M&G Dividend Fund a sub-fund of M&G Investment Funds (3) Annual Short Report June 2017 For the year ended 30 June 2017
Fund information The Authorised Corporate Director (ACD) of M&G Investment Funds (3) presents its Annual Short Report for M&G Dividend Fund which contains a review of the fund s investment activities and investment performance during the period. The ACD s Annual Long Report and audited Financial Statements for M&G Investment Funds (3), incorporating all the sub-funds and 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 Please note that with effect from 16 December 2016: We have discounted the initial charge to zero on all new investments into sterling share classes that currently carry such a charge. We have waived the exit charges on future withdrawals from all Sterling Class X shares. Investment objective and policy The Fund invests mainly in a range of UK equities with the aim of achieving a steadily increasing income stream. The Fund will target a yield higher than that of the FTSE All-Share Index. Subject to this, the aim will be to maximise total return (the combination of income and growth of capital). Investment approach The M&G Dividend Fund employs a bottom-up stockpicking approach, driven by the fundamental analysis of individual companies. The fund manager seeks to invest in companies with excellent capital discipline and long-term dividend growth potential. The fund manager believes rising dividends create upward pressure on the value of shares. Dividend yield is not the primary consideration for stock selection. The fund manager aims to create a diversified portfolio with exposure to a broad range of sectors. He selects stocks with different drivers of dividend growth to construct a portfolio that has the potential to cope in a variety of market conditions. The fund invests with a long-term investment view and a typical holding period of three to five years. The initial charge on all sterling share classes and the exit charges on all Sterling Class X shares were effectively removed as from 28 April 2017. 1 2
Fund information Investment review Risk profile The fund invests in the shares of UK-listed companies and is, therefore, subject to the price volatility of the UK stockmarket and the performance of individual companies. The fund s focus is on shares of companies that have the potential to grow their dividends over the long term. Income distributions from the fund s holdings, however, are not guaranteed and may vary. Diversification is therefore key in managing liquidity risk and reducing market risk. The fund s risks are measured and managed as an integral part of the investment process. Please note that the risk management policies are set out in full in the financial statements and notes sections of the Annual Long Report and audited Financial Statements of M&G Investment Funds (3). The following table shows the risk number associated with the fund and is based on Sterling Class A shares. Low risk Typically lower rewards The above number: High risk 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. As at 3 July 2017, for the year ended 30 June 2017 Distribution summary Over the 12-month review period, the fund distributed income of 2.9472 pence per Sterling Class A (Income) share. This represents an increase of 3.7% on the previous year. The payout represented a yield (distributed income as a percentage of the published share price on 3 July 2017) of 4.54% versus a yield of 3.59% for the FTSE All- Share Index, a comparative index. We are pleased that fund distributions have grown over the past year, in line with the fund s objective and ahead of the rate of UK inflation. Domestic prices have risen over the past year as sterling s weakness led to the higher cost of imported goods. UK inflation as defined by the Retail Price Index was 3.5% over 12 months, while the Consumer Prices Index was 2.6%. In our previous reports, we expressed our concern about the prospects for dividends in the UK, not just because of the uncertainties created by Brexit, but because of the challenges faced by UK companies, whether domestic or multinational, to grow. We highlighted in the interim report when the reporting season was just beginning that there was a distinct lack of dividend growth among the UK s largest companies. (Dividends represent a share in the profits of a company and are paid out to the company s shareholders at set times of the year.) The oil majors Royal Dutch Shell and BP held their dividends flat in US dollars, while HSBC did the same in banks. These dollar earners benefited from sterling s decline, but favourable currency movements mask a harsh reality. These large multinationals are struggling to deliver underlying growth and the higher dividends received by sterling-based investors were purely a function of changes in the rate of currency. GlaxoSmithKline was more disappointing still with a dividend that was