Seeking income and interest rate protection with the M&G (Lux) Global Floating Rate High Yield Fund

8 min read 12 Nov 21

Summary: Actively managed global HY FRN strategies can allow investors to take a more defensive approach than by simply allocating to the broader market.

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

Low duration strategies attract investors’ attention

Ever since central banks unleashed unprecedent stimulus in response to the global pandemic, investors have been questioning how and when monetary policy will be tightened. The US Federal Reserve appears keen to avoid a repeat of 2013’s ‘taper tantrum’ and has signalled reduced monthly asset purchases before the end of the year, with potential interest rate rises in 2022. The European Central Bank may follow suit. However, recent inflation surges have intensified the debate around whether central banks can keep prices under control without disrupting financial markets.

At the same time, bond yields and investment grade credit spreads remain close to all-time lows, which has led many investors to turn their attention to low duration strategies. Among these, high yield floating rate notes (HY FRNs) have offered several potential advantages, including attractive income, relatively strong liquidity and interest rate protection. In today’s uncertain monetary policy environment, and with low default outlooks for many sectors, we believe the asset class may provide further potential opportunities in the period ahead.

Please remember that 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.

What are the potential benefits of global HY FRNs?

Physical HY FRNs share many similarities with traditional HY bonds, offering high potential yields due to their non-investment grade status, while providing additional duration protection through floating rate coupons. We estimate the global market is c.$50 billion in size1, with over 80% of notes rated as senior-secured, compared to less than 20% of the fixed rate market2. We believe the attractive yields of FRNs, currently c.3.8%3, combined with their lower duration, have contributed to their outperformance over other HY bonds in 2021.

Figure 1. High yield bonds performance comparison, 2021 YTD

Past performance is not a guide to future performance.

Source: BofA indices, 31 August 20214

The majority of HY FRN issuance takes place in Europe. In the US, borrowers typically access the loans market, which is much larger than its European counterpart. These loans are comparable to HY FRNs due to their floating rate coupons and non-investment grade credit ratings – however, HY FRNs have a significant potential liquidity advantage over loans. In normal market conditions, HY FRN settlement times are typically T+2 days, compared to T+5 to T+10 days for US leveraged loans and up to T+30 for European loans. This additional liquidity can help HY FRN strategies, such as the M&G (Lux) Global Floating Rate High Yield Fund, offer daily dealing, including in stressed market conditions, such as those in 2020.

A portfolio’s liquidity and potential opportunity set can be further enhanced by creating HY FRNs synthetically. We look to achieve this in two ways: firstly, we may purchase a fixed rate HY bond and effectively remove duration using interest rate swaps. This significantly increases the fund’s investable universe, given the breadth and depth of the global HY bond market. Alternatively, we may sell HY credit default swaps, which allow us to access the HY market’s credit risk premium with better liquidity than through physical bonds. 

Actively managed global HY FRN strategies can allow investors to take a more defensive approach than by simply allocating to the broader market. The M&G (Lux) Global Floating Rate High Yield Fund has access to a far wider range of issuers than its benchmark, the ICE BofAML Global Floating Rate High Yield Index (3% constrained), due to the index’s minimum issue size constraints. This allows us to seek to create a more diversified portfolio, with a view to protecting capital, reducing volatility and capturing additional potential opportunities. 

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.

How is the fund positioned?

As shown below, the fund is invested primarily in physical FRNs, with this allocation having been increased in 2021 to its highest weighting since inception. This is because we believe HY FRNs currently offer a potentially attractive relative value opportunity versus fixed rate HY bonds. We have maintained structurally underweight exposure to the retail and energy sectors, as we believe this helps to reduce volatility and support long-term diversification. We also continue to prefer asset-heavy companies, which potentially have higher recovery rates in default scenarios, and defensive sectors, such as media and telecommunications.

Figure 2. Fund positioning

How has the fund performed?

