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Optimal Income in more ways than one

FUND TIP: M&G Optimal Income Fund (MGOIAA)
March 31, 2010

BULL POINTS:

■ Highly flexible mandate

■ Experienced fund manager

■ Well-resourced team

BEAR POINTS:

■ High expense ratio

■ Coping with massive inflows

IC TIP: Buy at 120p

In bonds as in stocks, most likely the easy money was made last year - the 13 per cent return clocked up by the average UK corporate bond fund in 2009 was unprecedented. Now the outlook is mixed. Anaemic economic growth should be good for bonds, but economists fret about the effects of high government debt and so-called quantitative easing, which may a euphemism for de-basing the currency.

An investment in M&G Optimal Income is a good answer to this fuzzy macro-economic picture. The open-ended fund's essential attribute is flexibility. Its manager, Richard Woolnough, has complete freedom to allocate assets between the three types of bond - sovereign, investment-grade and high-yield. He can even invest up to 20 per cent of the portfolio in shares.

IC TIP RATING

Tip style: VALUE

Risk rating: LOW

Timescale: LONG-TERM

This is a huge benefit when there is no consensus on the long-term outlook for bonds. Now the sweet spot seems to be in high-yield, where spreads over government debt could tighten further. But given the transaction costs associated with open-ended funds, it makes little sense to buy a high-yield vehicle based on current valuations. Better to pick one that can cope with any economic environment that the next five years – and the UK's next government – might throw at us.

Of course, you have to trust the manager to make the right calls. Mr Woolnough is not the only investor with the requisite freedom but, with 25 years in the City behind him, he’s one of the most experienced. He made his name at Old Mutual, before being poached by M&G in 2004. M&G Corporate Bond, which he also runs, has outperformed its peer group in each of the six complete years he has run it – a consistency few managers can match.

PRICE120pSHARPE RATIO0.9
SIZE OF FUND£1.7bn6 MTH  PERFORMANCE7%
No OF HOLDINGS2791 YEAR PERFORMANCE34%
SET UP DATEDec 20063 YEAR PERFORMANCE33%
MANAGER START DATEsince launchTOTAL EXPENSE RATIO1.4%
YIELD4.6%INITIAL CHARGE4.0%
VOLATILITY0.6MINIMUM INVESTMENT£1,000
TRACKING ERROR0.3MORE DETAILSwww.mandg.co.uk

Top ten issuersPercentage
HSBC2.6
BAA1.7
Imperial Tobacco1.7
Bank of America1.3
Centrica1.2
Lloyds Banking1.2
BT1.1
Granite1.0
Anheuser-Busch1.0
JP Morgan1.0

Asset allocationPercentage
Investment grade bonds64
High yield bonds24
Equities7
Government bonds3
Cash2

His best year was 2008, which most bond managers would rather forget. He remained significantly underweight in banks from mid-2007 until the end of 2008. Since banks account for about half the European credit universe, this call generated substantial outperformance. The average strategic bond fund fell 13 per cent in 2008; M&G Optimal Income lost just 4 per cent.

Mr Woolnough’s critics dismissed him as a perennial bear who got lucky when crisis struck. Yet he was confident enough to move into junk bonds in early 2009, before many of his peers. He still retains the skew, believing the UK economy is not as beleaguered as some commentators claim.

Such top-down thinking is the biggest factor behind the manager’s success. But a secondary factor is M&G’s credit team, one of the largest in Europe. Intensive bottom-up research should allow Mr Woolnough to continue avoiding the solvency potholes that caught rivals last year.

Optimal Income's track record and one-stop-shop quality has attracted much interest. This is a concern - managers typically revert to average if their portfolios grow too fast. Optimal Income's total expense ratio at 1.4 per cent is also high; the sector average is 1.25 per cent.