business manager for a copy) and I have spent my time recently questioning market pricing.

Right now nearly everyone is focused on the timing of RBA rate hikes versus market expectations.

The near-term performance of funds we manage is all about solving that one.

But the issue that's been occupying my mind -- and I write about in the Quarterly -- is the long-term question of the terminal rate of a hiking cycle.

In other words, when rates do start going up, how far will they go?

I think rates will move up to 1.5% in 2023. Inflation will peak around 3% in early 2023 before tapering off back to 2.5%, led by modest goods price deflation kicking in.

This will see the RBA happy to leave cash rates there for at least a year or more.



Consensus is that 1.5% cash rates will see out the rate-hike cycle. The logic is that a 2% rise in mortgage rates would hit the economy hard.

But as the decade unfolds and investment remains strong, real yields could move modestly positive once more.

That would mean cash rates closer to 2.5% than 1.5% and bond rates nearer 3% than 2%.

I doubt markets will factor this in for some time, but it's a risk to consider for long-term asset allocators.

Of course in the meantime -- with cash stuck near zero -- it is expensive to be too underweight fixed interest.

Now rates have backed up, fixed interest is once again playing its part as a defensive asset.

For those of us managing portfolios, we must play the short term while keeping in mind the medium term.

We'll leave long term to the custodians of superannuation funds whose time horizons allow for it.


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