M&G Strategic Corporate Bond Fund Interim Short Report February 2017 For the six months ended 28 February 2017
Fund information The Authorised Corporate Director (ACD) of M&G Strategic Corporate Bond Fund presents its Interim Short Report which contains a review of the fund s investment activities and investment performance during the period. The ACD s Interim Long Report and unaudited Financial Statements for M&G Strategic Corporate Bond Fund, incorporating a Glossary of terms is available free of charge either from our website at www.mandg.co.uk/reports or by calling M&G Customer Relations on 0800 390 390. ACD M&G Securities Limited, Laurence Pountney Hill, London EC4R 0HH Telephone: 0800 390 390 (Authorised and regulated by the Financial Conduct Authority. M&G Securities Limited is a member of the Investment Association and of the Tax Incentivised Savings Association.) Important information In the 2016 Budget, the UK government announced that, effective from 6 April 2017, interest distributions from open-ended investment companies (OEICs) may be paid without deducting income tax (currently 20%). As a result, prices for the sterling share classes of M&G s bond funds will be calculated without an accrual for the deduction of income tax. This change, for different funds, will be phased in between October 2016 and March 2017. From 1 December 2016 the M&G Strategic Corporate Bond Fund s prices for the sterling share classes are now calculated without income tax deducted. Investment objective The fund aims to maximise total return (the combination of income and growth of capital). Investment policy The Fund invests mainly in investment grade bonds. The Fund may invest in derivatives in pursuit of the fund objective and for the purposes of efficient portfolio management. The Fund may also invest in other assets including collective investment schemes, other transferable securities and other debt instruments (including corporate, high yield and government debt, convertible and preference stocks), cash, and near cash, deposits, warrants and money market instruments. Investment approach The fund s investment approach is largely top-down : the fund manager s economic outlook will determine key investment decisions such as the portfolio s duration, and how the fund s assets are invested proportionally by asset class and corporate sector. The fund manager uses proprietary research, rather than external research. M&G s in-house team of credit analysts provides bottom-up analysis of the corporate bond markets, which complements the fund manager s top-down views. Additionally please note that with effect from 16 December 2016: We have discounted the initial charge to zero on all new investments into Sterling Shares that currently carry such a charge. We have waived the exit charges on future withdrawals from all Sterling Class X shares. We have discounted the annual management charges (AMC) for the Sterling Class X shares from 1.25% to 1.00%. 1 2
Fund information Investment review Risk profile The fund invests in fixed income securities, or bonds, issued by UK companies. It is primarily subject to the price volatility of the UK bond market as well as the performance of individual issuers. It is also influenced by developments in the broader global bond market. In addition, the fund is subject to fluctuations in currency exchange rates. The fund s focus is on high-quality corporate bonds, securities that are normally traded with relative ease. Up to 20% of the fund may be invested in other fixed income investments, such as government bonds, which are typically highly liquid assets, or high yield corporate bonds, which are higher risk assets that could potentially experience a degree of illiquidity in times of market distress. The fund s exposure to debt securities may be gained through the use of derivatives. In association with the use of derivatives, including those instruments not traded through an exchange, collateral is deposited, in order to mitigate the risk that a counterparty may default on its obligations or become insolvent. Portfolio diversification is key in managing liquidity and default risks as well as reducing market risk. The fund s risks are measured and managed as an integral part of the investment process. The following table shows the risk number associated with the fund and is based on Sterling Class A shares. As at 1 March 2017, for the six months ended 28 February 2017 Performance against objective Between 1 September 2016 and 1 March 2017, the M&G Strategic Corporate Bond Fund produced negative total returns (the combination of income and growth of capital) across all its different share classes. [a] The M&G Strategic Corporate Bond Fund invests predominantly in high quality sterling-denominated corporate bonds with the aim of maximising total return (the combination of income and growth of capital). Bonds are loans that are extended by an investor to