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Fixed interest: Check your ‘duration’ settings before inflation turns

Fixed interest investors should get their portfolio settings right now, before US inflation tops out and starts falling in the second half, says Pendal’s TIM HEXT

FEELING moody? It’s understandable says our head of government bond strategies Tim Hext.

Right now, US inflation reports are resetting the mood of investment markets every month, says Hext.

“The mood runs for about a month or so until the next set of numbers.

“Central bank officials in the US and Australia come out and express concern if the numbers are too high. Then they warn they’ll have to do a lot more.”

On the other hand, when inflation data is lower – like late last year in the United States – investors start thinking the rising interest rate cycle is nearer the end.

“We’re going to be in this environment for the first half of this year and we are going to be range-trading as the narrative goes backwards and forwards,” Hext explains.

But the uncertainty won’t last – and investors should be ready, says Hext.

“By the second half of the year, we are going to get a much clearer picture and we are going to see that inflation hasn’t just topped out but is coming down.

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Pendal’s Income and Fixed Interest funds

“Inflation could head back towards central bank target ranges faster than they think.”

Inflation to fall this year

Pendal’s income and fixed interest team estimates inflation will fall towards 4 per cent by the end of 2023. That compares to the Reserve Bank’s forecast of 4.75 per cent.

“The Reserve Bank is going to be pleasantly surprised by inflation,” Hext says.

“In this current March quarter, the number will still be higher because of utility charges, but then in the second, third and fourth quarters, there’s a chance we get readings below one per cent.”

Goods inflation is weakening, in large part because supply chain disruptions during COVID is broadly over. Services inflation continues – about two-thirds of the way through, Hext says. That’s why the inflation data remains elevated, and choppy.

“Investors will start believing the soft landing story,” Hext says, whereby the economy slows bringing inflation down, but doesn’t go into a recession.

“There is a risk though. Central banks might feel they haven’t done enough, particularly the US Federal Reserve.”

Hext believes there will be a couple more interest rate hikes in Australia in coming months, starting next week at the Reserve Bank board meeting.

As to how far the official cash rate set by the Reserve Bank goes, Hext says ten-year bond rates normally top out around the same level as the cash rates peaks.

“That’s where we are now. We are around about 385 basis points for ten-year bonds.

“The big message is that investors have a bit of time on their hands now, but things will start to move quite quickly by the middle of the year.

“So investors should be getting their duration sorted.”

That means checking the duration of your fixed income investments and their sensitivity to interest rate changes.

“Investors should be getting back to at least where their model portfolios tells them they need to be in the medium-to-long term.”

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.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal Group

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.

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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at March 1, 2023. PFSL is the responsible entity and issuer of units in the Pendal Monthly Income Plus Fund (ARSN: 137 707 996) and Pendal Dynamic Income Fund (ARSN: 622 750 734) (Funds). A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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