M&G Global Convertibles Fund

Transcription

1 Quarterly Review M&G Global Convertibles Fund Fourth quarter 2018 Fund manager Léonard Vinville FOR INVESTMENT PROFESSIONALS ONLY Highlights Most stockmarkets suffered sharp falls in the final quarter of 2018 as investors became increasingly pessimistic about prospects for the global economy and fearful of volatility. A range of factors contributed to an erosion of risk appetite that encouraged rotation into government bonds, whose yields fell. Spreads on corporate bonds widened significantly. Convertibles reflected the falls in equity prices, albeit to a lesser degree. The fund declined over the quarter and lagged the Thomson Reuters Global Focus Convertibles Index. The sterling unhedged share class performed better than the hedged share class, benefiting from the strength of the US dollar. We remain positive on the outlook for convertibles, which should benefit from their improved risk/reward profile in volatile markets and which tend to do well against a background of rising interest rates. We shall continue to identify investment opportunities that should provide asymmetric returns, capturing share price upside but offering some downside protection. Main risks associated with this fund: For any past performance shown, please note that past performance is not a guide to future performance. The value of investments and the income from them will rise and fall. This will cause the fund price, as well as any income paid by the fund, to fall as well as rise. There is no guarantee the fund will achieve its objective, and you may not get back the amount you originally invested. Convertibles are subject to the risks associated with both bonds and company shares, and to risks specific to the asset class. Their value may change significantly depending on economic and interest rate conditions, the creditworthiness of the issuer, the performance of the underlying company shares and general financial market conditions. In addition, issuers of convertibles may fail to meet payment obligations and their credit ratings may be downgraded. Convertibles may also be less liquid than the underlying company shares. Changes in currency exchange rates will affect the value of your investment. Further risk factors that apply to the fund can be found in the fund s Key Investor Information Document (KIID). Things you should know: The fund allows for the extensive use of derivatives. Quarterly, YTD and calendar year performance (5 years) 3 months YTD Sterling I Index Sector Sterling I-H Index (H) Sector Past performance is not a guide to future performance. 1 Source: Morningstar, Inc., UK database as at 31 December Sterling I class shares, income reinvested, price-to-price basis. Index: Thomson Reuters Global Focus Convertible. 2 Source: Morningstar, Inc., UK database as at 31 December Sterling l-h class shares, income reinvested, price-to-price basis. Index: Thomson Reuters Global Focus Convertible (Hedged). Sector: Morningstar Convertible Bond - Global GBP Hedged.

2 Performance attribution Largest positive contributors 3 months Largest positive contributors YTD Dish Network Corp Dish Network Corp Square Inc Citrix Systems Extra Space Storage Microchip Technology Largest negative contributors 3 months Largest negative contributors YTD Supernus Pharmaceuticals NXP Semiconductors Fresenius Medical Herbalife Nutrition Tesla Rag-Stiftung/Evonik Source: Xamin, investment returns (gross of fees) calculated in sterling, as at 31 December 2018, preliminary data. Performance contribution includes both stocks held and not held and weighting relative to Thomson Reuters Global Focus Convertible Index. Market background and fund performance Most stockmarkets fell sharply in the final quarter of the year, as investors became increasingly pessimistic. Various factors contributed to a more risk averse environment, including higher US interest rates, slower global economic growth, trade tensions and, later, political uncertainty in the US. Among the weakest equity markets were the Nasdaq and S&P 500 in the US, the Nikkei in Japan and the German DAX. The oil price also retreated. Some emerging markets performed better. In fixed income, although yields on US government bonds rose early in the quarter, they declined later as doubts arose over the strength of the US economy. Towards the end of the year, as investors became convinced that recession was approaching, they sought the perceived safety of government bonds, particularly from the US and Germany. However, credit spreads on corporate bonds widened substantially over the review period. Convertible bonds could not withstand the pull of falling share prices and declined over the quarter, although they did perform better than their underlying equities. The fund fell and performance lagged that of the Thomson Reuters Global Focus Convertibles Index. A stronger US dollar meant that returns of the unhedged share class were better than those of the hedged share class. Having outperformed earlier in the year, US equities fell sharply towards the end of the year and US convertibles were, in aggregate, the largest negative contributor to performance. In terms of sectors, holdings in the basic materials and healthcare sectors detracted. The largest detractor to performance was a holding in the convertible from US pharmaceutical group Supernus. The firm s shares and convertible declined after the trial of a new ADHD drug. Although most of the treatment s goals were met, some analysts were disappointed that the drug did not provide a clear alternative to an existing rival. In the same sector, Fresenius Medical Care, a German kidney dialysis company, one of the fund s largest holdings, declined significantly after it issued an unexpected profit warning, while Jazz Pharmaceuticals fell when the US FDA extended the review period for a new sleep drug. Among basic materials, convertibles into German chemical producer Evonik and global steel producer Aperam, as well as shares in Mexican cement producer Cemex, weighed on returns as investors became concerned about slowing economic growth. performance was pressured by not owning convertibles from electric vehicle manufacturer Tesla, whose shares and bonds rallied when the company reported its first profit. We remain sceptical that the company will generate sufficient cashflow to meet its significant debt obligations. On a positive note, value was added by the convertible from US REIT Extra Space Storage, whose earnings came in ahead of analysts forecasts. A stake in the share of KPN also made a positive contribution on hopes that consolidation in the Netherlands telecoms industry might lead to higher prices for providers. Exposure to Chinese train manufacturer CRRC was also beneficial, as investors speculated that China would boost infrastructure spending to stimulate its economy, while not owning shares in US pay-tv company Dish Network helped relative performance as the group suffered from declining subscriber numbers. The stock does not meet our selection criteria. Portfolio activity Portfolio activity was fairly brisk during the review period. Although the volatility in stockmarkets weighed on convertible issuance, with the amount of convertibles launched globally being the lowest for several years, we were able identify some investment opportunities. We added some newly issued

