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British fund with $32b makes big lurch Into treasuries

[MOSCOW] The UK’s biggest bond mutual fund is shifting money to the other side of the Atlantic as the interest-rate gap between Europe and the US widens to record levels.

M&G Limited has boosted US holdings in its £23.4 billion (S$42.3 billion) Optimal Income Fund this year to more than a third at the expense of positions in French, Italian and Spanish bonds. To cushion inflation risks and the impact of rising US rates, it’s gorging on short-term Treasury bills and paring credit risk.

“If you look at the relationship between the front end in Europe and the front end in the US, we’re multi-year wide,” M&G portfolio manager Stefan Isaacs said in an interview. “The front end of the US curve looks like good value to us. You’re getting a positive real yield there.”

The M&G Optimal Income fund, which Mr Isaacs helps oversee with lead manager Richard Woolnough, is the biggest actively-managed open-end bond fund domiciled in the UK, according to data compiled by Bloomberg.

The allocation shift underscores overseas demand for US securities, despite elevated currency-hedging costs, with short-dated yields higher than inflation, effectively for the first time since the crisis.

Bond investors cut exposure to all regions outside the US in the week ending May 2, according to EPFR Global data, while exchange-traded funds that track US government bonds have attracted more than US$17 billion so far this year.

M&G is striking a different note to Pacific Investment Management Co bond investor Andrew Bosomworth, who suggests shunning 10-year Treasuries in favor of Italian, Danish and Swedish debt, citing dollar-hedging expenses for money managers in Europe. Pimco estimated last month that the cost for euro investors could rise closer to 4 per cent next year from just below 3 percent.

As the US Treasury curve flattens to 2007 levels, Mr Isaacs’ strategy is defensive. The paring of the Federal Reserve’s balance sheet and "relatively robust" economic data raise the prospect of a slow but sure rise in long-dated US bond yields. As such, the M&G Optimal Income fund has a modest duration -a measure of the sensitivity of bond prices to changes in interest rates - at just 2.4 years.

The firm took profits on European bonds earlier this year after spreads narrowed versus Germany, while cutting exposures to high-yield debt. The fund’s flexible mandate allows it to take a position in equities, which now stands at 5 per cent, said Mr Isaacs.

While the fund is sitting on a loss of 0.3 per cent so far this year, it outperformed more than 80 per cent of peers over the past two, according to data compiled by Bloomberg.

“The trade has been out of the riskiest end of U.S. credit markets into the front end of the least-risky part of the market,” Mr Isaacs said. “Why take the additional risk when you can earn the vast majority of that income at the front end of the market?”


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