The M&G (Lux) Global Floating Rate High Yield Fund has delivered positive long-term returns, with particularly robust performance over the past year. The fund’s performance relative to its benchmark highlights our more conservative approach to investing in HY FRNs compared to the index, which is driven by our focus on maintaining portfolio liquidity, diversification and reducing volatility. Our structurally underweight allocations to the energy and retail sectors have naturally resulted in less exposure to some areas of the post-lockdown ‘reflation trade’. We have also kept minimal or no exposure to some distressed index constituents, which have since recovered. 

Returns (%) YTD  1yr pa 3yrs pa 5yrs pa Since inception pa*
Fund
(EUR A‑H) 
3.85 9.94 1.41 1.78 1.63
Benchmark 5.23 12.01 3.86 3.69 3.38
Sector 3.10 7.67 3.45 2.96 2.60

 

Returns (%) 2020 2019 2018 2017 2016
Fund
(EUR A-H)
-0.75 4.25 -2.57 1.62 6.51
Benchmark  1.99 6.84 -1.30 2.73 11.13
Sector 2.40 9.31 -5.08 4.29 9.89

Past performance is not a guide to future performance.

*Share class inception date: 11 September 2014.This is the inception date of the UK-authorised OEIC. Fund performance prior to 21 September 2018 is that of the equivalent UK-authorised OEIC, which merged into this fund on 7 December 2018. Tax rates and charges may differ.

Benchmark prior to 01 April 2016 is the ICE BofAML Global Floating Rate High Yield (Hedged) Index. Thereafter it is the ICE BofAML Global Floating Rate High Yield 3% Constrained (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.

The fund allows for the extensive use of derivatives. Further risks associated with the fund can be found in the fund’s Key Investor Information Document, available on the M&G website.

Why invest with M&G?

M&G is one of Europe’s leading active bond managers, with $243 billion of fixed income funds under management5. Our in-house credit research team is among the largest in Europe and we have access to an additional team of in-house analysts in the US. We believe global HY FRNs represent an attractive potential opportunity, given our extensive capabilities in this area and the uncertainty in the broader macro environment. In our view, the M&G (Lux) Global Floating Rate High Yield Fund remains well-positioned to capitalise on these potential opportunities for investors.

The views expressed in this document should not be taken as a recommendation, advice or forecast. 

Distribution of this document in or from Switzerland is not permissible with the exception of the distribution to Qualified Investors according to the Swiss Collective Investment Schemes Act, the Swiss Collective Investment Schemes Ordinance and the respective Circular issued by the Swiss supervisory authority ("Qualified Investors"). Supplied for the use by the initial recipient (provided it is a Qualified Investor) only, not for onward distribution to any other person or entity. 

The collective investment schemes referred to in this document (the "Schemes") are open-ended investment companies with variable capital incorporated in Luxembourg. The Instrument of Incorporation, Prospectus, Key Investor Information Document, as well as the annual or interim Investment Report and Financial Statements can be obtained free of charge in English from M&G International Investments Switzerland AG, Talstrasse 66, 8001 Zurich or from Société Générale, Paris, Zurich Branch, Talacker 50, P.O. Box 5070, 8021 Zurich, which acts as the Swiss representative of the Schemes (the "Swiss Representative") and acts as their Swiss paying agent.

Before subscribing investors should read the Prospectus, which includes a description of the investment risks relating to these funds. M&G International Investments S.A. may terminate arrangements for marketing under the new Cross-Border Distribution Directive denotification process.  

This financial promotion is issued by M&G International Investments S.A. Registered Office: 16, boulevard Royal, L 2449, Luxembourg.

 1 Source: Bloomberg, M&G analysis, 31 August 2021

 2 Source: M&G, Moody’s Research, ICE BofAML Global Floating Rate High Yield Index (3% constrained), ICE BofAML Global Fixed Rate High Yield Index, 31 December 2020.

 3 Source: Bloomberg, ICE BofAML Global Floating Rate High Yield Index (3% constrained), 21 September 2021

 4 Source: Global HY: ICE BoA Global High Yield Index. Global HY FRN: ICE BofA Global High Yield Floating Rate Loan (3% Constrained) Index. US HY: ICE BoA US High Yield Index. Europe HY: ICE BoA European High Yield Index., 31 August 2021.

 5 Source: M&G, 30 June 2021.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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