Stay Flexible with
M&G (Lux) Optimal Income Fund

The direction of bond markets is anything but straightforward when the economy slows down. Added to this, other uncertainties on a whole range of issues (the timing of any interest rates cuts, inflation data, even geopolitics) can make some types of bonds unattractive, while other areas of fixed income can appear appealing.

But we can help here: We can actively seek to capture any price opportunities that arise because we can be flexible across different markets and regions. We are also not forced to invest in a particular area – our investment mandate is highly flexible in this regard.

If a recession were to occur, a slight fall in interest rates would likely have a small impact on stimulating the economy, unfortunately. A more substantial intervention would be necessary, potentially causing bond yields to decline more than anticipated. This would mean bond prices may rise more than expected and we therefore believe that bonds still hold value even in the event of a recession. 

A weak economy doesn’t mean we sell out of corporate bonds and just ‘sit in’ safer government bonds until things improve. We can be very selective and identify some corporate bonds that our research analysts calculate are ‘fair’ or ‘good’ value. This can be in bonds issued by the same company, but yet have different characteristics (i.e. bonds with different time horizons, or bonds issued in different currencies). But, all things equal, a weaker economy will lead us to go up in quality within the bonds that we hold.

As interest rates fall, the return on cash investments decreases, resulting in lower yields and diminished income generation. This reduced income potential is particularly notable for those who rely on income from their investments to cover living expenses or achieve financial goals.

With cash holdings, the income generated from interest or dividends may no longer provide the same level of sustenance or growth.

As central banks reduce interest rates, the returns on cash diminish, whereas government bonds can typically compensate for the diminishing returns through capital appreciation, resulting in a possible outperformance. While cash has its merits, it is important to recognise its limitations, particularly during a period of falling interest rates. Assessing the broader financial landscape and exploring alternative investment possibilities, such as Optimal Income strategy, may help ensure the preservation and growth of income for investors favouring cash.

Given the Optimal Income strategy began in 2006, we have experienced many different types of markets, economic environments and bumps in the road. We have argued for many years that the wide-ranging flexible nature of the strategy means it is possible to have a smoother investment journey.

Crucially we have been able to adjust where we see opportunities. For instance, a cautious allocation to riskier high yield bonds when the economic outlook is poor. On the flip side, having more government bonds can be helpful as a buffer against volatility. This is because the prices of these investments generally rises when markets get nervous, just like it did recently when the US realised its weak jobs data. 

Finally, when the market steadies, and the global economy improves, we have the tools to add more riskier investments – like increase holdings of high yield bonds or corporate bonds more generally. 

Overall, it’s almost been two decades since Optimal Income strategy was launched. During this time, we believe having lots of flexibility – across duration and credit, and across global bond markets moreover – has been supportive of the strategy’s consistent, long-term investment performance.