unchanged in sterling, while Vodafone failed to inspire with a 2% dividend increase in euros. Only British American Tobacco (BAT) reported a respectable dividend increase among the market s biggest constituents. To add to the gloom, dividend cuts remained a feature with Pearson being one of this year s high-profile casualties. The world s leading educational publisher reneged on its dividend commitment as a result of mounting pressures in its business, particularly in North America. The shares were punished accordingly. We had a zero holding in the media company. Competitive pressures also affected the dividends of J Sainsbury, TalkTalk Telecom and Drax which are more focused on the domestic economy. We did not have any exposure to these 3 4
Investment review companies either. Food retail, telecommunications and utilities are often associated with stability, but their perception as safe havens proved to be at odds with their commercial reality. Companies with greater economic sensitivity were also not immune. Foxtons, London s leading estate agent, lowered its dividend in response to tougher trading conditions, while its peer Countrywide eliminated its payment completely. We were not invested in any of these companies as a result of our selective approach and our unflinching focus on dividend growth. Although we have been cautious about the progress of dividends in the UK market overall, we have been keen to emphasise the excellent opportunities for those who are prepared to look beneath the surface. Being selective is paramount. In this context, we are pleased that the majority of the fund s holdings continued to deliver dividend growth in the region of between 5% and 15%. BAT, the fund s largest holding, raised its dividend for 2016 by 10%, up from 4% in 2015. Imperial Brands, another large tobacco holding, continued to deliver on its target of 10% dividend growth. Financials were also well represented in this core group with 12% dividend increases from Prudential and Aviva. Both insurers rank among the fund s top 10 holdings. Micro Focus in the technology sector provided the biggest dividend increase during the review period. In July 2016, the infrastructure software group reported a 38% dividend increase for the financial year ended April, followed by the announcement in December of a 76% dividend increase for the six months ended October. Micro Focus pays dividends in US dollars. In between these routine announcements, the company also announced a special dividend to accompany the news of the acquisition of Hewlett Packard Enterprise (HPE) s software business. The special dividend, which was equivalent to more than 7% of the company s market value at the end of the review period, is expected to be paid before the deal is completed in September 2017. Elsewhere, media made a strong contribution to the fund s distribution after satellite company SES raised its dividend by 21% in euros and RELX, the provider of information and analytics, increased the payment by the same amount in sterling. DS Smith (packaging) and Intermediate Capital (asset management) were also among the companies that delivered dividend growth of more than 15%. Not all of our holdings delivered growth, however. AstraZeneca and BP held their dividends flat in US dollars although the strength of the currency resulted in an increase for sterling-based investors. Essentra was one of a handful of companies that left their dividend unchanged in sterling. There were no dividend cuts in the fund during the period under review. In addition to growth in regular dividends, we saw the continuation of special dividends as a theme. Micro Focus was not alone in stating its intention to make a one-off payment. Jupiter Fund Management announced a special dividend which was 15% higher than the previous year, while Compass (food service), GVC (online gaming) and Admiral (insurance) reported special dividends, not for the first time. We applaud the discipline of returning excess cash to shareholders if companies cannot invest that cash in a disciplined manner. That said a number of special dividends were not repeated this year. The insurers Hiscox and Prudential chose not to pay a special dividend along with the retailer Dunelm, but all three companies reported a significant uptick in the growth of their regular dividends. All three companies doubled the rate of growth with their full-year dividends rising by more than 10%. Against this backdrop, we also maintained a yield above that of the FTSE All-Share Index. The challenges presented by the concentration of yield in the UK market have been well documented and the assessment of potential risks associated with individual high-yielding stocks remains of the utmost importance. We believe from our thorough company analysis that the fund s higher yield has been achieved with due consideration of its sustainability. We continue to be selective about the dividend