| Spread duration | Rates duration |
| 1.5 years in EUR (1.2 years) | 1.1 years in EUR (0.7 years) |
| 1.1 years in GBP (1.2 years) | 0.4 years in GBP (0.6 years) |
| 0.4 years in USD (0.5 years) | 0.2 years in USD (0.3 years) |
| 3 years (3 years) | 1.7 years (1.6 years) |
Fixed income
Time to get defensive on interest rate risk? M&G (Lux) Short Dated Corporate Bond Fund
3 min read 8 Jul 24
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- Inflationary pressures may be easing, but uncertainty on the direction of bond yields remains, and this continues to impact fixed income portfolios as we enter the second half of 2024.
- The M&G (Lux) Short Dated Corporate Bond Fund is a defensive short-dated strategy. With its low duration range between 0 and three years (currently we are at 1.7 years), it is designed to protect against the unpredictable path of interest rates after the pandemic.
- A global credit analysis research team helps us select quality bonds at what we see as good valuations. We believe that short-dated corporate bonds, coupled with high-quality credit exposure to boost alpha generation, may offer an attractive risk-reward route in 2025 and beyond.
The value and income from the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested.
Protecting against interest rates volatility
At the start of the year, the consensus seemed to be that inflation was under control and that central banks would begin cutting interest rates. While inflationary pressures are thankfully easing, economic growth has shown resilience, particularly within the bellwether US economy. As a result, we have seen market expectations gyrate, with some investors pushing back their expectations of interest rate cuts to 2025.
While we believe the direction of travel is for central banks to begin to cut rates this year (it’s true that the ECB did so in June for the first time since 2019, but crucially, the US Federal Reserve has hinted at just a single cut in 2024), we would like to highlight the contemporary relevance of a lower duration strategy in corporate bond portfolios, and to argue that there is a place for strategies with lower interest rate risk exposure in a fixed income portfolio.
Considering a lower duration position – the M&G (Lux) Short Dated Corporate Bond Fund holds around 1.7 years of exposure to changes in interest rates - could protect against and minimise the risks of interest rates volatility over the coming months, in our opinion. Such a strategy could also provide a hedge against the long duration trade, should inflation become stickier than we all fear and consequently interest rates take even longer than expected to come down.
While past performance is never a guide to future performance, looking at a short-dated credit index versus a longer-dated credit index over the past few years may offer a useful illustration of the lower volatility profile that we would expect to accompany a shorter-duration portfolio.
Figure 1, overleaf, is a simple representation of the index values of European investment grade corporate bonds compared to the values of similar, good quality bonds but with a shorter duration exposure (in this case 1-3 years; the dark teal line appears smoother). We suggest this chart shows that since the advent of high rates uncertainty (in 2021 and still ongoing), which has been a big problem for bond investors, there has been less drawdown volatility in the case of low duration bonds. This was matched by a better total return profile.
Past performance is not a guide to future performance
Figure 1: The power of (low) duration - European IG index vs the short-dated European IG index
Source: ICE BofA Indices, 31 May 2024. *Total returns rebased from 31/12/2018
High quality corporate bonds issued at the shorter end of the yield curve are an asset we like, and we have been selectively active in this space for over 30 years (the strategy was launched in 1993 with an UK OEIC). Yet a scenario of bond yield volatility mentioned above has altered short-dated corporate bonds’ risk-reward opportunity set, in our opinion. If we consider Figure 2 below left – a very simple representation of different types of investment grade indices’ all-in yield1 - we are seeing different duration risk characteristics, yet yields on offer are very similar.
Based on data for the whole of 2022 – purposely chosen because it was the bond market’s annus horribilis (horrible year in Latin) - maximum drawdown losses were also smaller (about a third) for short-dated credit compared to longer-dated credit (see Figure 3, below right). So while 2022 was extremely tough for all investment grade bonds, lower-duration products had seemingly stronger loss-limiting qualities versus those investment grade bonds with longer maturity horizons.
Past performance is not a guide to future performance
Figure 2: All-in-yields look similar, but duration risk differs
Source: M&G Investments and Bloomberg indices – data extracted 31 May 2024. Please note - indices are not investible.
Figure 3: Maximum drawdown in 2022 (%)
Source: M&G Investments and Bloomberg indices – data extracted 31 May 2024. Please note - indices are not investible.
Active management is even more important today
Given volatility in interest rates and generally tighter credit spreads, let’s look at the three key ways we believe we can add value across the M&G (Lux) Short Dated Corporate Bond Fund.
Active in Global Credit - One area where we believe we can add value is being active within the global corporate bonds market – and in the process drawing on the expertise of M&G’s in-house credit research team as we seek to identify the most compelling opportunities across global credit markets. We believe the current backdrop of a more volatile market environment with increasing dispersion between individual credit valuations can provide a rich source of alpha-generating opportunities for active managers such as ourselves.
Figure 4, below, shows that within credit risk we currently favour being diversified across Europe and the UK in the main; rates risk is more biased towards Europe compared to this time in 2023 as we feel valuations are somewhat better.
Figure 4: Positioning across credit and rates this year vs. last year (2023)
The portfolio’s relative risk levels within interest rates and corporate bonds as at 31/05/24 compared to 31/05/23.
