Why Invest in High Yield Floating Rate Notes Today? M&G (Lux) Global Floating Rate High Yield Fund

• By their nature, high yield floating rate notes (HY FRNs) can potentially offer investors a valuable hedge against interest rate volatility, allowing them to lock in attractive levels of yield without sacrificing the potential for attractive returns.
  
  
• They offer some of the highest yields in fixed income, coupled with very low sensitivity to changes in interest rates (duration). We believe that from today’s¹ entry point, this could result in potentially attractive returns driven by carry² alone, while in a more adverse economic slowdown, HY FRNs’ defensive features could protect against downside risks.
  
  
• Over the long term, HY FRNs have demonstrated strong and stable returns, outperforming their closest investable peer group, the senior loan market.

Understanding HY FRNs

High yield FRNs are a growing segment within the global high yield bond universe, distinguished by three key features that set them apart from traditional high yield bonds:

1. Seniority in the capital structure: HY FRNs are issued as senior debt, sitting at the top of the capital structure. In the event of a default, bondholders benefit from the highest priority of claims, often leading to higher recovery rates compared to unsecured and subordinated debt.
   
   
2. Lower volatility than traditional HY bonds: HY FRNs tend to exhibit lower volatility than fixed-rate high yield bonds. This is due to their reduced sensitivity to changes in credit spreads, measured by spread duration. Credit spreads represent the difference in yield between corporate bonds and government bonds, and tend to widen when investors perceive greater risk in corporate bonds and tighten when confidence improves. 
   
   
3. Floating coupon structure: Unlike fixed-rate bonds, HY FRNs pay coupons that adjust periodically based on standard reference rates, including EURIBOR, SONIA, and SOFR for euro, pound sterling, and US dollar issuance respectively. Coupon payments reset quarterly, adjusting with the prevailing market rates. As a result, HY FRNs have a duration range between 0 and 0.25 years. 

Why do HY FRNs make sense for investors?

1. Compelling risk-reward

Despite tight credit spreads across the fixed income landscape, all-in yields for the global HY FRN asset class remain historically elevated at 6.75%, allowing investors to lock in attractive levels of income. 

Today, HY FRNs offer some of the highest yields in fixed income, coupled with very low sensitivity to changes in interest rates (see Figure 1 overleaf). While comparable yields may be found in traditional high yield bonds or emerging market debt, these alternatives imply taking on a greater amount of interest rate risk and potential volatility in a portfolio. 

Interest rate volatility has persisted into 2025, driven by heightened political uncertainty, concerns over economic growth, and shifting expectations for monetary policy. Factors such as the Trump administration's policies, rising inflation concerns, and questions surrounding Germany’s fiscal policy have all contributed to this turbulence. In this environment, HY FRNs could provide a valuable hedge against interest rate volatility, allowing investors to lock in an attractive level of yield without sacrificing the potential for attractive returns.

Past performance is not a guide to future performance

Figure 1: HY FRNs vs other fixed income asset classes   

Source: M&G, Bloomberg, 28 February 2025. Information is subject to change and is not a guarantee of future results. 

Global HY FRN: ICE BofA Global Floating Rate High Yield 3% Constrained Index US HY: ICE BoA US High Yield Index. Europe HY: ICE BoA European High Yield Index. Short Duration HY: ICE 1-3 Year US Corporate & HY Index. EM HY: ICE BoA HY US Emerging Markets Corporate Plus Index. CMBS: ICE BoA US Fixed Rate CMBS Index. EU ABS: ICE BoA Euro Asset Backed & MBS Index. UST: ICE BoA US Treasury Index. US IG: ICE BoA US Corporate Index. Bunds: ICE BoA German Govt Index. 

2. Resilient returns under different market environments

Historically, HY FRNs have benefited from relatively elevated carry levels, averaging 5.2% (USD hedged) over the past decade. This has reinforced their resilience across various market cycles, as the steady income generated by the asset class has helped enhance returns, even during periods of price volatility. 

Figure 2 overleaf illustrates this point, demonstrating how HY FRNs have delivered stable levels of income. The carry component has helped in further boosting returns during favourable years, while also providing a cushion against the downside during periods of widening credit spreads. 