streams we back and remain sceptical about the dividend-paying capacity of certain high yielding stocks. For example up until now, we have avoided Royal Dutch Shell, the UK s largest company, which is paying an uncovered dividend, that is to say it is paying out more than the earnings generated by the business. With our core holdings, we endeavour to strike a sensible balance between long-term dividend progression and attractive valuation in full recognition of the fact that the combination of a high yield and rising distribution is important to our clients. We remain committed to delivering on these twin income objectives. The fund s distribution and distribution yield are shown in the Specific share class performance tables in the Annual Long Report and audited Financial Statements. The distribution is subject to changes in the market environment and there is no guarantee that the fund will increase the distribution in every reporting period. In keeping with prior years under the fund manager s tenure, special dividends formed a key component of the fund s income and these dividends should be seen as special and not necessarily recurring. 5 6
Investment review Performance against objective Between 1 July 2016 (the start of the review period) and 3 July 2017, the fund delivered a positive total return (the combination of income and growth of capital) across its share classes. However, not all of the fund s share classes delivered returns ahead of the FTSE All- Share Index which returned 17.6% over the 12-month period. That said the fund achieved all three aspects of its objective during the past year by growing distributions, generating a yield higher than that of the FTSE All-Share Index and delivering a positive total return through the combination of income and capital growth. Over a longer timeframe of five years, the fund has delivered on all three aspects of its objective.* 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. Long-term performance One Three Five Since year years years launch 01.07.16 03.07.14 03.07.12 % [a] % p.a. % p.a. % p.a. Sterling [b] Class A +16.2 +7.1 +9.4 +11.3 [c] Class I +17.1 +7.9 n/a +10.1 [d] [a] Absolute basis. [b] Price to price with income reinvested. [c] 6 May 1964, the end of the initial offer period of the predecessor unit trust. [d] 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 The fund delivered positive returns during the 12-month review period which provided a favourable background for stockmarkets. The UK market recovered from the initial shock of Brexit with the FTSE All-Share Index reaching a record high in May. Basic materials and financials led the market higher as sectors with economic sensitivity outperformed. By contrast defensive stocks, that is, shares of companies that tend to have steady earnings and are less affected by the peaks and troughs in the economy, failed to keep up. Telecommunications and utilities generated negative returns in a rising market, while consumer goods and healthcare also lagged. Positive stock selection was the key driver of performance with the fund adding value across a broad range of sectors. Financials were prominent among the top positive contributors with Nordea making the biggest impact. The Scandinavian bank, which we prefer to the alternatives in the UK, returned more than 60% in sterling over the past year, followed by Intermediate Capital and Jupiter Fund Management which continued to deliver strong growth in their respective businesses. Micro Focus was another notable contributor after the shares returned 45%. The acquisition of HPE s software business was well received by the market as the deal provides scale in a defensive industry with high recurring revenues. We like the strong cashflow characteristics of the business model and believe there is considerable scope to improve profitability. ConvaTec in the healthcare sector was another strong performer. The provider of medical products for the management of chronic conditions made its stockmarket debut in October and the company has leading positions in large and structurally growing markets. Cash generation is robust with high recurring revenues and we believe the dividend can grow quickly from a low base. Golar LNG bucked the trend in an underperforming oil & gas sector which struggled as the oil price drifted from its peak. Golar, whose shares are listed in the US, returned almost 50% in sterling. The company which owns and operates a fleet of liquefied natural gas (LNG) carriers is one of the few that we like in the oil & gas sector because of its new low cost infrastructure for Floating Liquefied Natural Gas projects, and its projects which are able to generate cash with the gas price at lower levels. The fund also benefited from not owning Royal Dutch Shell whose shares made little progress as the market rallied. The oil major accounts for more than 7% of the FTSE All-Share Index. 7 8
