Why should investors consider short-dated credit? M&G (Lux) Short Dated Corporate Bond Fund

Short-dated investment grade corporate bonds offer decent income potential, in our view, with little interest rate or credit risk. We believe the risk/reward dynamics are favourable, as it is a lower volatility asset class providing attractive yields. Our distinctive strategy takes a global approach to investing in short-dated Investment Grade (IG) corporate bonds, while adding diversification via off-benchmark instruments like floating rate notes and asset-backed securities (ABS), making full use of our extensive credit research teams and of our €15 billion + ABS capabilities.

The value of investments will fluctuate, which will cause prices to fall as well as rise. There is no guarantee the fund will achieve its objective, and you may not get back the original amount you invested. Where performance is mentioned, past performance is not a guide to future performance.

A defensive, lower volatility asset class

Inflation fears have re-ignited in the first quarter of the year as the Trump administration imposed tariffs on US imports and oil prices see-sawed on the ongoing Middle East conflict and continuing uncertainty over Russia’s war on Ukraine. In fixed income markets, resilience has been stronger at the shorter end of the yield curve than at the longer end. In this context, it is worth taking a deeper look at how investors could benefit from this asset class. When it comes to volatility, markets have had multiple reminders that it pays to look at the full duration spectrum (see Figure 1 below). 

Figure 1: Short-dated debt: Lower volatility, drawdown protection

Source: ICE BofA Indices, 31 January 2025.

Short-dated credit can potentially offer similar returns to more traditional corporate bonds, with less volatility. We see this as an attractive proposition for those who are less confident in making a duration call. As shown in Figure 1 on Page 1, over the last five years short-dated investment grade credit has had very similar returns to the all-maturity index. 

Of course, if you can call the top and bottom of the monetary policy cycle, then it pays to be in short-duration assets when interest rates are rising, and subsequently switch to longer-duration assets when interest rates fall. However, this is difficult to do, so we believe it makes sense to combine a structural allocation to short-dated investment grade debt with a more traditional allocation to corporate bonds.

The benefits of an active approach

Despite its attractive features, the short-dated debt market is not fit for simple index tracking, in our view. Tracking an index could potentially expose the investor to concentration risk, if the index has too many components from a certain sector/country, and default risk, if the index has too many components of low credit quality and/or weak balance sheets. 

Fixed income markets are notoriously inefficient, which we believe creates opportunities for active investors. Using the expertise of our large and experienced credit analyst team, we are able to exploit these inefficiencies in order to seek to generate outperformance over time. 

Importantly, an active approach ensures investors are diversified. Taking the M&G (Lux) Short Dated Corporate Bond Fund as an example, it can be seen that it has a greater level of diversification than the benchmark. 

While the benchmark is concentrated in European investment grade fixed rate assets, as a result of the flexibility of the mandate, we are diversified with positions across euro, US dollar and sterling-denominated fixed-rate bonds, investment grade floating rate notes, ABS and inflation-linked bonds. This means that we are reasonably uncorrelated with the benchmark -- the correlation coefficient towards the end of January was 0.435.

Figure 2: An active and diversified proposition

Source: M&G, for illustrative purposes only, as at 26 February 2025. Index is Markit iBoxx EUR Corporate 1-3 Year Index.

Some investors see our fund as a potential means to preserve capital while diversifying away from an index, whereas others also see it as a potential source of income. Indeed, although short-dated credit is a defensive asset class, there are attractive yields on offer in this part of the credit market, in our view (see Figure 3, below). 

Figure 3: Yield to maturity comparison: M&G (Lux) Short Dated Corporate Bond Fund vs credit quality spectrum

Past performance is not a guide to future performance

Source: M&G, as at 23 January 2025. For illustrative purposes only.

Why choose the M&G (Lux) Short Dated Corporate Bond Fund

There are three key features which, in our opinion, differentiate the M&G (Lux) Short Dated Corporate Bond Fund:

• Active global credit: The fund is not restricted to only euro-denominated investment grade credit, as it is not constrained by its euro benchmark; the fund managers can buy bonds denominated in any currency. This means greater opportunity for relative value trades across currencies and geographies, as well as access to companies that do not issue debt in euros. These small trades for spread and yield pick-up have the potential to incrementally add to performance over the long term.
  