an issuing entity such as a company or government in exchange for regular interest payments. Bonds issued by companies are referred to as corporate bonds, while those issued by governments are called government bonds. Investment grade corporate bonds refer to fixed income securities issued by a company with a medium or high credit rating from a recognised credit rating agency. They are considered to be at lower risk of non-repayment than those issued by companies with lower credit ratings (known as high yield bonds). The performance of investment grade credit markets can be influenced by the performance of government bonds. Low risk High risk Typically lower rewards The above number: Typically higher rewards 1 2 3 4 5 6 7 is based on the rate at which the value of the fund has moved up and down in the past and is based on historical data so may not be a reliable indicator of the future risk profile of the fund. is not guaranteed and may change over time and the lowest risk number does not mean risk free. has not changed during this period. 3 4
Investment review To give an indication of the performance of the fund, the following table shows the compound rate of return, per annum, over the period for Sterling Class A (Accumulation) shares and Sterling Class I (Accumulation) shares. Calculated on a price to price basis with income reinvested. Six Three Five Since months years years launch 01.09.16 03.03.14 01.03.12 % [b] % p.a. % p.a. % p.a. Sterling [c] Class A -0.9 +4.5 +5.1 +6.5 [d] Class I -0.7 +4.9 n/a +5.0 [e] [a] On 1 September 2009 the M&G Strategic Corporate Bond Fund de-merged from M&G Investment Funds (1) to become the M&G Strategic Corporate Bond Fund. [b] Absolute basis. [c] Price to price with income reinvested. [d] 20 February 2004, the launch date of the merging fund. [e] 3 August 2012, the launch date of the share class. Please note past performance is not a guide to future performance and the value of investments, and the income from them, will fluctuate. This will cause the fund price to fall as well as rise and you may not get back the original amount you invested. Investment performance As the review period began in September, several months after the UK s momentous vote in favour of leaving the European Union (EU), the Bank of England began a new programme of buying selected corporate bonds, one of several measures it had announced in August to mitigate any potential negative consequences of the Brexit vote. The bond-buying programme aimed to keep interest rates low and promote lending activity. Brexit-related uncertainty over the timing, and exact form that the country s departure from the EU might take was a significant driver of market movements for the remainder of 2016. In November, the government lost a landmark legal case on whether it had the right to trigger Article 50 to begin the process of taking the country out of the EU using what are known as prerogative powers rather than needing an act of Parliament. Although the Supreme Court then upheld the ruling in January 2017, the government swiftly began work to pass legislation through parliament that would enable Prime Minister Theresa May to trigger Article 50 by the end of March as originally planned. 5 The last few months of 2016 delivered further political surprises, the most significant of which was Donald Trump s US presidential election victory in November. The result caused US government bonds (also known as US Treasuries) to suffer their worst month in seven years. However, it did not deter the US Federal Reserve from completing only its second interest rate hike in more than 10 years a few weeks later in December. Also in December, a resounding No result in Italy s referendum on sweeping constitutional reform caused Prime Minister Matteo Renzi to resign. The start of 2017 saw markets turn their attention to rising inflation readings across developed markets, driven by a rising oil price and higher growth prospects. In the UK, sterling weakness following the Brexit vote also began to feed through into inflation data, with the Consumer Prices Index reaching 1.8% in the year to January 2017, its highest level since June 2014. The yield on UK government bonds (known as gilts) rose substantially over the six-month period as a whole, as investors reacted to rising inflation expectations and concerns about what a hard Brexit might mean for the UK economy. (Bond yield refers to the interest received from a fixed income security and is usually expressed annually as a percentage based on the investment s cost, its current market value or its face value.) Sterling corporate bonds also came under pressure, despite initial support from the Bank of England s bond-buying programme. As a result of the fund s significant exposure to these types of bond, all of the fund s share classes delivered modestly negative returns for the period under review. Investment activities One of the key drivers