Investment review However, looking at the market s biggest constituents, the fund s zero weighting in HSBC for most of the past 12 months held back performance. Shares of the global bank returned more than 60% over the year and accounted for more than 6% of the FTSE All-Share Index at the end of the review period. Not owning Barclays and Lloyds Banking Group also added to the pain. We continue to be sceptical about UK banks because we believe that the regulatory and competitive pressures, particularly for the domestic players, provide significant headwinds from a fundamental perspective. The fund s relatively small weighting in banks was a key factor in sector allocation having a negative effect, alongside the minimal exposure to mining. Not owning Glencore which returned almost 90% during the period was particularly unhelpful but we remain unconvinced about the capital discipline of many mining companies. We continue to believe that we can find better opportunities in other industries where companies have greater control of their own destiny. The fund s limited exposure to the negative returns in utilities and telecommunications provided some relief, but it was not enough to alter the outcome of negative sector allocation. Looking at the stocks we own, Dunelm and Imperial Brands were the leading detractors. Dunelm came under pressure after its trading statement in January was poorly received. The retailer is outperforming a difficult home furnishings market, but the company highlighted that profitability is being affected by sterling s weakness. The acquisition of the loss-making Worldstores out of bankruptcy also had an impact but will accelerate improvements to its delivery network and its e- commerce capabilities. Our holding in Imperial Brands experienced a rollercoaster ride with the first bout of underperformance occurring in November. Donald Trump s surprise victory in the US presidential election led to a reappraisal of economic prospects with the result that investors sought out economic sensitivity to the detriment of defensive sectors in the stockmarket. The negative sentiment took its toll on Imperial Brands, but the shares quickly recovered, recouping most of the lost ground by April. The shares weakened again, however, as the company highlighted additional investments into branding and marketing. Imperial Brands reported firsthalf results (the company s financial year ends in September) which were in line with expectations and we continue to believe that the shares are attractively valued. The stock offers a dividend yield of 5% with the dividend growing at 10%. The valuations attached to our tobacco holdings, including BAT, are much more compelling than those of other consumer goods companies which are relatively expensive. Valuation is a crucial aspect of our investment process and we continue to apply this discipline in our quest to deliver excellent returns for our clients. Investment activities As an active investor focused on fundamental analysis, investment decisions are based on detailed company research and the rigorous assessment of valuation. We determine whether a stock merits its place in the fund through the close examination of corporate strategies. Dialogue with senior management is integral to our approach. We aim to make informed judgments through human engagement. In the same spirit, we place great emphasis on company site visits as a means of developing a deep understanding of companies. As a long-term investor with an investment horizon of three years or more, we seek broader insight into a company. Understanding the operational and cultural aspects of a business enhances our understanding of a company s financial performance and helps us ultimately to form a more considered view. It is also important that our engagement with companies captures best corporate governance practices to ensure that the business is being managed in the interests of all stakeholders, including shareholders and employees. M&G has a long history of engaging companies in this way and we have a team dedicated to corporate governance and stewardship issues which works alongside the investment teams. We pursue a collaborative approach involving many investment experts to identify the best opportunities available for our clients and provide stewardship for our investments. The application of our approach has resulted in 12 new purchases and 13 complete sales over the past year. Prudential was the biggest purchase. The insurer is a beneficiary of long-term growth trends, particularly in Asia, but the stock made little progress for much of 2016, especially in US dollars. We have owned the stock in the past and saw an opportunity to re-enter in November. We also bought Sampo, the Finnish insurer, and Admiral, the car insurance specialist. The fund s exposure to insurance rose as a result of these new purchases, although the increase was tempered by the sale