Further falls in global stocks resulting in a bear market would provide a huge opportunity to significantly buy back into equities for the titan M&G Optimal Income bond fund, according to M&G’s Richard Woolnough, who sold down his large weighting in to stocks in 2014.
The FE Alpha Manager (pictured) is regarded as one of the very best bond managers in the business and with a total £31bn of assets across four funds, he has the cash to reflect this.
The £19.4bn M&G Optimal Income is his largest portfolio followed by the £4.5bn M&G Strategic Corporate Bond, £4.4bn M&G Corporate Bond and £2.3bn M&G European Corporate Bond funds.
As a member of the IA Sterling Strategic Bond sector, the fund – which is by far the largest among its peers – made full use of rules allowing it to hold 20 per cent outside of fixed interest until Woolnough sold out of equities in 2014 and currently has almost no exposure now – for the first time in its near 10 year history.
However, he says he is poised to reverse this should the recent weakness in global equity markets continue further into a ‘full bear market’ – most consider this to be a fall of 20 per cent. The FTSE 100 is down more than 20 per cent since its April high. However, Woolnough says they haven’t reacted materially so far.
Performance of index since 27 April 2015
Source: FE Analytics
“If the equity markets continue to fall and had a proper bear market we would start looking at equities again for M&G Optimal income. At the moment we have the lowest we have ever had in the ten years. We tend to buy defensive equities but they are now very dear whereas previously they were very cheap.”
“At the beginning of the year there were lots of inflows and now for some reason there has been outflows but that is the nature of running a unit trust and we are very aware of the smoothness of that. [In the sell-off] we found some assets became a bit cheaper than they otherwise would be but it is just short term noise for me, we tend not to focus on those events as we are not traders.”
“We get these quite regularly. It does mean that the bond market tends to rally and so we got a little bit shorter duration on the rally because it is short term noise and not a long term trend.”
Bond funds have been a precarious place to be in for most of 2015 as the average fund in the IA Sterling Strategic Bond, IA Sterling Corporate Bond and IA Sterling High Yield sectors all delivering flat returns but in a volatile fashion.
Woolnough’s giant M&G Optimal Income fund has also seen significant outflows due to worries over liquidity and while no fund in his sector had net inflows he lost by far the most – more than £3bn in the first of half of the year, according to FE Analytics.
However, the total outflows from its peak size appear to be greater.
Since the end of March – a period which was mostly categorised by increasingly negative sentiment towards fixed income and substantial spikes in government bond yields, the fund has shrank from £24.5bn to £19.4bn although some of this is due to falls in the underlying securities.
“It did change the nature of the portfolio. When you have inflows you are looking to find things which means some of the more neutral holdings will stay in their and when there are outflows it means you are looking to sell.”
On the concerns over liquidity unwarranted he said: “The secondary market is continuing to expand. We have managed large funds for a long time. Liquidity is not a big issue. It is not a big issue, it is blown up, exaggerated.”
M&G Optimal Income’s gigantic size is in no doubt due to Woolnough’s reputations in the fixed income space and the fund’s superior long-term performance.
According to FE Analytics, it has been the second best performing IA Sterling Strategic Bond fund since Woolnough launched the portfolio in December 2006 with returns of 87.37 per cent, putting it just behind the Pimco GIS UK Sterling Long Average Duration fund which has seen a decent rally in the past three months while most bond funds lost money.
Performance of fund versus sector since 2006
Source: FE Analytics
M&G Optimal Income has also beaten its peers in six out of the last eight calendar years and has been top decile for its risk-adjusted returns, annualised volatility and maximum drawdown since inception. The only portfolio do so in the sector.
It is a member of fund research group Square Mile Academy of Funds, where it holds an ‘AA’ rating.
The Square Mile team say its mammoth size has made it more difficult to manage at certain times but that it does have a broadly defensive style.
“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.”
“Given the focus on downside risk, the fund tends to have a fairly defensive return profile, outperforming when markets are troubled or falling, but lagging slightly during periods of strong market returns.”
“We believe the fund may be suitable for investors who are looking for a secure source of income and the flexibility to move through fixed income (and, to a certain extent, equity) markets.”
M&G Optimal Income currently 2.44 per cent and has a clean ongoing charges figure of 0.91 per cent.