Past performance is not a guide to future performance

Figure 2: HY FRNs have offered a consistent high income in all market environments

Source: M&G, Bloomberg, 31 December 2024. Global HY FRN index (ICE BofA Global Floating Rate High Yield 3% Constrained Index).

3. Compelling return potential

Looking ahead, we believe the economy remains in a reasonable position, despite some gradual deterioration. While risks to growth persist, overall high yield corporate fundamentals have remained relatively resilient, and we do not anticipate a broad-based recession. 

We expect central banks to continue normalising monetary policy, albeit at a slower pace than in 2024, given rising inflation concerns, particularly in response to US economic policy. 

The matrix overleaf (see Figure 3) outlines different scenarios for interest rates and high yield FRN credit spreads and aims to give an indication of potential total return outcomes over a 12-month period under the realisation of any of those scenarios. From today’s entry point, under a soft economic landing (characterised by a mild interest rate-cutting cycle -- progressively lower interest rates -- and well-behaved credit spreads), HY FRNs could potentially deliver mid-single digit returns based on carry alone (see data within the green square in Figure 3).

However, if economic conditions deteriorate more than anticipated (leading to wider credit spreads and a more adverse scenario), HY FRNs remain one of the most defensive segments of the high yield market. Their structural seniority and lower market beta provide a natural buffer against downside risk, helping to mitigate capital loss. With first claim on collateral in the event of a default and strong recovery rates, HY FRNs offer a less volatile return experience, even in more challenging environments. 

Thus, whether markets follow our soft landing expectations or take a more volatile path, the portfolio remains well-positioned to deliver healthy performance in both scenarios.

Past performance is not a guide to future performance

Figure 3: Scenarios -- how global HY FRNs might perform over the next 12 months

For illustration purposes only. This is not intended to provide expectations of future returns or yield and spread levels. Analysis based on a one-year holding period, assuming a static portfolio and parallel shifts in yield curves; excludes any exposure to equities. Analysis also assumes that any moves in rates and/or spreads are one-off shocks. Assumption of a 3% default rate with an average recovery of 60% for the floating high yield market and 30% for the global fixed high yield market. 

Source: M&G based on fund and index positioning, 11 March 2025. 

The fund’s base currency is the US dollar. Investors in the euro-denominated share classes will be exposed to changes in eurozone interest rates regardless of which underlying currencies the portfolio is invested in, due to currency hedging and to the principle of covered interest rate parity (CIRP) -- the market principle that underpins currency hedging and interest rates. According to CIRP, cross currency exchange rates quoted in the forward markets must reflect changes in interest rates between the two currencies over that same period, in order to prevent arbitrage opportunities and limitless risk-free gains in the markets.

Fund positioning and performance update

The fund aims to provide a combination of capital growth and income to deliver a return that is higher than that of the global floating rate high yield bond market (as measured by the ICE BofA Global Floating Rate High Yield Index (3% constrained) USD Hedged) over any five-year period. 

At least 70% of the fund is invested in high yield floating rate notes (FRNs), focusing on FRNs issued by high yield companies, which typically pay higher levels of interest to compensate investors for the greater risk of default. Part of the fund may be invested in other fixed income assets, such as government bonds. Asset exposure is gained primarily through physical holdings. Derivatives may also be used. 

The fund’s focus is on generating active return through credit selection whilst preserving an enhanced liquidity profile and avoiding the more pernicious downside of a hard default cycle, by being well diversified and more conservatively positioned than its benchmark.

The first months of 2025 have already seen a considerable amount of macroeconomic and market volatility. While investors have been focused on pricing in US growth and inflation signals, European markets have benefited from a more upbeat sentiment, driven by expectations of stronger growth and a potential resolution to the Ukraine conflict. Within high yield markets, this has led to the outperformance of European HY credit spreads, particularly over US high yield, which has been weighed down by tariff and growth concerns. 

Against this backdrop, we have taken the opportunity to increase our US fixed high yield senior secured risk exposure, both through primary and secondary markets. We also remain active in the HY FRN primary market, with new deals offering an opportunity to further diversify the portfolio and capture new issue premia. 

