An active and flexible mandate will be key in 2025 – M&G (Lux) Optimal Income 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 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. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.

Monetary policy is working with a lag and interest rates are coming down from their historical high level. As a consequence, inflation is easing, but we are seeing some tensions in key indicators such as housing and jobs. Currently, we are very mindful of a slowing US jobs market based on quit rates and hiring rates, making the chance of a recession higher than many investors believe. (Please see our recent BV blog - The US Economic Outlook: Labour Market Puzzle - "You're Hired or You're Fired" - Bond Vigilantes). All this change can impact asset prices, so it’s crucial to be as flexible and active in our bond calls as we can. Going forward, Trump’s convincing victory lends itself to different scenarios for the world’s biggest economy – there’s potential for higher growth and lower inflation should energy prices fall. There is also the overhang of a possible trade/tariffs war and its possible repercussions on the overall economy. We are ready to adjust our bond exposures based on our macro view. 

Why we favour duration, cautious on credit 

We have amongst the longest duration (7 years) call since inception. We believe duration is currently attractive as inflation and declining rates dynamic are strengthening the risk-reward for government bonds. Within our duration positioning, we currently favour US Treasuries over other markets. Conversely, we are more cautious on credit, as the extra compensation for holding this asset class is historically low and does not, in our view, adequately reflects some of the negative economic dynamics. However we continue to be active whether in pinpointing relative value trades or taking advantage of market volatility. Over the course of the year, we have reduced credit risk mainly through our high yield holdings, resulting in an underweight position. Equities remain a small part of our universe and are a ‘proxy’ for high yield. Currently, company shares exhibit an historically poor income stream compared to bonds. 

Source: M&G. Portfolio positioning for the M&G (Lux) Optimal Income Fund at 31 December 2023 vs 30 November 2024. *Vs portfolio neutral weight of 33% **Compared to historical average of c5% (max allocation to shares is 20%).

Outlook

Interest rates are at their peak and given inflation – a natural enemy of the bond investor - is coming down, we believe the risk-reward is stronger for owning bonds than in previous cycles (but with a limited downside as rates have little room to go higher, coupled with a greater capacity to fall from current high levels). As an active bond house, we can adjust and position our bond exposures across what is a large and global asset universe, using the full resources of our in-house expert team and based on our robust valuation framework. 

Performance 

• The year so far has been marked by declining inflation and resilient economic growth (but with signs of labour market uncertainty), particularly in the US. This resilience has facilitated tighter spreads while maintaining relatively elevated interest rates. 
  
  
• In this environment, the strategy has generated a positive absolute return, primarily driven by credit. Duration has also contributed positively to the overall performance supported by the coupon income generated. Additionally, our limited exposure to equities has contributed marginally to the overall performance.
  
  
• Relative to the index, the fund has underperformed, primarily due to our duration positioning, as interest rates have ended the period to date generally higher. In terms of credit, performance remains marginally negative. Notably, our underweight exposure to physical high yield and emerging market bonds have detracted the most, while our overweight positioning in financials and high yield CDS indices have benefited relative performance.

Figure 2. Performance: YTD, YTQ (%) and calendar-year performance (pa%) 

Past performance is not a guide to future performance 

YTQ = year to most recent quarter.

*Benchmark: 1/3 Bloomberg Global Aggregate Corporate Index EUR Hedged, 1/3 Bloomberg Global High Yield Index EUR Hedged, 1/3 Bloomberg Global Treasury Index EUR Hedged. The composite index was introduced as the fund’s benchmark on 7 September 2018. Fund performance prior to 7 September 2018 is that of the equivalent UK-authorised OEIC, which merged into this fund on 8 March 2019. Tax rates and charges may differ. 

The benchmark is a comparator used solely to measure the fund’s performance and reflects the scope of the fund’s investment policy but does not constrain portfolio construction. The fund is actively managed. The fund’s holdings may deviate significantly from the benchmark’s constituents. The benchmark is not an ESG benchmark and is not consistent with the ESG Criteria.

Source: Morningstar, Inc., as at 30 November 2024, Euro Class A Acc shares and USD Class A-Hedged shares, price to price, income reinvested. Performance data do not take account of the commissions and costs that may incur on the issue and redemption of units. Not all share classes are registered for sale in all countries. Details in Prospectus.

Fund description

The fund aims to provide a combination of capital growth and income to deliver a return based on exposure to optimal income streams in investment markets, while applying environmental, social and governance (ESG)  criteria. It seeks to make these investments using an exclusionary  approach, as described in the prospectus. Typically, at least 50% of the portfolio is invested in a broad range of fixed income securities of any credit quality and from any country, including emerging markets, and denominated in any currency. The fund manager selects investments wherever he sees the greatest opportunities, based on his assessment of a combination of macroeconomic, asset, sector and stock-level factors. The manager may also hold up to 20% of the portfolio in company shares when he believes they offer better value than bonds. 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 200% of its net asset value.  

Further risk factors that apply to the fund can be found in the fund's Prospectus. The Fund’s sustainability information is available to investors on the Fund page of the M&G website. 

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

This is a marketing communication. Please refer to the Prospectus and the KID before making any final investment decision.

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