of Legal & General, Lancashire Holdings and Direct Line Insurance. We saw a great opportunity to realign our insurance holdings into those with better longterm growth prospects without paying excessively for those prospects. Elsewhere in financials, we started a new position in Tritax Big Box, a real estate investment trust specialising in distribution centres and logistics hubs which are pivotal to the operational efficiency of retailers, both online and conventional. We bought the shares in a placing and the company will use the proceeds to acquire new assets. Tritax is committed to a progressive dividend policy and the shares offered a dividend yield of 4.7% at purchase. On the other hand, we sold P2P Global Investments, an investment trust dedicated to loans for consumers and small and medium-sized businesses. 9 10
Investment review The fund s exposure to the broader financials sector is now larger than the weighting represented in the FTSE All-Share Index, but we have no exposure to UK banks following the sale of HSBC early in the review period. Since then, Nordea has been our only bank holding. Even with our lone representative, we have been taking profits after a strong rally in the shares. Outside financials, we bought IMI in industrials. The engineering company is a potential beneficiary of a recovery with many of the markets it serves, particularly energy-related activities, at cyclical lows. We also started new holdings in Howden Joinery and VolkerWessels which are potential beneficiaries of a recovery in construction. Countryside Properties, a home builder and urban regeneration specialist, was another new holding based on a similar theme. In a diverse industrials sector, we also added to Essentra on weakness after the shares were oversold. The support services company which supplies plastic, packaging and fibre products has been under pressure after a series of profit warnings, but we see significant value in the company. The company welcomed a new chief executive in January and his plans to stabilise the business provided comfort to the market. Essentra was the biggest positive contributor to fund performance in the first six months of 2017. In terms of sales, we reduced our holding in BAE Systems, the defence company, whose shares have performed well for the fund. The stock has returned more than 50% since its initial purchase in September 2015. In other sectors with economic sensitivity, we started a new holding in Methanex, the world s leading producer of methanol. The methanol price is recovering from cyclical lows and we believe the potential for cash generation is significantly underappreciated by the market. The purchase of Methanex in the basic materials sector was counterbalanced by the sale of Rio Tinto and Covestro, both of which delivered excellent performance. Shares of the mining group Rio Tinto returned more than 60% during the course of 2016, while Covestro, the German chemicals company, saw its market value increase almost threefold since its spin-off from Bayer. In oil & gas, we bought Prosafe which provides accommodation vessels for the offshore industry. The company successfully completed its refinancing and we believe the stock s valuation can recover from its current distressed levels. Despite this new purchase, the fund s weighting in the sector declined as we trimmed our exposure to BP. Similar to our aversion to mining, we see better opportunities in other industries. In consumer services, we started a new holding in Ascential, the business-to-business media company which is focused on events and information services. The business model is highly cash generative and we believe the growth profile is attractive. Also in media, we sold our holding in WPP following a strong run. The advertising group returned 45% after we first bought the shares in September 2015. Turning to defensive sectors, we supported the initial public offering of ConvaTec in healthcare. We also added to our holding in AstraZeneca whose pipeline in oncology could lead to significant growth. GlaxoSmithKline provided the source of cash as we sold the majority of our holding. We also exited our position in Novartis, the Swiss pharmaceuticals group, which had been a great long-term contributor through share-price performance and currency. BT Group and Tate & Lyle were the other defensive stocks sold in their entirety. BT continues to face significant regulatory headwinds and the dividend looks increasingly challenged given a likely ramp up in capital expenditure, while we took advantage of a burst of performance to exit Tate & Lyle as the prospects for dividend growth look weak. As a result of these transactions, the number of holdings dropped to 45 from the same time last year. We remain committed to our aim of providing a concentrated fund of best ideas. Investment activity, however, is not confined to the buying and selling of shares in the