Financials, telecoms, peripheral eurozone economies and hybrid bonds are the four areas of the fixed income space M&G’s Richard Woolnough is finding value. 
Woolnough (pictured), who is lead manager of the £20.7bn M&G Optimal Income fund, said government bonds were trading at close to historic lows, while corporate bonds had moved from good value to fair value during the past year.
The FE Alpha Manager said bond markets were continuing to react to central bank activity around the world.
“The Bank of England has reversed a little bit of easing policy, [it’s] a very small player on the international stage, it’ll take two years to come through,” he said.
“The Fed has tightened and it will slow the economy down a little bit but there are many other reforms and things that have happened which are stimulating their economy.
“Finally, Europe remains ‘foot on the pedal’ – it still has an easing policy and it’s discussing when and how to take it off. Going forward, if monetary policy remains easy, the economy should remain strong.”
More recently, he said differing actions by the Bank of England and the Federal Reserve had meant UK and US 10-year government bond yields had started to diverge.
He said: “We think that is an anomaly; we think the Fed has tightened too much or the UK eased too much and therefore tend to favour US bond yields over the UK.
“Our personal view? Nobody is sure how Brexit will work. Will it be hard? Soft? Will it occur [at all]?”
He said: “My view is that the exchange rate will do a lot of the heavy lifting and, therefore, rates don’t have to move in order to solve the problem.
“It’s an international problem, they don’t get solved by interest rates. They get solved by exchange rate moves. That’s why I find it quite difficult to understand why the UK has diverged so much from the US.”
Woolnough said after last year’s EU referendum the fund had moved to net short for UK duration exposure, but has moved back towards a neutral position more recently.
“Over the last autumn this has changed, the Bank of England has recognised that maybe things in the UK economy aren’t the worst ever,” he said.
“I suppose markets noticed that and therefore UK bond yields are not as low as they were versus the US and particularly versus Europe.”
However, Woolnough said there are some parts of the market where he has paid special attention to more recently: areas where he has found good value.
“Financials are exceptionally good value,” said Woolnough. “There was lots of supply of financials [because] of bank regulation changes.
“At the same time the European Central Bank and Bank of England weren’t buying financials, that meant there was more supply than demand.
“When there’s more supply than demand then the prices adjust and it’s our job as a value manager to take advantage of that difference and therefore we increased our exposure to financials.”
Woolnough said he has taken exposure to financials when looking for more growth or higher beta rather than via European high yield assets.
Another segment of the market that seems attractively valued is telecoms where there has been a lot of corporate activity.
The manager said he preferred the sector because, like financials, it also had seen little distortion via the Bank of England and ECB.
“In the crisis of 2008 & 2009, the telecommunications sector was seen as a safe haven and now it’s seen as a risky place,” he explained.
“We think we’re at peak M&A. AT&T are running up against constraints of buying Time Warner; it’ll go through or won’t go through but you can see monopolies and mergers are becoming harder to do.”
He added: “Supply will be limited going forward. Eventually these company consolidations will come to an end, M&A will come to an end and the supply will come to an end.
“Prices will normalise and we accept that these assets to do well versus investment grade in the US.”
Another are of the market is the eurozone periphery, where Woolnough has found value particularly around several political crises.
“Eurozone peripherals became exceptionally good value around the French, Spanish and Italian scares that have occurred over the course of 2017,” he said,
“Suddenly eurozone peripherals or lower-rated eurozone corporates became attractive.”
Finally, the hybrid bond market has become another hunting ground for the manager.
“Hybrids are riskier than traditional investment grade bonds and are less risky than equities,” the manager said. “Basically, as long as the company pays its dividend, they legally have to pay me my coupon.
“That means they cannot pay a coupon and not default. It means they are more flexible for the issuer, riskier for the buyer.
“But at the same time if you think the underlying company is going to pay the dividend, then you can be pretty sure you’re going to receive the money in the bond.”
He said he expects the sector to shrink over time, as companies are now more able to access funding through corporate bond or equity markets.
“We think these yields have been very attractive and the sector has performed very well this year,” the manager said.
“The great thing is that all four of these sectors sit at the low end of investment grade,” Woolnough added. “We think these areas are very good value against higher investment grade and we think they’re historically good value against high yield. Therefore, the portfolio is centred more into investment grade than it has been before and definitely more towards BBB.”
Woolnough manages the M&G Optimal Income alongside Stefan Isaacs and aims to provide a total return based on the areas of the market where the managers see the best opportunities.
Over three years the fund has returned 12.91 per cent compared with a rise of 13.04 per cent for the average IA Sterling Strategic Bond sector fund.
Performance of the fund vs sector over 3yrs
Source: FE Analytics
The fund has an ongoing charge figure (OCF) of 0.91 per cent.