The Point

How Pendal’s head of multi-asset is thinking about equities, bonds and alternatives right now

As 2023 comes to a close there’s a relative calm in markets after several years of volatility in inflation, interest rates and markets.

That means it’s a good time for investors to examine their portfolios, says Pendal’s head of multi-asset Michael Blayney.

Financial markets have shifted to a “more normal” environment in recent months – and investors should think about portfolio allocation in a more traditional way, says Michael.

“Investors should maintain a balanced mix of equities and bonds and some alternatives,” argues Michael.

“In Australian equities you have a market that offers pretty good dividend yields and you get franking.

“We also still really like bonds. There is a yield cushion in case of further volatility.

“Alternatives should still be part of a portfolio, but with bond yields higher investors don’t need as large an exposure to alternatives to generate returns.”

Asset allocation: Why you could do with a little more home bias right now

Have you checked your “home bias” recently?

The term refers to the percentage of a portfolio invested in domestic versus international assets.

For years Australian investors drifted away from a traditional preference for investing at home.

Reasons included greater diversification in geography and sectors, better exposure to tech and lower carbon intensity.

But now those arguments are losing their punch.

“There were good reasons for that shift, but we think it is now done,” says Pendal multi-asset PM Alan Polley.

Alan argues investors should check their home bias “and either keep it as it is and stop drifting – or even marginally go the other way now and increment the home bias up a little bit”.

In a new article Alan explains why it’s time to consider moving back home.

Alan Polley: Balanced funds are looking more attractive as conditions normalise

After the GFC, investors generally had to chase greater risk to achieve targeted returns.

A lack of fiscal support from overly austere governments meant monetary policy had to take up the slack via non-conventional tools such as quantitative easing, says Pendal multi-asset PM Alan Polley.

“The resulting wall of money increased valuations, decreased prospective returns and risked asset bubbles,” says Alan. “But that’s now unwinding.”

Post-pandemic governments have realised monetary policy is out of bullets and fiscal policy needs to fire up again, he says.

“The transition to fiscal policy is good for investment returns, because governments will now do some of the work to bolster aggregate demand.

“There’s decent prospective returns for equities and bonds, and that now makes balanced funds more attractive.”

How to hold commodities in a sustainable portfolio (and why you would)

Commodities perform an important role in portfolio diversification.

They tend to be highly correlated with inflation and have a return distribution with a positive skew, meaning returns on the upside can be bigger than returns on the downside.

But commodities – typically metals, energy or agriculture materials – are often excluded by sustainable investors as ESG-unfriendly.

Pendal multi-asset PM Alan Polley argues it needn’t be that way.

A nuanced approach that weighs up the benefits and drawbacks of individual commodities can offer advantages over a simplistic commodity index approach or just negative screening, he says.

“Many buy the broad commodity index which has the fossil fuels and livestock and isn’t consistent with ESG.

“Others think ‘commodities are mining, and mining is bad’.

“But you have to think beyond that because the transition to net zero is materials and resources intensive.”

Got money in a global bond index fund? You should read this

Got money in a global bond index fund? Pendal’s head of multi-asset Michael Blayney has a note of caution for you.

Indexing bond investments appeals to many investors because it’s a low-cost way of incorporating diversified, defensive assets into a portfolio.

But global bond index funds have a hidden risk that may undermine their role in providing stability and defensiveness in portfolios.

That’s because global bond indicies tend to allocate higher weightings to the most indebted countries, which is a fundamental flaw, argues Michael.

“In bonds, it’s how indebted you are that determines your weight. Essentially, we are lending more to the people that owe the most money.”

Global bond benchmarks could be overweight to countries like China, Italy and emerging markets that might not pass a quality screen.

ESG investing: how to understand, measure and mitigate

Underperformance in some sustainable strategies may leave investors hesitant about ESG from time to time.

But research from Pendal’s multi-asset team suggests ESG investment risks can be quantified and mitigated – and in the long run, a sustainable approach is likely to outperform.

“Investing sustainably is the right choice in the long term,” argues Michael Blayney, who leads Pendal’s multi-asset team.

“But investors need to understand how much and for how long their performance could differ from unscreened portfolios – and be comfortable with that,” he says.

Pendal quantifies the level of risk inherent to ESG portfolios by comparing the tracking error of representative ESG indexes with unscreened indexes over eight years.

Tracking error is a measure of how closely a managed fund tracks its benchmark index.

The data suggests ESG funds deliver “something like half the risk you would get from an active manager, simply from negative screening”.