stockmarket. Providing financing for companies seeking capital is an important role of the fund management industry, particularly at a time when bank lending has been insufficient to meet corporate needs. Management of our clients money entails providing financial support for growing businesses, which in turn makes a direct contribution to the broader economy. We act as owners of businesses to participate in their future development. To this end, we invested 57 million in financing activities during the past 12 months, up from 51 million in the previous year, with the investments spread across a variety of businesses with no particular bias in terms of company size or sector. As with all investments, being selective is paramount, but we believe there are excellent growth opportunities for both companies and investors to share in the common goal of long-term success. Outlook The UK s vote to leave the European Union has had wide repercussions for financial markets and the economic impact is likely to remain unclear for the foreseeable future. The uncertainties were exacerbated towards the end of the review period with the Conservatives failing to secure a 11 12
Investment review majority in parliament, but macroeconomic concerns and the political climate should not deter investors from the stockmarket, in our view. The UK stockmarket continues to offer excellent opportunities for longterm stockpickers, particularly outside the largest companies which are struggling to grow. Medium-sized companies remain a source of attractive opportunities given their potential to deliver long-term growth for the benefit of shareholders. The UK is also home to a multitude of global businesses which are not reliant on the fortunes of the UK economy. We seek to invest in companies with greater control over their own destiny. Even among more domestically biased businesses, there are attractive opportunities for growth. With this in mind, our focus remains resolutely on the analysis of company fundamentals and valuation, in the strong belief that these factors drive stockmarket returns over the long term. We remain committed to our pursuit of a dividend growth strategy, and through the application of our conviction-based approach, we are ready to take advantage of new opportunities. We believe that the potential for investors in the stockmarket is best captured by a concentrated portfolio of best ideas and we remain dedicated to our task of generating excellent returns for our clients. We are encouraged by the fund s holdings which continue to raise their dividends in line with previous years and although special dividends are not as prevalent as they once were, we believe that the cash generative nature of the companies we are invested in, combined with their attractive valuation in the stockmarket, stands us in good stead for the future. The fund s yield of 4.54%, which we aim to grow over time, offers a favourable proposition for long-term investors, in our view. We appreciate your continued support. Phil Cliff Fund manager An employee of M&G Limited which is an associate of M&G Securities Limited. * 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 Annual Long Report and audited Financial Statements for M&G Investment Funds (3). 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. Portfolio statement as at 30 June 2017 2017 2016 Holding 000 % % Equities 1,315,456 102.10 100.57 Oil & gas producers 42,293 3.28 5.83 9,457,227 BP 42,293 3.28 Oil equipment, services & distribution 35,810 2.78 1.55 [a] 1,638,815 Golar LNG 28,398 2.20 2,990,875 Prosafe 7,412 0.58 Chemicals 23,408 1.82 0.73 700,000 Methanex 23,408 1.82 Mining 0 0.00 1.91 Construction & materials 12,807 0.99 0.00 603,512 Volkerwessels 12,807 0.99 Aerospace & defence 31,168 2.42 4.33 4,889,133 BAE Systems 31,168 2.42 General industrials 42,447 3.30 2.86 8,883,918 DS Smith 42,447 3.30 Industrial engineering 88,426 6.86 3.49 3,079,119 IMI 37,042 2.87 722,074 Kone 28,356 2.20 428,437 Spirax-Sarco Engineering 23,028 1.79 Industrial transportation 0 0.00 0.00 [a] Support services 89,555 6.95 3.83 9,230,000 Essentra 52,334 4.06 3,810,809 Howden Joinery Group 15,506 1.20 6,667,000 IWG (formerly Regus) 21,715 1.69 Beverages 20,917 1.62 2.02 3,020,502 Britvic 20,917 1.62 Food producers 0 0.00 1.88 Household goods & home construction 17,325 1.34 0.81 10,424,086 McCarthy & Stone 17,325 1.34 Leisure goods 36,321 2.82 0.00 2,209,326 Compass Group 36,321 2.82 Tobacco 131,110 10.18 11.52 1,642,581 British American Tobacco 86,465 6.71 1,276,291 Imperial Brands 44,645 3.47 Healthcare equipment & services 28,163 2.19 0.00 8,822,962 ConvaTec 28,163 2.19 Pharmaceuticals & biotechnology 77,348 6.00 10.97 1,113,073 AstraZeneca 57,813 4.49 1,186,432 GlaxoSmithKline 19,535 1.51 13 14
