FE Alpha Manager Richard Woolnough's (pictured) fund has attracted around £4bn in net new money over the past 12 months, almost seven times as much as the next most popular fund in the sector.
FE Trustnet carried a warning earlier this month from FE Alpha Manager David Coombs that mass inflows to the fund were destabilising the corporate bond market, because if it had to sell a significant proportion of its holdings it would severely depress prices.
Coombs also warned that when funds become too big it is difficult for them to continue to invest in the way that has brought them success.
M&G Optimal Income’s performance has dipped somewhat over the past 12 months, over which time it lags the sector average, returning 9.41 per cent as against 10.09 per cent.
Performance of fund vs sector over 1yr
Source: FE Analytics
While this may not be attributable to the fund’s size, it is reason enough for investors to consider at least diversifying their holding in the portfolio, if not switching.
One fund that may fit the bill is the £613m Artemis High Income, run by FE Alpha Managers Adrian Frost and Adrian Gosden, better known for their £5bn Artemis Income portfolio, which sits in the IMA UK Equity Income sector.
Like M&G Optimal Income, the fund invests in equities as well as bonds, where the lead managers’ expertise lies.
From an income perspective it is currently more attractive, with its yield of 4 per cent significantly higher than the 2.94 per cent of the M&G fund.
It has also outperformed Woolnough’s portfolio over the past three years, making 34.32 per cent compared with 28.52 per cent from the M&G fund.
Performance of funds over 3yrs
Source: FE Analytics
However, Artemis High Income is significantly more volatile: our figures show that it has an annualised score of 7.02 per cent over the past three years, compared with 5.28 per cent for M&G Optimal Income and 4.46 per cent for the average fund in the sector.
One of the reasons for this is that it has twice the weighting to equities that the larger fund has; whereas M&G Optimal Income currently holds 9 per cent in the asset class, the figure for Artemis High Income is 17 per cent.
The fund is highly rated by the FE Research team. Analyst Charles Younes explains that Frost and Gosden are supported by a highly competent team on the fixed interest side.
He says a mixture of their knowledge of companies and the analysts’ knowledge of the bond market is used to create ideas.
"Frost and Gosden use the same approach that has proved so successful in their Artemis Income fund, focusing on companies whose corporate bonds their analysis indicates will deliver the promised yield," Younes said.
"Ideas generated by the fixed interest team have greatly contributed to the outperformance of the fund, which FE is encouraged by, as this reduces the reliance on the equity personnel."
According to Younes, it is the stockpicking skills of the team that is key rather than their macro-economic calls.
"Frost is responsible for gathering the best ideas into a single portfolio and ensures that both teams generate these from an identical investment point of view: their analysis only focuses on a company’s ability to generate cash that will be available to shareholders," he said.
"Contrary to many competitors in the Sterling Strategic Bond sector, the team does not take macroeconomic views nor try to anticipate the movement of interest rates."
"Instead, it focuses only on generating a regular and attractive cash stream for the fund’s unit holders."
The managers are wary of the enthusiasm for corporate bonds, believing that it is currently a seller’s market.
"Corporates know a good thing when they see it and the current opportunity for issuance is too good to miss," they wrote in their most recent note to investors.
"Finance directors can scarcely believe that today they can finance at a fraction of the cost to five years ago. We tend to feel that the benefit of this lies more with equity – rather than bond – holders and therefore we are only participating occasionally."
The fund’s track record suggests that it will do better in times when the stock market is rising and will lag the M&G fund when the market does poorly.
Woolnough’s fund stands out when the performance of the portfolios is compared in falling markets.
In 2008, the fund lost just 4.34 per cent while the Artemis High Income fund lost 27.07 per cent, and in 2011 it made 5.68 per cent while the Artemis fund lost 1.97 per cent.
As the markets have risen in 2012 and 2013, it has been overtaken by Frost and Gosden’s fund. This suggests that more cautious investors may prefer to stick with Woolnough.
Performance of funds in discrete calendar years
| Name | 2013 returns (%) |
2012 returns (%) | 2011 returns (%) | 2010 returns (%) | 2009 returns (%) | 2008 returns (%) |
|---|---|---|---|---|---|---|
| M&G - Optimal Income | 2.53 | 12.91 | 5.68 | 8.33 | 32.68 | -4.34 |
| Artemis - High Income | 5.52 | 22.31 | -1.97 | 10.21 | 31.75 | -27.07 |
| FTSE All Share | 11.98 | 12.3 | -3.46 | 14.51 | 30.12 | -29.93 |
Source: FE Analytics
Artemis High Income is slightly cheaper than the M&G fund, with ongoing charges of 1.34 per cent comparing favourably to the 1.41 per cent charged by M&G.
The Artemis fund requires a minimum initial investment of £1,000 rather than the £500 requested by the M&G fund.