A recent FE Trustnet article highlighted that investors were pulling their money out of the £22.7bn M&G Optimal Income fund during the recent bond market rout, which saw sentiment turn increasingly negative towards fixed income as government bond yields spiked considerably.
According to FE Analytics, the fund’s AUM has shrunk by £1.8bn over the last two and half months (which includes capital losses) while approximately £800m has been redeemed from it in the three months up to the end of May while £630m came out during May itself.
Of course, opinion is very much split on whether investors are being prudent or overly alarmist. While the outlook for bonds is opaque to say the least and the fund is of a very substantial size, FE Alpha Manager Richard Woolnough (who launched the portfolio in December 2006) is arguably one of the best bond guru’s in the business.
Let’s not forget his fund has topped the sector from both total return and risk-adjusted return points of view since inception and has beaten its peers in six out of the last eight calendar years.
Performance of fund versus sector since launch
Source: FE Analytics
The debate about large corporate bond funds and diminishing levels of liquidity will no doubt rumble on until the prophesied bond market collapse eventually happens, but in this article we look at four possible alternatives to Woolnough’s Optimal Income fund for those who have already sold or are thinking of selling their position.
M&G Global Macro Bond – for those want to stay with M&G’s notable fixed income team
There is little doubt that M&G has one of the best fixed income teams available and its resources have been one of the major drivers of Optimal Income’s outperformance over the years.
Therefore, investors who are concerned about the size of Optimal Income may want to simply shift their assets across to the group’s £1.4bn Global Macro Bond fund, just like the team at Hawksmoor did a number of years ago.
One of Woolnough’s strengths has been his ability to correctly call the macroeconomic environment and as Jim Leaviss’ M&G Global Macro Bond fund’s name suggests, it too follows a similar top-down asset allocation style.
Ben Conway, fund manager at Hawksmoor, says there are some big differences between the two funds, such as the fact one sits in the strategic bond sector and the other sits in the global bonds peer group, and therefore Global Macro Bond is not a like-for-like replacement.
Nevertheless, Conway says that following the decision to sell M&G Optimal Income a number of years ago, this fund was a good way to regain access to the team.
“I think it is fair to say that if we wanted exposure to M&G’s excellent bond team, this is our favourite option. The reason we bought it was mainly because of the team, as when you look at the names that sit on that desk, it doesn’t get much better.”
According to FE Analytics, M&G Global Macro Bond has delivered a consistently lower return than Woolnough’s fund but is outperforming its own sector average over one, three, five and 10 years.
Performance of funds versus sector over 5yrs
Source: FE Analytics
As we know though, the past is no guide to the future and Conway says M&G Global Macro Bond is a good fit for the current environment.
He likes the idea that the fund is long the US dollar, which Conway thinks will strengthen as the US economy recovers, and the fact it has modified duration of just two years, which he considers a good bet given interest rates are likely to rise this year.
“M&G wouldn’t like me saying it, but it is a good fixed income fund for people who don’t like fixed income.”
M&G Global Macro Bond is a total return fund so has a yield of just 1 per cent. Its ongoing charges figure is 0.8 per cent.
Fidelity Strategic Bond – for those who want an equally experienced manager
One of the reasons M&G Optimal Income has proven to be so popular with investors is because of Woolnough’s long and successful career and many fund selectors say experience will be key for what is likely to be a very turbulent time for bonds over the coming years.
Therefore, if investors want an equally experienced manager they may wish to choose Fidelity Strategic Bond, which is headed up by Woolnough’s fellow FE Alpha Manager ‘hall of famer’, Ian Spreadbury.
Spreadbury has managed the £1.7bn fund since its launch in April 2005, over which time it has been a top quartile performer with returns of 79.9 per cent.
Performance of fund versus sector since launch
Source: FE Analytics
While there are similarities between Fidelity Strategic Bond and M&G Optimal Income, the major difference is that Spreadbury is renowned for his cautious approach and focus on downside protection.