Investment review Portfolio statement (continued) as at 30 June 2017 2017 2016 Holding 000 % % General retailers 37,109 2.88 4.66 3,301,707 Dunelm Group 19,909 1.55 8,221,883 Saga 17,200 1.33 Media 101,654 7.89 9.20 1,903,670 Ascential 6,101 0.47 2,450,000 RELX 40,915 3.18 2,977,905 SES Global FDR 54,638 4.24 Travel & leisure 26,805 2.08 4.50 3,543,304 GVC Holdings 26,805 2.08 Fixed line telecomunications 0 0.00 3.19 Electricity 17,614 1.37 2.29 1,199,876 SSE 17,614 1.37 Banks 28,469 2.21 4.04 2,879,734 Nordea Bank 28,469 2.21 Non-life insurance 70,621 5.48 4.55 1,135,970 Admiral Group 22,810 1.77 2,032,719 Hiscox 25,795 2.00 552,474 Sampo 22,016 1.71 Life insurance 142,268 11.04 5.31 9,161,940 Aviva 48,833 3.79 4,500,000 Phoenix Group 34,875 2.71 3,281,596 Prudential [b] 58,560 4.54 Real estate investment trusts 64,659 5.02 2.50 6,072,138 Countryside Properties 20,658 1.60 15,850,463 Hansteen Holdings REIT 19,782 1.54 3,593,563 NewRiver REIT 12,247 0.95 326,687 NewRiver REIT subscription shares 0 0.00 8,172,162 Tritax Big Box REIT 11,972 0.93 Financial services 93,992 7.30 4.68 3,743,000 Intermediate Capital Group 31,160 2.42 7,005,000 Jupiter Fund Management 35,340 2.75 1,120,285 Provident Financial 27,492 2.13 Equity investment instruments 18,527 1.44 1.39 1,240,394 Honeycomb Investment Trust 14,203 1.10 532,126 Ranger Direct Lending Fund 4,324 0.34 Software & computer services 36,640 2.84 2.53 1,611,974 Micro Focus International 36,640 2.84 Unlisted 0 0.00 0.00 377,518 Izodia [c] 0 0.00 Portfolio statement (continued) as at 30 June 2017 2017 2016 Holding 000 % % Forward currency contracts 990 0.08 (0.03) (49,810,516) Sold for 43,900,000 (expires 13.09.17) 64 0.01 $(64,738,323) Sold for 50,700,000 (expires 13.09.17) 926 0.07 Portfolio of investments 1,316,446 102.18 100.54 AAA rated money market funds [d] 8,633 0.67 0.73 8,633,000 Northern Trust Global Fund - Sterling 8,633 0.67 Total portfolio 1,325,079 102.85 101.27 Net other assets / (liabilities) (36,761) (2.85) (1.27) Net assets attributable to shareholders 1,288,318 100.00 100.00 All securities are on an official stock exchange listing except where referenced. [a] The comparative sector weightings have been re-analysed to reflect changes to the sector classifications. [b] Related party to the fund. [c] Suspended. [d] Uncommitted surplus cash is placed into AAA rated money market funds with the aim of reducing counterparty risk. 15 16
Investment review Financial highlights Fund performance Top ten portfolio transactions for the year to 30 June 2017 Largest purchases 000 Prudential [a] 51,512 IMI 37,775 Methanex 22,904 ConvaTec 22,554 Admiral Group 22,487 AstraZeneca 20,576 Sampo 19,998 Countryside Properties 18,927 Howden Joinery Group 16,107 Essentra 13,966 Other purchases 161,625 Total purchases 408,431 Largest sales 000 GlaxoSmithKline 52,705 BP 35,889 Novartis (Regd.) 35,529 BAE Systems 34,925 BT Group 31,680 Nordea Bank 30,213 Tate & Lyle 28,992 Rio Tinto 27,471 Direct Line Insurance Group 26,205 Saga 19,504 Other sales 185,984 Total sales 509,097 Purchases and sales exclude the cost and proceeds of AAA rated money market funds. [a] Related party to the fund. 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 charts 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 Investment Funds (3), 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 Annual Long Report and audited Financial Statements for M&G Investment Funds (3), 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 2017 2016 2015 as at 30 June 000 000 000 Fund net asset value (NAV) 1,288,318 1,212,080 1,311,970 17 18
Financial highlights Fund performance Share class performance since launch To give an indication of how the fund has performed since launch, the chart below shows performance of Sterling Class A (Accumulation) shares and Sterling Class A (Income) shares. With Accumulation shares, income received from an investment is reinvested, while with Income shares, the income is paid out to shareholders. Ten-year performance Please note that comparative data is not available from fund launch. Therefore a ten-year comparable performance chart is shown below. 180 Ten years, 3 July 2007 = 100, plotted monthly Chart date 3 July 2017 40,000 25,000 15,000 10,000 7,000 5,000 3,000 2,000 1,500 1,000 700 500 300 200 150 100 70 Share class graph. From May 1964 = 100, plotted monthly. Chart date 3 July 2017 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Sterling Class A Sterling Class A (Accumulation) shares* Sterling Class A (Income) shares * Income reinvested Source: Morningstar, Inc. and M&G 160 140 120 100 80 70 60 50 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sterling Class A (Accumulation) shares* Sterling Class I (Accumulation) shares* FTSE All-Share Index Morningstar (IA) UK Equity Income 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. 19 20