Source: M&G Investments, internal data only and subject to change. Data extracted 31 May 2024.
Our research premium in ABS - We consider M&G as something of a leader in investing in UK and European asset-backed securities (ABS), in which the fund can invest. The relative complexity of researching ABS is a key reason, in our view, why this asset class offers investors a risk premium in excess of regular corporate bonds. Investing in AAA rated ABS (in the below example, residential mortgage-backed securities) has in the past offered a similar level of credit spread to investors as short-dated BBB rated corporate bonds - and higher than short-dated AA rated corporate bonds. See Figure 5, below.
Figure 5: ABS complexity premium. AAA rated ABS have offered a similar risk premium to BBB corporates
Accessing the variable bond market - The fund also has the flexibility to invest in the floating rate note (FRN) market – these are bonds with coupons that fluctuate, or vary, with interest rates. Because coupons paid to investors (such as ourselves) by the issuer are made of a variable component plus a fixed spread, we argue that some sensible exposure can help protect investors from elevated rates and also add some upside coupon potential. As at 31 May 2024, portfolio exposure in FRNs was around 7.5%. These bonds are issued mostly by banks to help with their short-term liability matching. This can mean FRN exposure is sector-biased, with financial companies dominating issuance.
Fund Description
The fund aims to provide combined income and capital growth that is higher than that of the short-dated investment grade corporate bond market (as measured by the iBoxx EUR Corporates 1-3 year Index) over any five-year period while applying environmental, social and governance (ESG) criteria. At least 80% of the fund is invested in investment grade bonds issued by companies from anywhere in the world and asset-backed securities.
The fund manager considers principal adverse impacts on sustainability factors when investing. The bonds held in the fund are generally issues due to be repaid within a short period so as to minimize the effect of interest rate movements on the fund’s value. Engagement to help companies improve their behaviour and transparency regarding ESG forms a key part of the fund’s investment approach.
Asset allocation and stock selection are at the heart of the fund’s investment process. The fund invests in securities that meet the ESG criteria, applying an exclusionary approach as described in the prospectus. The fund’s recommended holding period is five years. In normal market conditions, the fund’s expected average leverage – how much it can increase its investment position by borrowing money or using derivatives – is 150% of its net asset value.
Past performance is not a guide to future performance
Figure 6: Performance: YTD, YTQ (%) and calendar-year performance (pa%)
| 2024 YTD | YTQ | 2023 | 2022 | 2021 | 2020 | |
|---|---|---|---|---|---|---|
| Fund (EUR) | 1.0 | 0.7 | 5.8 | -4.1 | 0.2 | 1.9 |
| BM* (EUR) | 0.9 | 0.6 | 5.1 | -5.2 | 0.0 | 0.7 |
| 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | |
| Fund (EUR) | 2.7 | -2.4 | 1.0 | 2.3 | -0.3 | 1.9 |
| BM* (EUR) | 1.4 | n/a | n/a | n/a | n/a | n/a |
YTQ = year to most recent quarter.
*The Markit iBoxx EUR Corporates 1-3 Year Index was introduced as the fund’s benchmark on 13 March 2018.
The benchmark is a comparator against which the fund’s performance can be measured. The index has been chosen as the fund’s benchmark as it best reflects the scope of the fund’s investment policy. The benchmark is used solely to measure the fund’s performance and does not constrain the fund's portfolio construction.
The fund is actively managed. The investment manager has complete freedom in choosing which investments to buy, hold and sell in the fund. The fund’s holdings may deviate significantly from the benchmark’s constituents. The benchmark is shown in the Share Class currency.
Source: Morningstar Inc., 31 May 2024, EUR A Acc share class, net of fees, income reinvested, price to price. Performance data do not take account of any commissions and costs incurred on the issue and redemption of units. Fund performance prior to 26 October 2018 is that of the equivalent UK-authorised OEIC, which merged into this fund on 26 October 2018. Tax rates and charges may differ.
Main risks associated with this fund:
- Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund. High yield bonds usually carry greater risk that the bond issuers may not be able to pay interest or return the capital.
- The fund may use derivatives to profit from an expected rise or fall in the value of an asset. Should the asset’s value vary in an unexpected way, the fund will incur a loss. The fund’s use of derivatives may be extensive and exceed the value of its assets (leverage). This has the effect of magnifying the size of losses and gains, resulting in greater fluctuations in the value of the fund.
- The fund is exposed to different currencies. Derivatives are used to minimise, but may not always eliminate, the impact of movements in currency exchange rates.
- Investing in emerging markets involves a greater risk of loss due to greater political, tax, economic, foreign exchange, liquidity and regulatory risks, among other factors. There may be difficulties in buying, selling, safekeeping or valuing investments in such countries.
Other important information
- The fund makes extensive use of derivatives.
- Investing in this fund means acquiring units or shares in a fund, and not in a given underlying asset such as a building or shares of a company, as these are only the underlying assets owned by the fund.
For an explanation of technical terms, please refer to the glossary via the link:
https://www.mandg.com/dam/global/shared/en/documents/glossary-master-en.pdf
For European investors, the fund’s sustainability-related disclosures can be found at the following link: