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Tim Hext: The case for inflation-linked bonds

Inflation should soon start to fall — but not as much as some expect. Inflation-linked bonds could be a good option, argues Pendal’s head of government bonds TIM HEXT

“The sun is shining, the weather is sweet, yeah|
Make you wanna move your dancing feet”

Bob Marley

A LONG overdue spell of warm and sunny weather has lifted spirits here in Sydney.

For the first time in three years everyone is out and about and looking forward to celebrating Christmas. Party invitations are issued and fingers are crossed on the health front.

However, the tone in markets is more sombre.

Cumulative central bank tightenings are starting to hit hip pockets and liquidity is worsening.

In simple terms a decade of low rates — and the associated investment structures built up around them — are starting to unravel. It’s increasingly looking partly structural not just cyclical.

This is what central banks intend to happen.

For years one of our major themes was the chase for yield. Now it is the chase for inflation protection — though too many remain stuck in the mindset of the last decade.

The ultimate aim of the superannuation industry should be to protect the spending power of their members —who defer consumption today for their retirement.

If the economy is productive, hopefully that money can grow a little faster than inflation to increase the standard of living.

A decade of low inflation and falling interest rates made that look easy. 

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Pendal’s Income and Fixed Interest funds

In 2022 with super funds down on average 5% and inflation close to 8%, the spending power of members has gone backwards by 13%. Not so easy now.

Inflation could settle at 3-4%

We expect US inflation will fall soon and Australia will follow by mid-2023.

“Risk markets may take some encouragement from this, but inflation is likely to remain around 3-4%.

“Goods prices may fall — or even go negative — but inflation on services will remain stubbornly high.

The markets may look for rate cuts, but inflation could prevent that. At least rates will stop rising. “

In this environment investors need the defensiveness of bonds, which have now restored their insurance credentials after this year’s hits, says Hext.

“My recommendation would be to buy inflation-linked bonds.

Returns from inflation-linked bonds are adjusted for inflation, allowing investors to protect real returns.

They’re not popular in Australia, which is something of a mystery to Hext.

“The mainstream investment community seems to prefer standard, nominal bonds — as evidenced by the nominal-only benchmark proposed for bonds in the Your Future Your Super guidelines.

“In my view this is poor policy, overlooking the benefit that inflation-linked bonds provide for retirees or those near retirement.”

While we enjoy summer in Australia, the wintertime blues of an energy-constrained northern hemisphere will mean summertime blues for markets in Australia.

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

Contact a Pendal key account manager

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at November 9, 2022. 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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