M&G Corporate Bond 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 Corporate Bond 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 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, has been phased in between October 2016 and March 2017. From 1 January 2017 the M&G Corporate Bond Fund s prices for the sterling share classes are now calculated without income tax deducted. 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. We have discounted the annual management charge (AMC) for Sterling Class X shares. 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. The AMC for Sterling Class X shares was effectively reduced from 1.25% to 1.00% from 28 April 2017. 1 2
Fund information Investment objective up to 24 May 2017 The Fund aims to achieve a higher total return (the combination of income and growth of capital) from investment than would be obtainable in UK government fixed interest securities (ie gilts) of similar maturities. Investment policy up to 24 May 2017 The Fund invests mainly in sterling denominated corporate debt instruments. The Fund s exposure to corporate debt may be gained through the use of derivatives. Any currency exposures within the Fund may be managed by currency hedges into sterling. The Fund may also invest in other assets including collective investment schemes, other transferable securities and other debt instruments (including corporate debt and government and public securities denominated in any currency), cash and near cash, deposits, warrants, money market instruments and other derivative instruments. Investment objective from 25 May 2017 The Fund aims to provide income and capital growth. Investment policy from 25 May 2017 At least 70% of the Fund is invested in sterling-denominated corporate debt instruments. The Fund s exposure to corporate debt may be gained through the use of derivatives. Derivatives may also be used for efficient portfolio management. Any currency exposures within the Fund may be managed by currency hedges into sterling. The Fund may also invest in collective investment schemes, other transferable securities and other debt instruments (including corporate debt and government and public securities denominated in any currency), cash, near cash, other money market securities, warrants and other derivative instruments. Investment approach The Fund s strategy is based on the principle that corporate bond market returns are driven by a combination of macroeconomic, asset, sector and stock-level factors. As different factors dominate returns at different stages of the economic cycle, the manager applies a dynamic investment approach, changing the blend of duration and credit exposure in the portfolio to weight them appropriately. The fund manager has the investment freedom to take a high-conviction approach when selecting credits for the portfolio. Diversification across individual issuers as well as industries is an essential element of the Fund s strategy to limit the potential for losses in the event of default. The Fund s investment style combines top-down and bottomup analysis, and the fund manager is assisted in the selection of individual credits by a large team of independent sovereign and public credit analysts. Risk profile The fund invests mainly in sterling-denominated 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. 3 4
Fund information Investment review 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 Performance against objective In the 12-month period between 1 July 2016 and 3 July 2017, the M&G Corporate Bond Fund produced a positive total return (capital performance with income reinvested) across all sterling share classes. Due to the weakness of sterling against the euro over this period, investors in euro share classes received lower returns.* The M&G Corporate Bond Fund invests predominantly in high quality sterling-denominated corporate bonds with the aim of providing income and capital growth. 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 corporate bond markets can be influenced by the performance of government bonds. 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. 5 6
Investment review 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 +4.1 +5.2 +5.3 +6.4 [c] Class I +4.6 +5.7 +5.7 +7.3 [d] [a] Absolute basis. [b] Price to price with income reinvested. [c] 15 April 1994. All performance data prior to 11 March 2002 (the launch date of the share class) has been calculated by reference to a conversion factor due to a change of the nominated share class. [d] 2 July 2007, 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 period under review began immediately following the UK s surprise vote in favour of leaving the European Union (EU). Following an initial sell-off, markets regained their footing in July, calmed by expectations that the Bank of England would implement policy measures to mitigate any potential negative consequences of the Brexit vote. In August, the central bank met those expectations, announcing a package of measures designed to shore up the economy, including a reduction of the base interest rate to 0.25% and a new round of quantitative easing. This included an undertaking to buy selected corporate bonds, a programme that began in September and provided further support to the UK corporate bond market. 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 the year. 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 to suffer their worst month in seven years. Politics continued to dominate financial markets in early 2017, with Dutch parliamentary elections, the UK s formal triggering of Article 50, and the run-up to hotly contested presidential elections in France, among the main events. These took place against a backdrop of broadly positive economic data releases, indicating that the global economy is in good health. For the first time in a long while, the economic situation in Europe in particular looks considerably brighter. The unemployment rate has fallen back below 10% for the first time since 2011, while business surveys suggest a further steady pick-up in growth over the coming months. Political tensions also receded, with Emmanuel Macron s decisive victory in the French election helping to boost European markets towards the end of the review period. In the UK, snap parliamentary elections held in June that resulted in a hung parliament only served to muddy the waters as Brexit talks formally began. Despite this uncertain result, markets were relatively unmoved. However, a speech by Bank of England governor Mark Carney right at the end of the reporting period caused investors to judge that the timing of a first interest rate increase in some 10 years might have moved forward, leading to greater volatility and pushing the currency higher. Sterling corporate bonds experienced mixed fortunes over the 12- month period, but prices generally rose, and as a result the fund delivered positive returns for investors in all of its sterling share classes. 