Financial highlights Fund performance Historic yield The chart below shows the historic yield of Sterling Class A (Income) shares against that of a comparative index. Distribution since launch The charts below show the annual distribution of Sterling Class A (Income) shares and Sterling Class I (Income) shares since launch. 16 Yield comparison from May 1964 = 100, plotted monthly Chart date 3 July 2017 3.0 Annual distributions since launch of the share class Chart date 3 July 2017 14 12 10 8 6 4 Distribution (pence per share) 2.5 2.0 1.5 1.0 0.5 2 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Sterling Class A (Income) shares yield FTSE All-Share Index yield Source: Morningstar, Inc. and M&G 0.0 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Year ending June Sterling Class A (Income) shares Source: M&G Historic yield: The historic yield reflects distributions declared over the past twelve months as a percentage of the mid-market price, as at the date shown. It does not include any preliminary charge and investors may be subject to tax on their distributions. 60.0 Annual distributions since launch of the share class Chart date 3 July 2017 Distribution (pence per share) 50.0 40.0 30.0 20.0 10.0 0.0 2013 2014 2015 2016 2017 Year ending June Sterling Class I (Income) shares Source: M&G 21 22
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 shares and Sterling Class I 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 6 May 1964. for the year to 30 June 2017 2016 2015 Change in NAV per share UK p UK p UK p Opening NAV 594.58 612.62 568.76 Return before operating charges and after direct portfolio transaction costs 131.29 (8.10) 53.68 Operating charges (11.07) (9.94) (9.82) Return after operating charges 120.22 (18.04) 43.86 Distributions (20.18) (28.70) (26.37) Retained distributions 20.18 28.70 26.37 Closing NAV 714.80 594.58 612.62 Direct portfolio transaction costs UK p UK p UK p Costs before dilution adjustments 0.93 1.23 0.74 Dilution adjustments [a] (0.13) (0.19) (0.15) Total direct portfolio transaction costs 0.80 1.04 0.59 Performance and charges % % % Direct portfolio transaction costs [b] 0.12 0.17 0.10 Operating charges 1.66 1.66 1.66 Return after operating charges +20.22-2.94 +7.71 Historic yield 2.83 4.72 4.25 Effect on yield of charges offset against capital 0.01 1.66 1.66 Other information Closing NAV ( 000) 88,701 80,425 94,465 Closing NAV percentage of total fund NAV (%) 6.89 6.64 7.20 Number of shares 12,409,112 13,526,383 15,419,752 Highest share price (UK p) 736.85 630.43 643.79 Lowest share price (UK p) 601.50 544.66 522.62 Sterling Class I Accumulation share performance The share class was launched on 3 August 2012. for the year to 30 June 2017 2016 2015 Change in NAV per share UK p UK p UK p Opening NAV 1,327.98 1,358.02 1,251.31 Return before operating charges and after direct portfolio transaction costs 294.13 (17.92) 118.72 Operating charges (13.60) (12.12) (12.01) Return after operating charges 280.53 (30.04) 106.71 Distributions (56.52) (63.88) (58.27) Retained distributions 56.52 63.88 58.27 Closing NAV 1,608.51 1,327.98 1,358.02 Direct portfolio transaction costs UK p UK p UK p Costs before dilution adjustments 2.09 2.74 1.65 Dilution adjustments [a] (0.30) (0.42) (0.33) Total direct portfolio transaction costs 1.79 2.32 1.32 Performance and charges % % % Direct portfolio transaction costs [b] 0.12 0.17 0.10 Operating charges 0.91 0.91 0.91 Return after operating charges +21.12-2.21 +8.53 Historic yield 3.52 4.70 4.23 Effect on yield of charges offset against capital 0.01 0.91 0.91 Other information Closing NAV ( 000) 19,636 16,664 12,028 Closing NAV percentage of total fund NAV (%) 1.52 1.37 0.92 Number of shares 1,220,766 1,254,832 885,734 Highest share price (UK p) 1,657.16 1,398.07 1,426.17 Lowest share price (UK p) 1,343.61 1,213.02 1,152.45 [a] In respect of direct portfolio transaction costs. [b] As a percentage of average net asset value. 23 24
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 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. The table below shows direct portfolio transaction costs paid by the fund before and after that part of the dilution adjustment relating to direct portfolio transaction costs. To give an indication of the indirect portfolio dealing costs the table also 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 for the year to 30 June 2017 2016 2015 Average [a] Direct portfolio transaction costs [b] % % % % Broker commission 0.04 0.05 0.04 0.04 Taxes 0.10 0.15 0.08 0.11 Costs before dilution adjustments 0.14 0.20 0.12 0.15 Dilution adjustments [c] (0.02) (0.03) (0.02) (0.02) Total direct portfolio transaction costs 0.12 0.17 0.10 0.13 as at 30 June 2017 2016 2015 Average [a] Indirect portfolio transaction costs % % % % Average portfolio dealing spread 0.12 0.13 0.13 0.13 [a] Average of first three columns. [b] As a percentage of average net asset value. [c] In respect of direct 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 and method of execution. 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. 25 26
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. 55236_SR_310818