MEDIA RELEASE: The domestic economy will continue to weather the global macro storm however investment in the decarbonisation transition will be critical in 2023, according to SG Hiscock & Company portfolio manager, Hamish Tadgell.

Mr Tadgell said decarbonisation is the key issue of our time but there needs to be balance and appropriate policy and incentives in ensuring energy reliability and stability.

“The Russia Ukraine crisis is not the root cause of the current energy crisis - rather, lack of supply, lack of investment, lack of energy diversification and poor public policy are the real issues.

“Transition to a lower carbon world requires a strong and stable policy framework providing incentives to invest across the energy supply chain as well as recognising fossil fuels (and particularly gas and LNG) have an important role to play in the transition,” he said.

Mr Tadgell said Australia sits in a relatively sound position in a world of rising geopolitical tensions and higher inflation. He added that political stability, geographic remoteness, financial stability, and a strong resources sector collectively are supportive of the domestic economy.

“Australia has outperformed most of the developed world this year and there’s no reason this shouldn’t continue into 2023. We have a robust democracy at a time when a number of countries are seeing a hollowing out in their political systems and more of a divide between the left and right.

“Our superannuation system is also structured in a way that provides a strong basis for financial investment and security. Further, we’re heavily resources-rich, in terms of both hard and soft commodities such as lithium, copper and nickel and gas, which will be important in the energy transition and is in demand from the rest of the world,” he said.

“Looking into 2023, we are conscious of balancing the headwinds from tightening financial conditions against the large de-rate we have already seen in valuations as real yields have increased.

“If the inflationary impulse in Australia remains below European and US levels and the pace of RBA rate increases slows, it should be a further net positive for Australian equities to the extent it helps allay recessionary fears and concerns of higher bad debts cycle.

“It also needs to be remembered that ultimately the intention of central banks in raising rates is to tame demand and thereby inflation. This increases the risk that company earnings will eventually slow into next year.

“This set-up is likely to see equity markets remain volatile and result in an ongoing high level of dispersion in sector returns. This favours active management and stock selection,” he said.

In positioning portfolios, Mr Tadgell said he continues to maintain exposure to inflation beneficiaries and in particular commodities and energy stocks and companies benefiting from higher interest rates.

“We also maintain some exposure to Covid recovery beneficiaries as well as essential infrastructure and services plays which are more defensive but benefit from their unique market position and pricing power.

“Other sectors that are likely to benefit from a higher inflationary environment include financials (banks) and companies that have high cash balances.

“Infrastructure-led companies, including cyber networks, support and logistics and waste management, will also benefit from these conditions over the coming 12 months,” he said.

Portfolio manager of Australian Real Estate Investment Trusts (AREITs), Grant Berry, said property assets are traditionally a good source of income yield, and this will continue into 2023.

He said valuations within the AREIT sector are also favourable, with property subsectors such as office more expensive in the direct market.

“Property is an enduring, tangible asset class. The traditional AREITs have been trading at a discount to Net Tangible Asset Value in recent months that is comparatively favourable to direct property pricing. In addition, investment in AREITs incur very minimal transaction costs, which contrasts to direct property purchases, where aggregate transaction costs including stamp duty can exceed five per cent.

“Office AREITs in particular have been hit hard with the shift to flexible working likely to be enduring, and more elevated vacancy rates are now starting to reflect this shift.

“While we recognise these challenges, there are nuances with a flight to quality, stronger demand from smaller tenants, and fringe/suburban markets generally performing better than CBD counterparts. Pricing in the direct market appears slow to recognise these issues, whereas the AREIT sector has over-adjusted in our view.

“In terms of retail property, the consumer has proven to be resilient, displaying a willingness to enjoy life after two years of lockdowns, with associated challenges in online fulfillment benefitting bricks and mortar retail.

“Over the past quarter investors have had the opportunity to obtain exposure to high quality property assets via AREITs at a sizeable discount to direct property. This has not always been the case in the past and in doing so, presents an opportunity.”

Mr Berry said as global supply chains improve and demand moderates, inflation should subside from very high levels and central bank policy response is likely to moderate, which should provide a more favourable backdrop for property.

“Longer term we expect inflation in the coming decade to be higher than the previous decade but not at the current very elevated levels. Investors should therefore seek assets providing adequate inflation protection.

“We regard industrial property as very expensive in the direct market and within the AREIT sector we see more compelling opportunities,” he said.

The SGH Property Income Fund was recently named as a finalist in the Lonsec Fund of the Year Awards in the property and infrastructure category. It was also a finalist for SQM Research and Financial Newswire Awards (Australian Equities - Real Estate Category).