3 bonds, feeling that they were attractively priced and offered exposure to interesting and undervalued companies. This included convertibles from global biotechnology business Qiagen and Spanish pharmaceutical manufacturer Almirall, as well as an exchangeable bond that converts into Swiss duty-free store operator Dufry. The largest addition was a convertible from US internet services provider Akamai Technology, which should complement an existing holding from the issuer. Declines in the underlying share price improved the valuation of a bond converting into French aircraft manufacturer Dassault. We also initiated positions in convertibles from US healthcare groups Exact Sciences and Jazz Pharmaceuticals. Several convertibles left the portfolio as they were redeemed. This included bonds from Asian real estate company CapitaLand, Russian internet firm Yandex and Spanish technology firm Indra Sistemas. Meanwhile, two convertibles from Clearway Energy were bought back by the issuer and a convertible from US investment company Altaba (formerly Yahoo!) was sold ahead of expiry. We realised profits by selling an exchangeable bond into Russian steel producer Severstal following good performance, while we disposed of several exchangeable bonds with low equity sensitivity. These bonds were unlikely to participate in any potential share price recovery and included Bayer into Covestro, Telenor into Veon, Haniel into Ceconomy and America Movile into KPN. Low-delta convertibles that left the fund comprised bonds from Safran, Electronics for Imaging and Wereldhave. Sector breakdown The fund s weighting in industrials and healthcare increased during the period, while that in financials and telecommunications declined. The addition of convertibles from industrial groups such as Dassault, plus increased exposure to Vinci, Siemens and CRRC, ensured the sector remained the largest in the fund. The size of the healthcare sector was boosted by the purchase of convertibles from Jazz Pharmaceuticals and Exact Sciences, while the redemption of a CapitaLand bond and sale of Wereldhave resulted in a decline in the weighting of financials. The reduction of holdings in bonds converting into KPN and Veon accounts for the lower proportion of the fund in telecoms. It is worth reiterating that the sector breakdown does not reflect a top-down view of the relative merits of the different sectors, but simply that we have not been able to find convertibles in those industries that satisfy our fundamental and technical requirements for inclusion in the portfolio. Country breakdown The proportion of the fund invested in the US increased during the quarter as we added several positions and increased exposure to certain existing holdings. Similarly, the weighting of the fund held in convertibles from France and Japan rose as we bought a bond convertible into Dassault and increased exposure to bonds from Vinci, Total and Sony. Conversely, the total size of holdings in Germany declined following the disposal of convertibles into Covestro and Ceconomy and a reduction of exposure to Evonik. There are more than 20 countries represented in the fund s holdings. Currency breakdown The fund s currency distribution simply depends on the securities selected. Being the most common currency for convertible bond issues, the US dollar represented the largest proportion of the fund s holdings, more than half. The euro was the next largest currency of denomination, although the proportion of the fund s holdings held in the single currency declined due to disposals. Since the fund s exposure to the US dollar is meaningfully higher than the weighting of the US dollar in the convertibles universe, and exposure to Japanese yen lower, we retain a currency hedge to increase the yen currency exposure and reduce the US dollar exposure. This brings the fund s currency holdings more in line with the TR Global Focus Convertibles Index and should reduce the unintended risk that the position represents. Credit breakdown As with the broader convertibles market, a large proportion of the fund consisted of non-rated convertibles. We believe these bonds can create opportunities, given our bottom-up stockpicking approach, as a deep understanding of the credit profile of these companies could lead to participation of any re-rating of credit. Fund weight () Dec 18 () Sept 18 () Change () Investment grade High yield No rating Source: M&G, as at 31 December 2018 excludes cash and equity holdings. Risk The sharp weakness in equity prices took many convertibles down towards their bond floors, reducing their sensitivity to further share price movements. Thus, the fund s average equity sensitivity fell to 0.33 at year-end, compared to 0.45 at the end of September. Meanwhile, the average distance to the bond floor declined to 5.4, having ended the previous quarter at The fund s convexity was slightly lower at 4.5, compared to the end of the third quarter, when it stood at 5.2. This means that, if the fund s underlying equities were to increase by 30, the portfolio would increase by 10.3 on average, all else being equal. However, if the equities were to fall by 30, the portfolio should only decline by 5.8. At quarter-end, the portfolio yield (a combination of yield to maturity and current yield) was approximately 2.0.

