Fund in focus: M&G Corporate Bond

Posted by Liz Rees in Fund and industry updates category on 07 Aug 19


The proposition

M&G Corporate Bond Fund aims to provide steady income and some capital growth. At least 70% of the fund is invested in sterling-denominated investment grade bonds, issued by companies. The fund may have up to 20% in government bonds and 10% in high yield bonds. It is also permitted to hold cash and other liquid assets.

The current yield on the income units is around 3.5%. However, like any investment, bonds are not risk-free; their prices are affected by changes in interest rates and inflation. When prices rise, yields fall and vice versa.

Corporate bonds tend to have a higher yield than government bonds, which have low risk of default, yet below high yield bonds which have lower credit ratings. Bonds offer fixed coupon payments so may appeal to investors looking for a regular income stream.

The team

Richard Woolnough joined M&G in January 2004 and is fund manager of the company's three flagship fixed interest funds, including this one. The deputy manager, Ben Lord, joined M&G in 2007.

Woolnough has over 30 year’s industry experience and is supported by one of the largest fixed income teams in the City, comprising 11 other managers and over 90 credit analysts. This provides the necessary resource to meet with a large number of companies and carry out independent research.

Investment philosophy & process

Woolnough has a conservative approach, carefully managing risk in order to limit capital downside. This means he holds a widely diversified portfolio with a large number of holdings. He believes a thoughtful appreciation of macroeconomic trends combined with detailed credit analysis at a company level is the best way to produce a reliable flow of income.

Woolnough formulates his own views of the economic outlook to help him determine the most appropriate weightings by geography, bond type and sector but he debates ideas with other managers in both the bond and equities teams. He assesses the key drivers at each point in the economic cycle and re-positions the fund accordingly as conditions change.

The in-house credit analysts carry out detailed research in their specialist area. Every bond covered, including new issues, is given an internal rating following an assessment of valuation and liquidity characteristics, before the managers make a decision to invest. An accurate understanding of interest rate and credit risk is critical to ensuring risk of defaults is mitigated.

Liquidity is always an issue with bonds so is strictly monitored. Indeed, the fund sets a minimum amount of liquidity to participate in an offering. However, Woolnough has learnt from experience that when there is excess liquidity in the system, this is usually the worst time to buy, as was the case in 2007.

Current positioning

As the UK bond market has become increasingly concentrated in a few sectors, Woolnough has looked internationally for diversification. He believes longer-dated BBB rated bonds currently offer the best value so the fund is overweight in this space. Recent purchases include American Airlines, BT and a new issue in Gatwick Airport.

Biggest positions include the bonds of well-known companies such as Lloyds Bank, Microsoft and AT&T. The largest sector exposure is asset-backed securities and banks. The portfolio is well- diversified, with the largest holding amounting to 2.7%, at the end of June, to reduce default risk.

In the second quarter of 2019, the fund sold out of a number of US dollar-denominated telecoms bonds including Verizon, and Vodafone; switching into sterling for the latter. These relative value trades are ongoing in financials and telecoms positions. Woolnough has also sold sterling-denominated bank debt from HSBC, Goldman Sachs and Bank of America, switching into Wells Fargo and Yorkshire Building Society.

Performance & Costs

The manager’s cautious approach can mean it lags its peers in a strong bull market but the focus on quality should limit drawdown (peak to trough falls) in more challenging conditions.

During the period of Woolnough’s tenure, from February 2004 to the end of July 2019, the fund has achieved annualised growth of 5.9% vs 4.4% for the IA Sterling Corporate Bond sector. Over five years it is slightly ahead of the peer group with an annualised return of 4.9%. (Data to 31/07/2019, FE Analytics).

The OCF (ongoing charges figure)is a little above average for a bond fund but as M&G covers research costs the total cost is not excessive.

Current outlook

Woolnough retains a positive outlook on the global economy. While he acknowledges we must prepare for the next global recession he is adamant that, according to the indicators he uses, it is not around the corner. He holds the view it is unlikely to occur when unemployment is so low-indeed, his analysis concludes it may not happen for around 2.7 years! In such a scenario, he does not believe significant interest cuts are necessary.

The size of the global bond market has expanded rapidly and there are interesting opportunities arising all the time. Premiums on new issues have fallen since the financial crisis with many British companies now opting to raise capital in Europe and the US.

US credit ratings have not changed whereas in the UK and Europe they have fallen; in particular, Government bond quality in Europe has declined. However, a number of important sectors, including tech, are not driven by what is happening in the economy.

Default rates remain very low and credit spreads indicate good value in investment grade bonds. Woolnough sees the main risks as political; a labour government could bring further pressure on sterling.

Our view

Woolnough has one of the best long-term track records in its field and his cautious approach means he could be considered a safe pair of hands. Low interest rates and steady growth are the conditions most conducive to this strategy doing well.

The prices of bonds tend to be less volatile than equities, so they are sometimes regarded as less risky. That said, many experts consider the asset class expensive so careful selection is imperative.

The M&G Fixed Income Team’s ability to make the right calls in a variety of conditions has been impressive. Key decisions such as being underweight in banks ahead of the credit crunch and minimising exposure to peripheral Eurozone countries have enhanced their reputation.

One caveat is that the size of the funds under management of the team is extremely large (albeit well below their peak size) which could present liquidity issues if market conditions were to deteriorate.

Important information: Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment.

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