One of the best performing bond funds in the UK
The M&G Optimal Income Fund is one of the most unconstrained bond funds available on the market. Launched in December 2006, fund manager Richard Woolnough has the freedom to invest across the entire fixed income universe. This means he can focus the fund on high yield bonds, investment grade corporate bonds or government bonds of any maturity depending on where he sees the most value.
Richard aims to use the fund’s flexibility, coupled with his investment management expertise, to consistently outperform its official sector, the IMA UK Other Bond sector, as well as the UK Corporate Bond sector and the UK Gilts sector. As can be seen in the table below, it has done exactly that since it was launched just over a year ago, making it one of the best performing bond funds in the UK.
A proven investment approach
Richard manages the portfolio using the same top-down investment approach that he has successfully used for the M&G Corporate Bond Fund. The M&G Corporate Bond Fund is the only fund in the IMA UK Corporate Bond sector to be top quartile in 2004, 2005, 2006 and 2007 (as at 31 December 2007).
In essence, Richard aims to buy the fixed income assets that produce the most attractive combination of credit and duration risk given his outlook for growth and interest rates. He explains, “The two biggest drivers of performance are duration and credit risk, so it’s important to get these big calls right”.
The secret to the fund’s success
Flexibility to manage duration is critical. If Richard believes interest rates are likely to rise, then he will position the fund with a short duration to protect its value. The fund’s duration was very low at launch and this lack of interest rate risk enabled it to outperform its competitors as UK interest rates rose over the first half of 2007.
However, after the credit crunch hit in the summer, Richard increased the fund’s duration. This served to boost returns over the second half of the year as the US Federal Reserve and the Bank of England cut interest rates.
Since the number of potential economic scenarios is vast, the M&G Optimal Income Fund has been specifically designed to equip Richard with all the tools he needs to meet the changing market environment. For example, he can now also make money for the fund when interest rates rise, by using interest rate futures.
Credit risk is crucial too
From a bottom-up perspective, Richard is able to draw on the proprietary work of M&G’s experienced team of credit analysts – one of the largest in Europe.
If he believes that the economy is strong and that high yield bonds offer exciting prospects, then Richard can increase the amount of credit risk the fund takes on. For now though, he sees the most value in government bonds and higher rated corporate bonds. In the current environment, perhaps the most useful tool is being able to use credit default swaps (CDS) to buy protection (i.e. go short) on corporate bonds and high yield bonds that are unattractive. The fund’s ability to use such instruments gives it a big advantage over traditional bond funds, because in a long-only bond fund, if a manager has a negative view on a particular credit, their only option is to not buy it.
What’s the outlook for 2008?
Richard expects the global economy to slow significantly during 2008 as the full effects of the recent events feed through to consumers. The US economy was already growing below trend and the last thing it needed was a credit crunch. Recent housing statistics also paint a gloomy picture. Richard comments, “There remains a huge oversupply of houses on the market in the US, and prices will inevitably continue to fall until this excess supply is cleared. Meanwhile, in the UK, lead indicators suggest that the housing market will continue to weaken in 2008 and could well fall”. In both the US and the UK, a housing market collapse has always coincided or resulted in recession, and Richard believes interest rates will need to fall by more than the market expects.
Source: S&P/Case Shiller Composite-10 Home Price Index (% change YoY)
Why invest now?
The fund’s scope to invest across the range of fixed income asset classes means there is never a bad time to invest in the M&G Optimal Income Fund, but with the economic environment expected to deteriorate in 2008, bond funds are now firmly back on the agenda. The fund already has an impressive track record and it could be a good choice for investors looking for a dynamic fixed income product supported by proven fund management expertise.
For further information visit www.mang.co.uk
For financial advisers only. Not for onward distribution. No other persons should rely on the information contained in this document. Source of performance figures: Morningstar, Inc. as at 31 December 2007, bid to bid with net income reinvested, Sterling Class A Shares. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The company’s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776. JAN 08 / 21469
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