of a bond fund s performance is its ability to adjust the portfolio s sensitivity to changes in interest rates, known as duration. Having increased the fund s duration by around one year to 6.1 years immediately after the UK referendum in June 2016, it then hovered between 5.6 and 5.8 years during the six-month review period, and was always short relative to the fund s comparable index, the iboxx Corporate Index. Having reduced the fund s exposure to investment grade bonds and increased its cash position and allocation to government bonds around the EU referendum to moderate its risk profile, we then reversed these moves over the reporting period. Exposure to investment grade corporate bonds was held at around 86% over the six months. We added a number of bonds from financial companies, for example, some from Goldman Sachs, Morgan Stanley, J.P. Morgan, BNP Paribas and HSBC. However, we remain highly 6
Investment review selective when lending to firms in that sector. We sold a number of holdings that performed well over the reporting period, including some from Walmart and Amgen. We continue to find value in long-dated investment grade bonds in US dollar denominations, particularly in the very active new issue market. (Long-dated bonds refer to issues repaid over relatively long periods.) Classification of investments Debt securities % of the fund value (net assets attributable to shareholders) Outlook We believe that US and UK politics remain key in 2017, while there is a heavy political calendar in Europe this year that is also exerting an influence on markets. President Trump s policies of reducing taxation and encouraging companies to repatriate funds currently held offshore will prove supportive for US corporate bond markets. But the biggest danger to markets is President Trump s unpredictability something that markets and investors will have to get used to. Yet while President Trump may be able to stop the march of globalisation partially, from a US perspective, we expect that this theme will remain intact, albeit less aggressively. Meanwhile, although UK Prime Minister Theresa May is pushing for a hard Brexit, it will be several years until any deal is concluded and until then, the UK s economy is working at full capacity. While UK interest rates are not expected to rise significantly in the immediate future, the weakness of sterling since the EU referendum result means that inflation is once again back on the agenda. We believe that the global economy remains in reasonable health, and company default rates remain low. As a result, we remain positive on corporate bonds, especially issues from US companies. By contrast, we remain cautious on government bonds. We believe that further interest rate rises in the US are likely this year, as the US Federal Reserve tries to control rising inflation there. Richard Woolnough Fund manager An employee of M&G Limited which is an associate of M&G Securities Limited. [a] For the performance of each share class, please refer to the Long-term performance by share class table in the Fund performance section of the Interim Long Report and unaudited Financial Statements for M&G Strategic Corporate Bond Fund. Please note that the views expressed in this Report should not be taken as a recommendation or advice on how the fund or any holding mentioned in the Report is likely to perform. If you wish to obtain financial advice as to whether an investment is suitable for your needs, you should consult a Financial Adviser. 7 AAA credit rated bonds AA credit rated bonds A credit rated bonds BBB credit rated bonds BB credit rated bonds B credit rated bonds D credit rated bonds Bonds with no credit rating -0.05% Credit default swaps -0.03% Interest rate swaps Forward currency contracts -0.57% -0.13% Interest rate futures contracts -0.01% AAA rated money market funds [a] [a] Portfolio transactions Uncommitted surplus cash is placed into AAA rated money market funds with the aim of reducing counterparty risk. 28 February 2017 31 August 2016 8.03% 10.24% 5.96% 8.49% 5.90% 4.91% 0.39% 0.34% 0.00% 0.01% 0.00% 0.00% 0.02% 8.93% 7.65% 5.47% 0.86% 16.63% 18.43% Source: M&G 47.69% 46.82% for the six months to 28 and 29 February 2017 2016 Portfolio transactions 000 000 Total purchases 611,272 708,719 Total sales 1,248,688 983,064 Purchases and sales exclude the cost and proceeds of derivatives and AAA rated money market funds. 8