“This fund is set up to be a traditional bond fund, taking on the risks associated with bonds and their traditional role of diversifying the risks specific to equity,” the FE Research team said.
“This is in contrast to some strategic bond funds which have sought to chase higher returns and higher yields in riskier areas which behave more like stocks. The fund is therefore a good diversifier for those with equity exposure in their portfolio.”
This more cautious approach is highlighted by the fact while Fidelity Strategic Bond has narrowly underperformed against Woolnough’s fund since launch, it has had a lower maximum drawdown over that time.
Fidelity Strategic Bond, which yields 2.68 per cent and has an OCF of 0.67 per cent, is highly diversified in terms of holdings and has exposure to government bonds, corporate credit and asset-backed securities.
GAM Star Credit Opportunities – for those who want a more nimble fund
Of course, the two alternatives mentioned so far are still £1bn in size and one of the major reasons why investors may have sold their stake in M&G Optimal Income is because of the gigantic AUM and the illiquidity risks that come with it.
Unfortunately though, and is so often the case in the fund management industry, there aren’t many funds which still have a small stature but are headed-up by experienced and highly-rated management teams.
However, one exception to the rule is FE Alpha Manager Anthony Smouha’s £184m GAM Star Credit Opportunities fund.
Smouha has decades’ worth of experience in bond markets and launched the GAM fund, which carries five FE Crowns, in July 2011. Over that time it has been the best performing portfolio in the IA Sterling Strategic Bond sector and nearly doubled M&G Optimal Income’s returns with gains of 55.48 per cent.
Performance of funds versus sector since launch
Source: FE Analytics
The major reason for that performance is Smouha’s approach which revolves around focusing on investment grade issuers, but buying debt lower down the capital structure. While this means the fund’s yield is higher than most at 5.25 per cent and offers the chances of higher capital returns, the FE Research team says it can be more risky.
“The logic behind investing in subordinated debt of higher quality companies is understandable, especially when considering the extra returns available,” the team said.
“There is clearly an in-depth investment process that scrutinises each company and individual bond before it enters into the portfolio, however this combination of broad economic analysis with company-specific research can only go so far in protecting the fund in times of market stress.”
GAM Star Credit Opportunities has an OCF of 1.18 per cent.
Newton Global Dynamic Bond – for those who want to be ultra-cautious
The risk-profile of the GAM fund may not suit most investors’ outlooks, especially as there have been growing concerns about the future of fixed income with many expecting a more ‘brutal’ correction in the market over the coming years.
Therefore, those that have sold M&G Optimal Income may be looking for a bond fund which is designed to offer diversification away from equities and, more importantly, to focus on downside protection.
Investors who are looking for that sort of exposure shouldn’t be looking for high return, but a fund that can act as a strong form of defence within a portfolio. One which aims to do just that and has become more and more popular with fund selectors is Newton Global Dynamic Bond.
The £1.2bn fund, which is headed-up by Paul Brain, sits in the IA Targeted Absolute Return sector and Fidelity’s Tom Stevenson says it is a good option in the currently uncertain market backdrop.
“One way of reducing risk when investing in bonds is to take a global view, especially as the asset class matures around the world, particularly in emerging markets,” Stevenson said.
“The fund exhibits a global thematic approach to investing. The fixed income team conducts its own research to translate relevant themes into investments to capture the returns. The fund looks to beat a short-term cash index and does so by investing in government (developed and emerging markets) and corporate debt (investment grade and high yield) around the world.”
According to FE Analytics the fund, which invests across global bond and currency markets, has returned 57.82 per cent since its launch in April 2006 and has been lowly correlated to corporate bonds and equities and has been far less volatile.
Performance of fund versus indices since launch
Source: FE Analytics
It has a had a maximum drawdown of just 10 per cent of that time and has posted positive returns in seven out of the last eight full calendar years – including a slight 0.14 per cent gain in the crash year of 2008.
Newton Global Dynamic Bond has an OCF of 0.81 per cent and yields 3.23 per cent.
