M&G Optimal Income - bond markets offer little value

• Richard Woolnough doesn’t see much value in bond markets
• He's increased exposure to cash and government bonds
• This could provide some shelter if bond markets go through a tougher time

Our view

M&G Optimal Income is a flexible bond fund.

This means Richard Woolnough, the fund's manager, can invest across a wide range of bonds, from government bonds and higher-risk high yield bonds, to UK and overseas bonds. He can even hold some company shares when he thinks the opportunity for income looks more attractive, and has the ability to invest in emerging market debt and derivatives, which adds risk.

The fund is often invested differently to other bond funds and the manager will sometimes change his view quickly when he spots opportunities. This means it can perform differently to other bond funds too.

It’s an approach that’s worked well over the long term, though Woolnough won't get it right every time and the fund will fall in value as well as rise, which means you could get back less than you invest.

We think he'll do a good job for long-term investors who are comfortable with a slightly more adventurous approach to earning some income and capital growth from the bond market. The fund isn't currently on the Wealth 50 list of our favourite funds though. We think there are other great choices in the Strategic Bond sector, which also come with lower charges.

Is the global economy stronger than you think?

Richard Woolnough thinks the global economy looks healthy. The recovery we’ve seen since 2008’s financial crisis is long by historical standards, but he doesn’t currently see anything on the horizon to derail it.

In countries like the US and UK, Woolnough says unemployment is low and wages could grow from current levels. This could boost consumer spending, which is ultimately good for businesses and the economy.

The way bond markets have recently performed suggests other people disagree and think the economy is in a weaker state. For example, government bonds, which are perceived to be a haven during times of uncertainty, recently did well. But higher-risk parts of the market, such as corporate bonds, financials bonds and shares haven’t held up as well.

The fund's exposure to these areas recently held back performance. This is a short timeframe though and Woolnough has an impressive long-term record. Since he took over the fund in December 2006, it's grown 120.7%* compared with 56.8% for the Strategic Bond sector average. Please remember past performance isn't a guide to future returns.

Past performance is not a guide to the future. Source: *Lipper IM to 31/05/2019

Woolnough doesn't think there's much value on offer in bond markets at the moment. They've generally performed well for a number of years and, as prices have risen, yields have fallen.

This means bond yields don't have much room to fall, but there's plenty of room for them to get higher (and for prices to fall). As a result, the manager's reduced the fund's duration to a new low. Duration is a measure of the fund's sensitivity to changes in yields or interest rates. A lower level of duration means it should be less effected if bond markets fall, and yields or interest rates start to rise.

Woolnough has also increased exposure to cash and bonds issued by developed market governments, such as the US and Germany, to around 30% of the fund. This should offer some shelter if bond markets run into trouble. Overall the fund is able to invest in more than 35% in securities issued or guaranteed by a member state of the European Economic Area.

He reduced exposure to emerging markets government bonds though. He has some concerns over US President Donald Trump's protectionist policies and trade conflicts with countries like China.

Finally, the fund also has 4.4% invested in company shares, which differentiates it from most other bond funds. Woolnough invests in shares when he thinks the income on offer is more attractive than what bonds issued by the same company pay. He currently invests in UK and European companies, and focuses on sectors such as autos, banks and tobacco.

M&G Optimal Income Key Investor Information

More about this fund, including charges