  
• Floating-rate exposure: Floating rate notes are an off-benchmark position for the fund that allow the fund manager to gain exposure to credit without taking on duration risk. Due to their coupons, which typically reset quarterly, these instruments have almost zero duration. This means that in periods of rising interest rates, these instruments benefit from increases in the underlying risk-free rate, on top of which a credit risk premium is paid. This has been a positive contributor in the recent periods of inverted and flat yield curves that we have experienced, giving us extra carry from the front end of the curve.
  
  
• Asset-backed securities (ABS): The fund makes use of M&G’s leading capability in the ABS space – we have a strong and experienced team with €15.0 billion in assets under management (AUM). The fund invests in AAA rated ABS, which have historically provided a BBB corporate bond-like spread. Although this relationship has diverged in the last couple of years, it still offers a greater spread than traditional AA rated corporate bonds. These are high quality instruments on which we have done the credit research work, and they provide extra yield for the portfolio.

Additionally, we believe our strong analysis capabilities are another defining feature making us different to our peers. In our investing strategy, the key question that we always ask ourselves is: ‘are we being paid to take risk?’ Once the credit analysts have assessed the fundamentals of a corporate bond, the fund management team then determine whether we think the price is attractive versus those fundamentals. 

Identifying mispriced bonds is the cornerstone of our value-based investment approach, and we believe it has been the key to the fund’s long-term outperformance.

What the fund does, and how we drive active returns 

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 Markit 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 bonds held in the fund are generally issues due to be repaid within a short period. 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.

The fund is managed by lead fund manager Matt Russell and co-manager Ben Lord. The ‘engine room’ of the fund is M&G’s leading credit analyst team – in our view one of the largest and most experienced credit analyst teams in Europe, supported by further credit analyst resources in the US and Asia. We strongly believe that the key to success in short-dated investment grade credit is in doing the credit research work. Matt and Ben are also supported by the other highly experienced fixed income fund management team members, who offer best ideas across the asset classes. This strategy’s simple yet differentiated approach has generated healthy active returns for investors over a prolonged period.

Last year, performance was flat versus the benchmark and, although we want to generate alpha every single year, all things considered, we were comfortable with this exception. Over the course of 2024 we continued to increase the credit quality and liquidity of the portfolio. When credit spreads get tight, we increase quality – for example through covered bonds, or AAA rated ABS. By contrast, when spreads get wider, we will increase the risk in the portfolio. 

This is the investment approach that we have taken over the last 12 years. Examples of when this has worked well for us include in the run up to the COVID pandemic and the Russian invasion of Ukraine. While we do not anticipate events such as these, the prior environments were fairly benign, with expensive valuations necessitating an approach whereby we were light on credit risk. Therefore, when unexpected risk-off events occurred, we were well placed to add credit risk.

Past performance is not a guide to future performance

¹ Performance Comparison: The Markit iBoxx EUR Corporates 1-3 Year Index was introduced as the fund’s benchmark on 13 March 2018. Benchmark returns are stated in EUR. Index returns in the USD share class currency are not available. 

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. 

² Year to end of Most Recent Quarter: 31 December 2024

Source: Morningstar Inc. 28 February 2025, EUR C Acc and USD A-H Acc share class, income reinvested, price to price, net of all fees. Gross returns are product returns (priced at midday) from Morningstar, with the actual Ongoing Charge Figure reinvested back into the price, including income reinvested. Fund performance prior to 26 October 2018 is that of the M&G Short Dated Corporate Bond Fund, a UK-authorised OEIC, which merged into this fund on 26 October 2018. Tax rates and charges may differ. Performance data does not take account of commissions and costs incurred on the issue and redemption of units.

Main risks associated with this fund

• 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. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested. 
• 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. 
• 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. 

Further details of the risks that apply to the fund can be found in the fund’s Prospectus available on our website

Please note, 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.

Sustainable information:

The fund promotes Environmental/Social (E/S) characteristics and while it does not have as its objective a sustainable investment, it will have a minimum proportion of 20% of sustainable investments with an environmental objective in economic activities that do not qualify as environmentally sustainable under the EU Taxonomy and with a social objective

The fund’s sustainability information is available to investors on the fund page of the M&G website.

Find out more about the fund