Credit: A bulwark against market volatility?

5 min read 17 Apr 24

Credit: A bulwark against market volatility?

Gaurav Chatley, rated AAA by Citywire, manages the M&G European Credit Investment Fund. In an interview, he explains how, as a bottom up investor, the strategy has been able to, according to him, capture attractive investment opportunities during episodes of market volatility.

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. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance.

The M&G European Credit Investment Fund was launched in 2011. What are its main features?

The M&G European Credit Investment Fund is €5.07 billion in size (as at 13 March 2024) and primarily invests in euro-denominated investment grade corporate bonds. It is highly diversified and uses a bottom-up approach. With little exposure to high yield, the fund takes no active position in interest rates, inflation or currencies. These risks are kept at neutral levels relative to its benchmark, the ICE BofA Euro Corporate Index, and aims to provide a total return in line with the index plus 0.75% (gross of fees per annum), over any five-year period.

We invest throughout the cycle. We find this a particularly effective approach, especially when the market is highly volatile, illiquid or experiencing episodes of turbulence. During these episodes, risk and valuation can become increasingly mis-aligned, allowing us to identify attractive opportunities when the market falls. Similarly, as markets normalise and prices reach fair value or become overvalued, we begin to reduce risk. With our investment approach, we tend to operate in a way that is different from the rest of the market.

What are the benefits of this approach for an investor?

We manage a highly diversified portfolio with close to 600 positions, which tends to have a long-term beta very close to the index. Something you're likely to get from a passive ETF. At the same time, we think that our active approach allows us to outperform by focusing on stock selection. In our opinion, the fund is a good alternative for investors who are usually more focused on passive management to gain exposure to the asset class.

What were the performance drivers last year?

The market was fairly volatile in 2022, mainly because of the conflict in Ukraine, rising levels of inflation and central bank rate hikes. As markets weakened, we found a large number of opportunities which we took advantage of. As we gradually built up risk positions in the fund over the year, we ended the year with long positions in credit.

When the market recovered significantly in the first quarter of 2023, and after the market turbulence from the financial sector in March 2023, many of the specific positions we had added in the fund made a positive contribution to overall performance.

These included the utilities, financial services and property sectors, which contributed to our performance over the year as a whole. Ultimately, we outperformed the index by 0.93% in 2023.

We are focusing on valuations, taking care to sufficiently offset the credit risk we hold at any given time.

Source: M&G, Benchmark: ICE BofA Euro Corporate Index (Ref.ER00) *Inception date, 12 April 2011 for oldest share-class (E) which is closed to new investors.**New institutional investors are eligible to invest in share-class A which has a TER of 0.18% p.a. other share classes are available. Data as at 29 February 2024.

How has 2024 started? 

We think that 2024 has got off to a good start. We have outperformed the index by 0.74% to date (As at 29 February 2024). At the end of last year, the market was forecasting a peak in the interest rate cycle. As a result, a rate cut was in sight, which was supported by the language of the central banks. There was a rally in the investment grade market and credit spreads tightened in the fourth quarter of 2023. This led to a significant recovery in interest-rate-sensitive positions, in which we were overweight relative to the benchmark.

The property sector, for example, is one of the most interest-rate-sensitive sectors in our universe at the moment. We focused on investment grade companies, which generally have an LTV ratio of 40% to 50% on average. We also looked at companies that still have a lot of access to secured funding or that have good quality assets that they are prepared to sell, if necessary, to get through the next two or three years of the liquidity crisis that these companies are facing. In terms of asset quality, we are fairly well covered. Our overweight in the sector is around +2.63%.

Clearly, with the recovery in the rates market in the fourth quarter of last year, many companies have been able to access the unsecured lending market and start funding some of the bonds that were due to be issued over the next two or three years. This creates a positive cycle for these companies: the more they are able to refinance, the more they are able to extend their liquidity window. As a result, the property market has continued to recover.

What will you be keeping an eye on over the next few months?

There are a lot of political uncertainties that are causing volatility in the market. There's obviously the situation in Ukraine and the Middle East, but there are also other risks from China concerning economic growth and geopolitics, which are factors of volatility. Not forgetting the US elections and a repeat of the 2020 election between Joe Biden and Donald Trump. A second Trump presidency could be a major factor that contributes to volatility in Europe.

Many other risks could add volatility to the markets. It's in this context that we try to move away from predicting market trends and not position ourselves according to them. Many things can go wrong, but our bottom-up approach and the diversity of positions within the fund allow us to find opportunities and value.

We will continue to focus on credit fundamentals and careful selection of individual stocks, and take advantage of any future market weaknesses. A number of opportunities are still emerging in the financial, utilities and property sectors however, investment opportunities are becoming scarce as credit spreads continue to tighten.

Ratings should not be taken as a recommendation.

Please note, investing in this fund means acquiring units or shares in a fund, and not in a given underlying asset such as building or shares of a company, as these are only the underlying assets owned by the fund.

Main risks related to the fund:

Market risk: The value of investments and the income from them will rise and fall. This will cause the Sub-Fund price, as well as any income paid by the Sub-Fund, to fall as well as rise. There is no guarantee the Sub-Fund will achieve its objective, and you may not get back the amount you originally invested.

Credit Risk: The value of the Sub-Fund may fall if the issuer of a fixed income security held is unable to pay income payments or repay its debt (known as a default).

Interest Rate Risk: When interest rates rise, the value of the Sub-Fund is likely to fall.

Derivatives Risk: The Sub-Fund may use derivatives to gain exposure to investments and this may cause greater changes in the Sub-Fund's price and increase the risk of loss.

Asset-Backed Securities Risk: The assets backing mortgage and asset-backed securities may be repaid earlier than required, resulting in a lower return.

Contingent Convertible Debt Securities Risk: Investing in contingent convertible debt securities may adversely impact the Sub-Fund should specific trigger events occur and the Sub-Fund may be at increased risk of capital loss.

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

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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