Financial highlights Fund performance Please note past performance is not a guide to future performance and the value of investments, and the income from them, will fluctuate. This will cause the fund price to fall as well as rise and you may not get back the original amount you invested. The following chart and tables show the performance for two of the fund s share classes Sterling Class A (Accumulation) shares and Sterling Class I (Accumulation) shares. We show performance for these two share classes because: The performance of the Sterling Class A (Accumulation) share is what most individuals investing directly with M&G have received. It has the highest ongoing charge of all the share classes. Performance is shown after deduction of this charge. All investors in the fund therefore received this performance or better. The performance of the Sterling Class I (Accumulation) share is the most appropriate to compare with the average performance of the fund s comparative sector. It is the share class used by the Investment Association in the calculation of the comparative sector s average performance. This share class is available for direct investment with M&G subject to minimum investment criteria, or via third parties who may charge additional fees. The performance shown takes the deduction of the ongoing charge for this share class into account but it does not take account of charges applied by any other party through which you may have invested. The fund is available for investment in different share classes, each with varying levels of charges and minimum investments; please refer to the Prospectus for M&G Strategic Corporate Bond Fund, which is available free of charge either from our website at www.mandg.co.uk/prospectuses or by calling M&G Customer Relations. For the specific performance tables of all share classes, please refer to the Interim Long Report and unaudited Financial Statements for M&G Strategic Corporate Bond Fund, which is available free of charge either from our website at www.mandg.co.uk/reports or by calling M&G Customer Relations. Fund level performance Fund net asset value 28.02.17 31.08.16 31.08.15 as at 000 000 000 Fund net asset value (NAV) 3,658,529 4,287,965 4,483,064 Performance since launch To give an indication of how the fund has performed since launch, the chart below shows total return of Sterling Class A (Accumulation) shares and Sterling Class I (Accumulation) shares. 240 220 200 180 160 140 130 120 110 100 90 February 2004 = 100, plotted monthly Chart date 1 March 2017 Sterling Class I (Accumulation) shares* Sterling Class A (Accumulation) shares* 04 05 06 07 08 09 10 11 12 13 14 15 16 Sterling Class A (Accumulation) shares* Sterling Class I (Accumulation) shares* Morningstar IA Corporate Bond sector average * Income reinvested Source: Morningstar, Inc. and M&G The fund s Sterling Class I (Accumulation) shares were launched on 3 August 2012. Performance data shown prior to this date is that of the fund s Sterling Class A (Accumulation) shares. 17 9 10
Financial highlights Fund performance To give an indication of how the fund has performed during the period the tables below show the performance of Sterling Class A (Accumulation) shares and Sterling Class I (Accumulation) shares. All Performance and charges percentages represent an annual rate except for the Return after operating charges which is calculated as a percentage of the opening net asset value per share (NAV). Dilution adjustments are only in respect of direct portfolio transaction costs. Sterling Class A Accumulation share performance The share class was launched on 20 February 2004. Six months to Year to Year to 28.02.17 31.08.16 31.08.15 Change in NAV per share UK p UK p UK p Opening NAV 114.64 104.21 103.13 Return before operating charges and after direct portfolio transaction costs (0.43) 12.26 2.90 Operating charges (0.65) (1.24) (1.22) Return after operating charges (1.08) 11.02 1.68 Distributions (1.44) (2.95) (2.99) Retained distributions 1.30 2.36 2.39 Closing NAV 113.42 114.64 104.21 Direct portfolio transaction costs [a] UK p UK p UK p Costs before dilution adjustments 0.00 0.00 0.00 Dilution adjustments [b] 0.00 0.00 0.00 Total direct portfolio transaction costs 0.00 0.00 0.00 Performance and charges % % % Direct portfolio transaction costs 0.00 0.00 0.00 Operating charges 1.16 1.16 1.16 Return after operating charges -0.94 +10.57 +1.63 Distribution yield 2.62 2.40 2.74 Effect on yield of charges offset against capital 0.00 0.00 0.00 Other information Closing NAV ( 000) 1,196,283 1,330,254 1,645,532 Closing NAV percentage of total fund NAV (%) 32.70 31.02 36.71 Number of shares 1,054,776,739 1,160,411,896 1,579,066,058 Highest share price (UK p) 114.52 114.65 108.73 Lowest share price (UK p) 110.15 102.80 102.16 Sterling Class I Accumulation share performance The share class was launched on 3 August 2012. Six months to Year to Year to 28.02.17 31.08.16 31.08.15 Change in NAV per share UK p UK p UK p Opening NAV 1,263.12 1,143.66 1,127.25 Return before operating charges and after direct portfolio transaction costs (4.67) 134.88 31.71 Operating charges (4.06) (7.77) (7.61) Return after operating charges (8.73) 127.11 24.10 Distributions (18.96) (38.26) (38.43) Retained distributions 17.03 30.61 30.74 Closing NAV 1,252.46 1,263.12 1,143.66 Direct portfolio transaction costs [a] UK p UK p UK p Costs before dilution adjustments 0.02 0.04 0.02 Dilution adjustments [b] 0.00 0.00 0.00 Total direct portfolio transaction costs 0.02 0.04 0.02 Performance and charges % % % Direct portfolio transaction costs 0.00 0.00 0.00 Operating charges 0.66 0.66 0.66 Return after operating charges -0.69 +11.11 +2.14 Distribution yield 3.12 2.90 3.24 Effect on yield of charges offset against capital 0.00 0.00 0.00 Other information Closing NAV ( 000) 1,049,186 1,109,224 832,500 Closing NAV percentage of total fund NAV (%) 28.68 25.87 18.57 Number of shares 83,770,114 87,816,178 72,792,397 Highest share price (UK p) 1,262.00 1,263.23 1,190.55 Lowest share price (UK p) 1,214.80 1,130.25 1,116.94 [a] As a percentage of average net asset value. [b] In respect of direct portfolio transaction costs. 11 12
