Investors wary of emerging investment risks


Hamish Tadgell

The market continues to shift from the hope to the growth phase as the Australian economy rebounds from the shock of the COVID-19 pandemic and associated lockdowns, but new risks are emerging that investors’ need to position for, according to portfolio managers at SG Hiscock & Company.

Hamish Tadgell, Australian equities portfolio manager, said the recovery in the last 12 months has proceeded faster than widely expected driven by the extraordinary level of policy support and vaccine roll-out.

“The unique nature of this crisis has seen an unusually sharp rotation and outperformance of cyclical versus defensive sectors over the last year, but the recovery has followed a fairly typical pattern from despair to hope to growth.

“While the cyclical recovery is now clear for investors to see, the risk is we are fast approaching peak growth, and as this cycle matures, growth remains positive but slows.

It’s to be expected that the rate of change and growth momentum will start to slow, but it seems premature to be calling the end of the cycle.

Business confidence and conditions are at – or close to – all-time highs in most developed countries, including Australia, and labour markets are still recovering, with central banks, including the RBA, adopting a broader measure of full employment before considering policy normalisation.

“Against this backdrop, there are little signs government fiscal policies are about to be prematurely withdrawn,” said Mr Tadgell.

Grant Berry, AREIT portfolio manager, said this theme is apparent in domestic property markets also.

“While there are some property investments trading on very high multiples, there is also a number of AREIT assets that are underappreciated by the market. Low price doesn’t necessarily mean low quality at the moment; nor does high price mean high quality. There are opportunities to gain exposure to quality core real estate at a discount with attractive yields.

“For example, in the office property sector, there is no doubt the rise of working from home is having an impact on office occupation. However, there will remain a place for offices; the key is to select the locations and set-ups that can grow. CBD offices may still be challenged but we have been increasing our exposure to suburban offices with lower rents, good parking and more favourable tenancy demand,” he said.

Mr Berry is also seeing opportunities for REITs with convenience retail holdings, and is increasing the Fund’s exposure to this subsector, “given favourable pricing, while benefitting from consumers shopping more locally.”

He expects growth in niche property AREIT sectors, which can be less economically sensitive, however pricing needs to be considered as they can trade at premiums to private market levels as well as core real estate within the AREIT sector.

Mr Tadgell added that a key question for investors is around inflation risk, and whether inflation is transitory or structural and how central banks will respond to this dilemma.

“The thing we are conscious of is investors have not seen an environment of strong synchronised global growth, rising commodity prices and inflation expectations for three decades.

“Investors didn’t really expect high levels of inflation in the early 1970’s to persist initially. It took some time for expectations to adjust. Similarly, in the early 1980’s, investors were doubtful of the start of a new deflation trend. Looking back over the last 100 years it’s also notable rising inflation rate episodes were mostly due to unexpected supply shocks leading to sustained increases in prices.

“The COVID crisis has been a major shock to the system, and the effective lockdown of all economies has arguably resulted in the biggest global supply shock in history,” he said.

Mr Tadgell said it’s important to recognise the forces of deflation have proved to be powerful and persistent, and the combination of extreme monetary policy, technology disruption and an aging population have been highly influential in contributing to the economic circumstances and disinflationary setting.

“The dominant secular and structural trends emerging from this crisis are far from clear, but we are seeing the maturing of the cycle, changing growth outlook and inflation risks requiring a more nuanced approach rather than necessarily through the lens of growth versus value.

“As a result, we’re focusing on identifying opportunities and building a portfolio around companies with pricing power, cyclicals leveraged to the cycle, and structural growth companies that have been derated on the back of higher inflation expectations. We’re also avoiding longer-duration assets without an adequate margin of safety or clear catalyst to re-rating, said Mr Tadgell.

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