Bulent Badsha, Portfolio Manager at M&G Investments
For investors seeking lower-risk investment solutions with some capital growth potential, multi-asset income funds have become a popular choice, particularly in the current elevated interest rate environment where these funds have the potential to deliver higher-than-usual returns and equity performance has been disappointing.
At M&G Investments, our investment approach of being valuation-based, long-term and active is enshrined in our multi-asset income solution in the unit trust space, the M&G Enhanced Income Fund. Our investment process allows us the flexibility to construct the portfolio in favour of the most attractive mix of assets from within the traditional fixed income universe of money market, floating rate notes (FRN’s), nominal bonds, inflation-linked bonds (ILB’s) and foreign bonds. Importantly, however, we can also allocate tactically outside of these assets to interest rate swaps (IRS), bond options, listed property, currency and even equities. An advantage of being part of an established global asset manager is that we also take advantage of the global depth and breadth of the M&G Public Fixed Income Team in accessing foreign bond investments.
One instrument type we avoid, however, is structured products such as Credit Linked Notes (CLN’s), due to their opaque nature. We do not approve of the cost-plus accrual methodology some use to price these instruments, thereby avoiding mark-to-market pricing and creating an illusion of low volatility. Rather, we prefer to be very transparent in the risks that the fund assumes and use JSE-published market values for listed assets where we deem these to be fair, and mark-to-market our unlisted money market instruments as well.
Longer-term management lessons
Of course, no fund with 14 years of history can have perfect performance given the ups and downs of financial markets, not to mention the major disruptions caused by the 2013 “Taper Tantrum”, December 2015’s “Nenegate” drama and the Covid-19 crash. Given the importance of avoiding meaningful drawdowns for investors in this lower-risk fund category, over time we realised that employing a long-term Strategic Asset Allocation (SAA) model in managing the fund was not ideal, in that its relative strictness resulted in excess volatility. As such, we refined the process by introducing more flexibility into the asset allocation process, managing it more tactically and adjusting position sizes more frequently. This worked well in the Covid-19 crash, mitigating the fund’s drawdowns relative to its peers, and has subsequently resulted in less volatility.
Weathering more recent storms
The most recent incident that caused a meaningful drawdown for local fixed income assets was the “Lady R” affair. The comments made by the US Ambassador to South Africa in early May sparked severe sell-offs in both the rand and South African bonds to record-weak levels. Although the M&G Enhanced Income Fund did experience a drawdown, this was relatively well contained because in prior months we had been actively reducing the fund’s risk, giving it limited exposure to interest rate risk ahead of the sell-off. And as the geo-political tensions eased in June, both the currency and local bonds recovered, with the fund performing strongly. The incident afforded us the opportunity to increase our interest-rate exposure at very attractive yield levels at a time when we had capacity to increase risk.
Apart from reinforcing that this more flexible approach has proved correct, the incident also highlighted that outperformance can be obtained both from being underweight risk during bear markets and overweight risk during bull markets. Limiting losses during drawdowns helps to both smooth out an investor’s journey and reach the return destination faster. For the year ended 30 September 2023, the fund has returned 10.1% (net of fees), healthily outperforming its benchmark’s 7.5% return, as well as the ASISA category average of 8.4%. And it easily ranks in the top 25% of its ASISA category over both the one- and two-year periods to 30 September 2023.
Looking ahead, we would expect these volatile conditions to continue for the foreseeable future. In our view, the M&G Enhanced Income Fund is currently well-positioned to take advantage of this. As fund managers we are able to respond tactically and flexibly to the rapidly changing markets and can exploit the entire spectrum of fixed-income instruments, as well as the best opportunities in listed property, equity and global assets. While we can’t expect it to be all smooth sailing, we are confident that we have the right people, philosophy and processes in place such that the fund continues to fully deliver on investor expectations.
ENDS
