The three funds, which have combined assets under management (AUM) of more than £30bn, are go-to products for private investors and advisers looking for fixed interest exposure.The £21bn Optimal Income fund has seen inflows of almost £4.5bn in the last 12 months alone, making it the best-seller in the entire IMA universe over the period.
Managing director of Square Mile Romer-Lee (pictured) rates Woolnough as one of the best bond managers in the business, but says the mass inflows have limited his ability to add alpha.
For that reason, he has not included the funds in the 22-strong list of AAA-rated portfolios.
“When funds are continually hampered by inflows, it can be a problem,” he said.
“The bond market can be pretty illiquid because it’s a secondary market, and when huge amounts of money come through the door it can be harder to trade in certain areas.”
“Woolnough is an exceptional manager, but because of that, fund size can have an impact on performance.”
A note from Square Mile on the fund added: “In recent years the corporate bond proposition at M&G, which encompasses the Corporate Bond and Strategic Corporate Bond funds, has seen substantial growth - testament to Woolnough's careful stewardship of the funds. However, this has made the funds more difficult to manage at certain times.”
“Whilst this fund has the advantage of being able to invest across fixed income markets, it will usually have a significant proportion of its assets invested in corporate bonds, and the reduced flexibility that this weight of assets brings, is reflected in our rating of the fund.”
Optimal Income, Corporate Bond and Strategic Corporate Bond all have AA-ratings, putting them high up on Square Mile’s recommended list.However, Romer-Lee and his team have decided to back nimbler portfolios ahead of them, including FE Alpha Manager Ian Spreadbury’s £88m Fidelity Moneybuilder Income Reduced Duration fund and £445m Fidelity Extra Income fund.
Woolnough (pictured) has a better record than Spreadbury in recent years, with M&G Optimal Income comfortably beating Extra Income and Strategic Bond – as well as the IMA Strategic Bond sector average – since its launch in late 2006.
Performance of funds and sector since Dec 2006
Source: FE Analytics
The fund’s flexibility has been one of its key strengths, enabling it to move quickly in and out of asset classes to take advantage of valuation opportunities.
M&G acknowledge that Woolnough’s ability to add value through stock picking has been hampered, but believe that they have adequate flexibility and resources to keep outperforming.
“The size of a fund does make it harder to add value through individual stock selection but we combat it by constantly improving our skill set by adding to our considerable team strength,” a spokesperson for the group said.
“We are fortunate to work within one of the best resourced credit research and investment teams.”
M&G says that Optimal Income’s ‘go-anywhere’ mandate means that it has a higher capacity than specialised funds in the IMA Corporate Bond and even IMA Strategic Bond sectors, meaning that inflows are less of a problem for it.
“The M&G Optimal Income fund is truly flexible and invests within a very large investment universe,” the group said.
“The fund’s flexibility to alter duration and ability to invest up to 20 per cent in equities means it is still able to perform.”
“There are many ways to add value, through asset class allocations, yield curve duration across sectors, and between different credit rating levels.”
“There are no plans to stem flows into the M&G Optimal Income fund,” the spokesperson added.
Indeed, even as the Optimal Income fund has grown, it’s continued to outperform.
FE data shows that it’s ahead of its peers over one, three and five year periods, though has fallen marginally behind Extra Income over one and five.
Source: FE Analytics
M&G stopped marketing the £5.3bn Strategic Corporate Bond and £5bn Corporate Bond funds two years ago due to fears over liquidity; however, the group says that the risks have now subsided.
“The headwinds that persuaded us to moderate flows into [the two funds] in the summer of 2012 have long since subsided,” the group said.
“Corporate bond markets have continued to evolve, growing in both size and dynamism. Markets today boast a far greater mix of corporate issuers than they did some years ago, both investment grade and high yield, while innovative structures, such as hybrid bonds and structured credit, reflect their sophistication.”
“Both these funds have been amongst the top performers in the IMA Corporate Bond sector,” M&G added.
According to FE Analytics, M&G Strategic Corporate Bond and M&G Corporate Bond are both top quartile performers in their sector over a 10 year period, though their margin of outperformance has lowered in recent years.
Strategic is a second quartile performer over one, three and five years, while Corporate Bond is marginally underperforming over one and five years compared to its sector average.
Performance of funds and sector over 5yrs
Source: FE Analytics
Square Mile has given three corporate bonds a AAA-rating: Invesco Perpetual Corporate Bond, Fidelity Moneybuilder Income and Fidelity Moneybuilder Income Reduced Duration.
The last of these does not yet have a three year track record, but the other two have a similar performance record to the M&G portfolios.
Paul Causer and Paul Read’s Invesco Perpetual Corporate Bond fund has tended to be more volatile in recent years however, thanks the managers’ willingness to invest in riskier debt, including European financials.
The two funds are very large in their own right – Invesco Corporate Bond is £5.5bn in size, while Fidelity Moneybuilder Income is £3.1bn. However, M&G’s total bond strategy dwarfs that of its rivals.
Rob Gleeson and his FE Research team continue to recommend M&G Optimal Income, Corporate Bond and Strategic Bond in the FE Select 100, though say they are watching performance closely to ensure that Woolnough’s strategy isn’t adversely impacted.
Managing director at Whitechurch Gavin Haynes is more concerned however, and highlights fund size as the primary reason why he doesn’t hold Optimal Income across client portfolios.
“There are certain areas of the bond market that I would say have as much liquidity risk as in the equity market. Take high yield for example – if there is a flight from risk and a lot of money comes out of this at the same time, there could be a problem,” he said.
“When a fund is £21bn, there’s no doubt that liquidity restricts where you can go. While they have certain instruments to help them such as derivatives, we’d rather look elsewhere.”
Haynes says he holds Jupiter Strategic Bond and Artemis Strategic Bond in place of M&G Optimal Income.
