M&G’s Woolnough cuts duration to record low
The manager has cut duration in the £15bn fund to just two years, having taken profits on a short position in US two-year government debt. Short-dated US debt has sold off more than long-dated debt this year, a development which is sometimes seen as indicative of a forthcoming US recession.
But Mr Woolnough has increased his short position in 10-year government debt in the belief that this fear is not justified by the fundamentals.
Gordon Harding, an investment specialist on the fund, said: “The reason for [the duration shift] has been the steep falls in government bond yields at the start of this year.
“We [believe] the labour market in the US is very strong at the moment,” Mr Harding said. “We also think that the manufacturing industry isn’t a big driver of the US economy - it has been in decline over the last 80 years or so. Meanwhile the services sector has been doing very well.”
Instead, Mr Woolnough and team are now focusing more on credit spread movements. Spread duration - the fund’s sensitivity to a tightening or widening of the gap between government bond and corporate bond yields - now stands at six and a half years.
“We increased the credit risk in the fund. We are reasonably bearish on the outlook for government bond yields, but positive on the outlook for credit spreads,” Mr Harding said.
“It’s much more likely that performance is driven by credit spreads contracting than further falls in government bond yields.”
The shift in the fund’s focus came as deputy fund manager Stefan Isaacs warned investors were “not being compensated” for taking interest rate risk.
Mr Isaacs said: “The Optimal Income fund [....] has very little interest rate risk [...] reflecting the fact that we do think that government bond yields are very low by historic standards, that the economy is actually doing relatively well and as a consequence you’re not being compensated.”
“Spread duration is significantly higher than our interest rate risk at six and a half years, looking to take an advantage of tightening spreads, and the fund will have benefited from spreads having come in in the last couple of weeks,” he added.
Optimal Income has been under intense scrutiny in the last year as M&G seeks to reassure investors amid major outflows. According to FE Analytics, the vehicle’s assets under management exceeded £24.5bn in late 2014, before falling from April 2015 onwards to the current level of £15bn.
Last October Mr Woolnough told investors he still had the flexibility to adapt to these redemptions.
“The levers you can pull are still enormous in this fund,” he said. “When the fund gets larger and larger it’s harder to add [value] with individual stock selection.
According to FE Analytics the fund has returned 8.6 per cent over three years, compared with 8.3 per cent from peer group the Investment Association Sterling Strategic Bond sector.
Despite underperforming in 2015 the fund is also now ahead of peers over one year, shedding 0.9 per cent versus a sector average loss of 1.4 per cent.
