Investors have flooded back into Richard Woolnough’s M&G Optimal Income fund over the past 12 months, pushing assets past the £20bn mark, but is this the right time to buy into the fund? 
At the start of 2015 the fund had assets under management of close to £25bn and was the most popular member of the IA Sterling Strategic Bond sector thanks to a strong track record.
But after two years of underperformance – it failed to beat its average peer in both 2014 and 2015 by a slim margin – and concerns over the bond market, the fund was hit by significant outflows and AUM had declined to less than £15bn. This represented a 40 per cent decline in size.
Rob Morgan, pension and investment analyst at Charles Stanley Direct, said: “The fund fared well in terms of performance and growth in assets under management was very strong as a result.
“However, something of a tipping point occurred as a number of investors in the fund became concerned about liquidity – the manager's ability to get in and out of assets readily and particularly in relation to any sell-off that might occur in bond markets. As the largest fund in the sector it was deemed to be at risk.”
AUM of M&G Optimal Income over 3yrs
Source: FE Analytics
Things have changed since then, however. M&G Optimal Income’s AUM has climbed back up to £21bn – with FE Analytics suggesting that it has taken in more than £5bn of net inflows over the past 12 months.
This came after a turnaround in performance, with the fund posting second-quartile returns in 2016 and over 2017 so far. Performance has strengthened over shorter time frames with the fund in the peer group’s first quartile over six months and the top decile over three months.
“Overall flows into bonds have continued to be strong and this trend has benefitted the fund as many longer-term investors continue to view the management team in high regard,” Morgan added. “Indeed, performance through periods of heavy inflows and outflows has continued to be good.”
The fund’s performance relative to its peers isn’t the only factor supporting the fund’s flows. While global monetary policy remains stimulative, several central banks – including the Federal Reserve, the Bank of England and the European Central Bank (ECB) – have tightened in recent months.
Sheridan Admans, investment manager at The Share Centre, said: “I suspect flows are picking up now as investors who need to allocate to bonds have sought an experienced manager to steer them through the withdrawal of monetary stimulus, whether that is the Fed tightening, ECB reducing its asset purchase programme, Brexit or Japan maintaining its easing programme.
“I’m not surprised that this fund, and funds like this, have seen a pickup in inflows given the dynamic backdrop of monetary policy in a number of key markets and the preference for experienced managers to have a broad base of tools available to them to manage those dynamics.”
M&G Optimal Income is designed to capture the most attractive income stream at any point of the economic cycle. The process behind it uses a combination of top-down macroeconomic analysis and bottom-up stock selection; Woolnough and his team are known for the strength of their macroeconomic analysis, while a focus on downside risk means the fund tends to have a defensive return profile.
Asset breakdown (%) of M&G Optimal Income
Source: M&G Investments
For some time, the fund has been positioned for an environment where central banks start to gradually reduce stimulus, which is one of the reasons it underperformed in the years this failed to come about. The portfolio is significantly short duration at 2.2 years, compared with a neutral position of 5.9 years.
Admans highlighted this as a reason why investors have been returning to the fund: “We are stepping further into uncharted territory with monetary policy as central bankers start to, or are contemplating, the removal of the stimulus and starting the journey back to more normalised balance sheets.
“Stimulus removal is also moving in step with rate hikes in some economies and a fund like M&G Optimal Income has flexibility in its duration management, a tool that fixed income investors like for dampening or increasing the volatility within such a portfolio.”
Adrian Lowcock, investment director at Architas, added that investors continue to like bonds for several reasons, despite the recent outperformance of equities. These reasons include continued demand for income, growing political risk and high equity valuations increasing the need for diversification and more attractive yields in the fixed income space.
“This sort of fund is well-suited in the current environment as investors need a fund with a flexible mandate which is able to go anywhere and has a very experienced manager in Richard Woolnough,” he added.
“There are areas of the bond market that have performed well in the current climate such as high yield. The fund is run on a total return strategy so isn’t necessarily targeting a consistent and reliable income. This fund is different from other bond funds in that it can hold 20 per cent in equities, which is used if the manager sees equities as significantly more attractively valued than bonds.”
But should investors consider following the crowd back into M&G Optimal Income?
Admans pointed out that the fund has been a part of The Share Centre’s preferred range of funds for many years, thanks to Woolnough’s experience of managing it through the boom & bust cycle of the global financial crisis.
Morgan agreed that it is a quality offering in the space. “My view is that I like strategic bond funds as opposed to conventional ones in the current tricky environment for fixed interest and M&G's team is one I rate very highly,” he said.
“I think the fund is high quality but generating outperformance is going to have to come from macro calls rather than stock selection. The managers do have a good track record in this regard, though.”
However, Morgan added that the size of the M&G Optimal Income might prove off-putting to some investors. He prefers to use smaller strategic bond funds that still have the ability to generate returns through stock selection and more concentrated portfolios.
Admans added that other options in the sector can be found outside its larger members: “Investors looking for alternatives may also want to take a look at the L&G Dynamic Bond Trust run by Shahzada Omar Saeed, who is currently managing duration at 0.85 years and has a flexible mandate within global fixed income.”
L&G Dynamic Bond Trust is currently in the IA Sterling Strategic Bond sector’s bottom quartile over one-, three- and five-year periods. However, it has performed strongly more recently and is the peer group’s fourth highest returner over the past three months.
M&G Optimal Income has an ongoing charges figure (OCF) of 0.91 per cent and is yielding 1.87 per cent. L&G Dynamic Bond, which has assets of £458.8m, has a 0.63 per cent OCF and a 6.60 per cent yield.