The £18.4bn M&G Optimal Income fund has been managed since its 2006 launch by FE Alpha Manager of the Year Richard Woolnough (pictured below) and has a stellar long-term track record.
In fact, over this time it has returned 87.05 per cent, more than doubling the performance of its average peer in the IA Sterling Strategic Bond sector.
Performance of fund vs sector since launch
Source: FE Analytics
However, more and more investors have been rotating out of fixed income assets due to their low yields and increasing their exposure to equities and other income producing assets. 
M&G Optimal Income hasn’t remained unscathed and has seen £4.7bn in outflows over the last six months alone which, according to data from FE Analytics, making it the most sold fund over the time frame within the entire Investment Association universe.
The fund that has seen the second-largest inflows over the last six months within the universe is Newton Asian Income, although this fund has lost less than half the amount that M&G Optimal Income has.
Within the IA Sterling Strategic Bond sector, the fund that has experienced the second-largest outflows over six months is Invesco Perpetual Monthly Income Plus, although the fund has still seen 10 times less outflows than M&G Optimal Income.
It should be noted that the fund is more than seven times the size of Newton Asian Income and more than five times the size of Invesco Perpetual Monthly Income Plus, and so a shift in favour away from bonds will trigger outflows of a larger scale.
Over the six months to the end of September, M&G Optimal Income's outflows were equivalent to 19.3 per cent of its £24.5bn assets under management at the start of the period. This is more than twice the loss of Invesco Perpetual Monthly Income Plus, on a proportionate basis.
Source: FE Analytics
Only four other funds in the sector have seen higher proportionate outflows than the M&G fund, three of which are less than £100m in size – these are City Financial Diversified Fixed Interest, Legg Mason IF Brandywine Global Income Opportunities and F&C Institutional Aggregate Fixed Interest.
The two funds that are larger in size and have seen a greater proportion of outflows are Man GLG Strategic Bond, although these still have an AUM of less than £1bn.
So why has such a large fund with a successful long-term record experienced such a significant increase in outflows?
Martin Bamford, chartered financial planner and managing director at Informed Choice, believes that the outflows appear to have been driven by the fund’s recent underperformance and also concerns about its large size, as well as a wider move by investors from bonds to equities.
“Capacity constraints are something that I think should have been properly addressed by M&G much earlier in the life of this fund. It reached a peak of £25bn of assets, which whilst very profitable for M&G, surely cannot be good news for the ability of Woolnough to make allocation decisions,” he said.
“As an investor, I still believe £17bn is far too large for a fund in the IA Sterling Strategic Bond sector. Any future bond sell-off could trigger even greater outflows, but performance is the biggest concern due to the difficulty surely faced by the manager in allocating such a large portfolio in an evolving investment environment.”
While the fund is in the top quartile for its performance over five years and was in the top quartile during the financial crisis of 2008 and the bear market of 2011, it is in the bottom quartile for its performance so far this year and over the last 12 months.
Performance of fund vs sector over 1yr
Source: FE Analytics
Neil Jones, investment manager at Hargreave Hale, says that it is difficult to manage a fund where there are constant outflows so it must be a particularly challenging time for Woolnough. This, he adds, is could have been made worse if the manager is expecting outflows to continue as cash is likely to be retained to cover this which is therefore not being put to work.
Currently, M&G Optimal Income has a 3.48 per cent weighting in cash, which amounts to more than £640m.
“Investors should be mindful when a fund is experiencing such large outflows, simply as performance may lag as a result,” he said.
“However, Richard Woolnough is an experienced investor, so if investors are looking for a long term holding in this sector he would be a decent person to back. But outflows could act as a drag on performance, so investors should be mindful of this.”
“Overall, while inflation remains subdued and interest rate rises are unlikely to happen anytime soon, I believe there is no reason to panic and indeed, fixed interest within a portfolio does provide some ‘safety net’ elements when the backdrop for equities is difficult.”
Woolnough has had to defend the size of his fund on a number of occasions in the past, even admitting that every time the fund grows it becomes more difficult to add value on a stock by stock basis.
He points out though that M&G Optimal Income has always been run from a top-down, macroeconomic perspective.
Nevertheless, one worry that investors may have is that the bond market is yet to experience its widely predicted sell-off (following a bull market which has lasted for close to three decades) and, if M&G Optimal Income is already experiencing outflows, they could worsen if there is a significant rout in the asset class.
Performance of sectors versus index over 25yrs
Source: FE Analytics
“There hasn’t been a mass sell-off in bonds but certainly there has been a sharp uptick in outflows across the fixed interest spectrum,” Apollo’s Ryan Hughes said.
“M&G is the most owned fund in the sector and therefore it is unsurprising that they are bearing the brunt of the outflows. I have broader worries about fixed interest liquidity if outflows pick up sharply and would urge investors to be very aware of the liquidity profile of their fixed interest exposure and how the assets are being priced.”
Hughes warns that existing investors in the fund need to always be conscious of what is happening to the fund size of any investment they have, and that the main consideration when a fund’s size is changing is how this will impact on the manager’s investment strategy.
“Manager Richard Woolnough has hinted that he is having to adapt his approach to cover the current levels of outflows by holding more cash,” he continued.
“While I wouldn’t advocate an outright sell on the fund, investors need to think hard about whether they are comfortable with a fund that is losing a significant amount of assets where the manager has said it is having a direct impact on the investment strategy.”
While M&G was unable to comment regarding the outflows of the Optimal Income fund, a spokesperson from the company said that investors who are concerned about the recent underperformance should take into consideration the short duration approach of the investment vehicle.
“The M&G Optimal Income fund has been defensively positioned for some time as we think the US economy is at or close to full employment so we continue to believe that the Fed should act soon to prevent inflation further down the line,” they said.
“Monetary policy is a blunt tool and even if the Fed hikes now, the labour market will continue to tighten for some time.”
M&G Optimal Income has a clean ongoing charges figure of 0.91 per cent and yields 2.38 per cent.