Financial highlights Operating charges and portfolio transaction costs We explain below the payments made to meet the ongoing costs of investing and managing the fund, comprised of operating charges and portfolio transaction costs. Operating charges Operating charges include payments made to M&G and to providers independent of M&G: Investment management: Charge paid to M&G for investment management of the fund (also known as Annual Management Charge). Administration: Charge paid to M&G for administration services in addition to investment management any surplus from this charge will be retained by M&G. Oversight and other independent services: Charges paid to providers independent of M&G for services which include depositary, custody and audit. Operating charges do not include portfolio transaction costs or any entry and exit charges (also known as initial and redemption charges). The charging structures of share classes may differ, and therefore the operating charges may differ. Operating charges are the same as the ongoing charges shown in the Key Investor Information Document, other than where an estimate has been used for the ongoing charge because a material change has made the operating charges unreliable as an estimate of future charges. For this fund there is no difference between operating charges and ongoing charges figures, unless disclosed under the specific share class performance table. Portfolio transaction costs Portfolio transaction costs are incurred by funds when buying and selling investments. These costs vary depending on the types of investment, their market capitalisation, country of exchange, method of execution and the quality of research provided. They are made up of direct and indirect portfolio transaction costs: Direct portfolio transaction costs: Broker execution commission and taxes. Indirect portfolio transaction costs: Dealing spread the difference between the buying and selling prices of the fund s investments; some types of investment, such as fixed interest securities, have no direct transaction costs and only the dealing spread is paid. Investments are bought or sold by a fund when changes are made to the investment portfolio and in response to net flows of money into or out of the fund from investors buying and selling shares in the fund. To protect existing investors, portfolio transaction costs incurred as a result of investors buying and selling shares in the fund are recovered from those investors through a dilution adjustment to the price they pay or receive. As the fund invests mainly in fixed interest securities, the direct transaction costs paid on other investments are too small to be reflected in the table below. To give an indication of the indirect portfolio dealing costs the table below shows the average portfolio dealing spread. Further information on this process is in the Prospectus, which is available free of charge on request either from our website at www.mandg.co.uk/prospectuses or by calling M&G Customer Relations. Portfolio transaction costs as at 28.02.17 31.08.16 31.08.15 Average [a] Indirect portfolio transaction costs % % % % Average portfolio dealing spread 0.84 0.93 0.75 0.84 [a] Average of first three columns. 13 14
Contact Customer Relations* 0800 390 390 Write to us at:** M&G Securities Limited PO Box 9039 Chelmsford CM99 2XG Our website: www.mandg.co.uk Email us with queries: info@mandg.co.uk * For security purposes and to improve the quality of our service, we may record and monitor telephone calls. You will require your M&G client reference. Failure to provide this will affect your ability to transact with us. ** Please remember to quote your name and M&G client reference and sign any written communication to M&G. Failure to provide this may affect your ability to transact with us. Please note that information contained within an email cannot be guaranteed as secure. We advise that you do not include any sensitive information when corresponding with M&G in this way. M&G Securities Limited is authorised and regulated by the Financial Conduct Authority and provides investment products. The company s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England number 90776. 55173_SR_311017