4 Outlook We remain positive on the outlook for the convertibles market as we move into Typically, convertibles benefit as volatility increases in the markets, with their debt characteristics providing some support when share prices are falling. We think that the asymmetric risk/reward profile of convertibles, participating when share prices rise but receiving some protection when shares fall, should be attractive to investors if 2019 proves to be as turbulent as some fear. The potential good performance of convertibles was demonstrated in 2018, when the asset class was the second-best performer globally, significantly ahead of equities, high yield and investment grade credit and only lagging government bonds. A background of rising interest rates should also be a helpful influence on our market. As interest rates increase, convertibles generally benefit from having lower duration, or sensitivity to changes in interest rates, than other corporate bonds. Also, if interest rates are increased for the right reasons, that is, because the economy is expanding, the convertibles market have the potential to deliver good returns as rising share prices more than offset any weakness in bond prices. Despite the pause in issuance in the final quarter of 2018, the primary market was strong for the year as a whole, with the amount raised being the most since As well as record equity prices earlier in the year, bond issuance was encouraged by higher interest rates and increased volatility. Higher short-term interest rates make the issuance of convertibles appealing because the potential benefits to investors of higher equity prices mean they can usually pay lower interest rates than conventional bonds. Tax incentives in the US also pushed companies towards financing methods that carried lower coupon rates. Encouragingly, almost half of global convertible launches came from first-time visitors to the market. Anything that increases the diversity of the market has to be good news. Equity market weakness in the final quarter of 2018 has left the convertibles market less sensitive to changes in share prices, with much of the universe trading close to their bond floors. While this makes the market more defensive and likely to outperform in the event of further falls in equity prices, it also means that participation in potential share price rallies could be limited. This increases the importance of stock selection and of taking action to ensure the sensitivity of the portfolio as a whole is within the desired parameters. On the other hand, some convertibles that were previously deep in the money and vulnerable to falls in the underlying equity price have now become more balanced and eligible for consideration in our fund. While we acknowledge that the recent performance of the fund has been disappointing, we believe the convertibles universe continues to offer compelling opportunities for stockpicking that should enable us to gain exposure to under-researched companies in a wide variety of countries and sectors. We will continue to search for those convertibles that offer the best balance of risk and reward by focusing on the basic characteristics of the issuing companies and by developing a deep understanding of the underlying business. We also rigorously analyse the technical qualities of each potential investment. We shall also continue to work closely with M&G s credit research and risk management teams. We believe this approach has the potential to deliver healthy returns to investors over time. Long-term performance Sterling I 1 year 3 years pa 5 years pa Since launch (13 July 2007) pa M&G Global Convertibles Fund Thomson Reuters Global Focus Convertible Index Morningstar Convertible Bond - Global sector Fund quartile ranking in sector Source: Morningstar, Inc., UK database as at 31 December Sterling I class shares, income reinvested, price-to-price basis. Sterling I-H 1 year 3 years pa 5 years pa Since launch (28 Sep 2012) pa M&G Global Convertibles Fund Thomson Reuters Global Focus Convertible (Hedged) Index Morningstar Convertible Bond - Global GBP Hedged sector Fund quartile ranking in sector Source: Morningstar, Inc., UK database as at 31 December Sterling I-H class shares, income reinvested, price-to-price basis. Past performance is not a guide to future performance.

5 For financial advisers only. Not for onward distribution. No other persons should rely on any information contained within. This financial promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No _354603