Performance-wise, the fund had a strong start to 2025, delivering +2.26% returns (as of 28th February 2025) ahead of its benchmark (Q884). It is also currently outperforming the main HY markets as well as its closest investable peer group, the senior leverage loan fund community (see Figure 4 below).

Past performance is not a guide to future performance

Fund performance: Monthly, quarterly and long-term

*Benchmark: ICE BofA Global Floating Rate High Yield Index (3% constrained) USD Hedged Index. For the EUR share class, benchmark prior to 01 April 2016 is the ICE BofA Global Floating Rate High Yield (EUR Hedged) Index. Thereafter, it is the ICE BofA Global Floating Rate High Yield 3% Constrained (EUR Hedged) Index. For the USD share class, benchmark prior to 01 April 2016 is the ICE BofA Global Floating Rate High Yield (USD Hedged) Index. Thereafter, it is the ICE BofA Global Floating Rate High Yield 3% Constrained (USD Hedged) Index. 

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.

Fund performance prior to 21 September 2018 is that of the M&G Global Floating Rate High Yield Fund (a UK-authorised OEIC), which merged into this fund on 7 December 2018. Tax rates and charges may differ.

Source: Morningstar, Inc and M&G, as at 28 February 2025. Returns are calculated on a price-to-price basis, net of fees, with income reinvested. Benchmark returns stated in EUR and USD terms respectively. Performance data does not take account of the commissions and costs that may incur on the issue and redemption of units. Not all share classes registered for sale in all countries. Details in Prospectus.

Figure 4: Fund versus high yield market performance

Past performance is not a guide to future performance

Source: ICE Bank of America Indices, 28 February 2025. Index performance shown 100% hedged to USD. Information is subject to change and is not a guarantee of future results.  

M&G (Lux) Global Floating Rate High Yield Fund, USD CI Acc. Global HY: ICE BoA Global High Yield Index (USD Hedged). Global HY FRN: ICE BofA Global Floating Rate High Yield 3% Constrained (USD Hedged) Index. US HY: ICE BoA US High Yield Index. Europe HY: ICE BoA European High Yield Index (USD Hedged). US Senior loans: S&P UBS Leveraged Loan Index (Formerly: Credit Suisse Leveraged Loan Index) 

HY FRNs are often seen as a more liquid alternative to investing in senior bank loans³. Over the longer term, the strategy has also delivered consistently greater returns than comparable senior loan strategies, both active and passive, demonstrating the value of its value-based, bottom-up driven active investment approach (see Figure 5 overleaf). 

Given the late-cycle market environment and tight spreads, our investment process is guided by robust credit selection. Our fund managers work alongside one of the largest and most experienced global credit research teams, with over 50 sector-specialist analysts across London, Chicago, and Singapore. This depth of expertise allows us to identify and capture the best risk-adjusted opportunities in the market. 

This disciplined approach has delivered strong results, with the fund experiencing significantly fewer defaults than the benchmark, with an average default rate of 0.47% vs. 2.3% for the benchmark over the past decade. 

Our depth of investment experience, combined with our global research capability, allows us to identify and take advantage of market mis-pricings across the global high yield spectrum, in our opinion. As volatility remains elevated, we believe active management and disciplined credit selection will be critical to navigating the current environment, making strong credit research capabilities more critical than ever.

Figure 5: Strong long-term outperformance vs comparable strategies

Past performance is not a guide to future performance. 

Source: M&G, Bloomberg, 31 December 2024. Performance shown hedged in USD. Information is subject to change and is not a guarantee of future results. Comparison made on a like-for-like basis. Details on competitor ETF funds shown are available on request. 

Further details of the risks that apply to the fund can be found in the fund's Prospectus.

Other important information

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 explanation of the terms used in this document, please refer to the glossary.

Find out more about the fund

¹ As at the time of writing, 11 March 2025.
² Here, carry refers to the income received by bondholders from regular coupon payments. 
³ FRNs are traded in a more liquid market, with T+2 settlement. US loans are less liquid, with typically T+5 to T+10 days to settlement.