While the M&G Optimal Income fund remains an attractive option for investors looking to take some risk out of their portfolios investors should be cautious over its size, according to several industry experts.
Last week it was revealed that the £22.5bn behemoth fund run by FE Alpha Manager Richard Woolnough and deputy Stefan Isaacs was the most bought fund of 2017.
The fund’s assets under management (AUM) rose from £15.9bn to £22.52bn over the year with £311m attributed to performance, equating to £6.2bn of net inflows.
Performance of fund vs sector in 2017
Source: FE Analytics
The fund has been in and out of favour in recent years, as investor concerns over the bond market coincided with underperformance of the peer group in 2014 and 2015 led to outflows. Overall, its AUM fell from a peak of £24.5bn to a low of £14.5bn before trending upwards again.
As such, below FE Trustnet asks market commentators whether now is a good time for existing investors to sell or remain invested.
It is interesting to note that the most bought fund of 2017 was a bond fund at a time when central banks are widely expected to raise interest rates globally and possibly most significantly in the US.
However, as Premier Asset Management senior investment manager Simon Evan-Cook noted: “People love certainty, even if that certainty relates to getting poor – if any – real returns from bonds going forward.”
Since the financial crisis of 2008 there has been a huge amount of credit issuance thanks in part to the incredibly low interest rates imposed by central banks, according to Daniel Adams, senior analyst at Psigma Investment Management.
This has occurred at the same time as regulatory clampdown on the investment banks has seen inventory levels collapse.
“We believe this warehousing of stock is imperative for a fully functioning market, acting as a temporary buyer when sentiment in the market shifts,” he explained. “Without this function, volatility will be elevated.”
He added that as yet there have been no signs of a meaningful reverse to this, though with interest rates set to rise more quickly it could still happen.
This should have a bigger impact on larger funds, if investors begin to sell out amidst this reversal they may become forced sellers of assets into a market where there are fewer buyers.
“Our biggest concern is not the underlying assets or often the managers, but the investors within the strategy,” he added.
“As a small investor in a large strategy, your performance is strongly impacted by the sentiment of the other investors within the fund.”
Rob Morgan, pension and investment analyst at Charles Stanley Direct, agreed, noting that – given the size of the fund – its future success largely rests on the manager’s correct interpretation of the macroeconomic environment rather than adding much value at a stock level.
“However, this has been the case for some time and performance has remained impressive; investors are clearly willing to back the manager’s judgement.
“I’d say that’s the right call but would prefer a smaller fund that can make slightly bolder, focused decisions more easily. So, I would say it’s a ‘hold’ overall.”
However, he said he would complement the fund with the £623.3m Aviva Strategic Bond fund run by Chris Higham and James Vokins.
The strategic bond fund has been a top quartile performer since its launch in 2008 and has made similar returns to M&G Optimal Income over the period, as the below chart shows.
Performance of fund vs Optimal Income and sector since launch
Source: FE Analytics
The fund can invest across the bond spectrum but, unlike Woolnough’s fund, does not have an allocation to equities or the ability to use derivatives.
While M&G Optimal Income’s size may be off-putting for some, Andy O’Shea, head of investment research at Pharon Independent Financial Advisers, said it should deservedly continue to attract the attention of investors.
“M&G Optimal Income fund is a good strategic bond fund, with arguably one of the widest opportunity sets in the sector, not only in terms of paper quality and duration but also assets, given the fund’s ability to invest a portion of its assets in equity income stocks,” he said.
One of its key advantages is the ability to include up to 20 per cent in equities, should stand investors in good stead as we enter the next phase of monetary policy by central banks.
“This will help shorten the duration of the fund, not forgetting the ability for Richard to use derivative contracts to achieve this as well,” he noted.
Duration has been a big part of the fund’s process in recent years, according to Square Mile Research's Victoria Hasler.
The head of research said its underweight duration – or interest rate risk – position has been a headwind for the last couple of years, as the below chart shows.
However, in 2017 duration was less of a driver in bond markets and the fund fared much better, beating the sector median.
“This underweight duration position should protect the fund on a relative basis if yields rise from here,” Hasler noted.
Performance of fund vs sector over 3yrs to 31 December 2016
Source: FE Analytics
She added that the flexible nature of the fund to go so short duration is a key reason it has proven so popular.
“I suspect it is this which largely attracts investors at this point in the cycle, as many are forced – or want – to hold bonds for diversification purposes, but do not want to own traditional gilts, which look rather expensive at present,” she said.
Having been an investor in the fund for many years, Pharon’s O’Shea sold out in 2015 due to concerns over the size of funds under management and the impact that this was having on management style and process.
Despite recent inflows, however, the fund remains off its peak and O’Shea said that “it is not surprising to see the fund top buy tables”.
“Given Richard’s vast experience, the flexibility offered by this fund and the lessons learnt from the past, I believe that this fund should deservedly continue to attract the attention of investors,” he said – although he noted that the AUM was worth keeping an eye on.
Psigma’s Adams, however, does not use the fund, instead opting for smaller funds such as the TwentyFour Core Corporate Bond fund, which he said was the most comparable to Optimal Income despite its £104m size.
The fund run by Chris Bowie, Gordon Shannon and deputy Jack Daley was launched in 2016 and has returned 11.94 per cent versus its iBoxx GBP Corporate Bond Index benchmark’s 16.95 per cent gain.
It largely invests in the UK corporate bond space though can invest up to 20 per cent in high yield debt and has the option of using derivatives.
The fund has a yield of 3.16 and an OCF of 0.55 per cent.