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. Immediately after the UK referendum, we increased the fund s duration by around one year to 7.1 years. We then reduced it slightly to 6.9 years in October 2016. From then on, it moved in a band between 6.9 and 7.1 years for the remainder of the period, staying roughly the same amount short relative to the fund s comparable index, the iboxx Corporate Index. 7 8
Investment review Having reduced the fund s exposure to investment grade bonds and increased its cash position and allocation to government bonds around the time of the EU referendum to moderate its risk profile, we then gradually reversed these moves over the reporting period. At times, when European government bonds were negatively affected by concerns about political developments in the region, we took advantage of these valuations and added them to the portfolio. We added a number of bonds from financial companies, for example from Goldman Sachs, Morgan Stanley and HSBC. We believe that such banks can do well in a reflationary environment. We remain highly selective when lending to financials and work closely with our team of credit analysts when making investment decisions. We sold a number of holdings that performed well over the reporting period, including some from the European Investment Bank, Walmart and Amgen. We have been finding significant opportunities in the asset-backed securities market, especially those backed by residential and commercial mortgages. Such securities tend to be floating rate in nature, meaning they adjust periodically depending on the change in a reference interest rate, and should therefore perform well even when interest rates rise. Even if it is not yet clear what Brexit will mean for the UK economy in the long term, consumers will carry on making mortgage payments. There has never been a default on a UK mortgage-backed security, even during the financial crisis. Outlook We believe that UK monetary policy is working and we are at, or close to, full employment. Due to sterling s weakness since the Brexit vote, inflation is once again back on the agenda in the UK. This weakness is arguably helping to keep the UK competitive, despite Brexit-related uncertainty. While it will be almost two years until any Brexit deal is concluded, until then we consider that the UK s economy is working well at near full capacity, and that the Bank of England should begin to remove some of the support it has provided to markets. In our view, the global economy is in reasonable health, we are in a period of synchronised global growth, and company default rates remain low. We are therefore positive on corporate bonds, especially issues from US companies. However we are cautious on government bonds, believing that they are already expensive and therefore there is little more upside but considerable downside as further interest rate rises in the US are likely. Richard Woolnough 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. US and UK politics will remain key for the remainder of 2017, while Europe s heavy political calendar continues to influence markets. The biggest danger remains President Trump s unpredictability something that markets are still getting used to. President Trump s planned tax reforms and policies to encourage corporate repatriation of funds should prove supportive for US corporate bond markets if they are introduced. 9 10
Financial highlights Fund performance Classification of investments Debt securities % of the fund value (net assets attributable to shareholders) 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. AAA credit rated bonds AA credit rated bonds A credit rated bonds BBB credit rated bonds BB credit rated bonds B credit rated bonds Bonds with no credit rating Credit default swaps Forward currency contracts -0.01% -0.81% 9.43% 8.66% 10.09% 14.17% 17.61% 20.22% 3.34% 3.15% 0.04% 0.13% 12.63% 11.47% 0.00% 0.10% 43.99% 39.95% 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. Interest rate futures contracts Interest rates swaps AAA rated money market funds [a] [a] -0.25% -0.05% 0.02% 0.00% 2.13% 1.55% Uncommitted surplus cash is placed into AAA rated money market funds with the aim of reducing counterparty risk. 30 June 2017 30 June 2016 Source: M&G 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) 4,127,165 4,490,189 4,807,312 11 12
Financial highlights Fund performance 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. 450 400 350 300 260 230 200 180 160 140 120 100 90 April 1994 = 100, plotted monthly Chart date 3 July 2017 Sterling Class A (Accumulation) shares* 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Sterling Class A (Accumulation) shares* Sterling Class I (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 2 July 2007. Performance data shown prior to this date is that of the fund s Sterling Class A (Accumulation) shares. 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 15 April 1994. for the year to 30 June 2017 2016 2015 Change in NAV per share UK p UK p UK p Opening NAV 65.67 61.78 59.35 Return before operating charges and after direct portfolio transaction costs 4.54 5.01 3.54 Operating charges (0.79) (0.73) (0.72) Return after operating charges 3.75 4.28 2.82 Distributions (1.84) (1.95) (1.95) Retained distributions 1.66 1.56 1.56 Closing NAV 69.24 65.67 61.78 Direct portfolio transaction costs UK p UK p UK p Costs before dilution adjustments 0.00 0.00 0.00 Dilution adjustments [a] 0.00 0.00 0.00 Total direct portfolio transaction costs 0.00 0.00 0.00 Performance and charges % % % Direct portfolio transaction costs [b] 0.00 0.00 0.00 Operating charges 1.16 1.16 1.16 Return after operating charges +5.71 +6.93 +4.75 Distribution yield 2.52 2.86 3.08 Effect on yield of charges offset against capital 0.00 0.00 0.00 Other information Closing NAV ( 000) 459,881 508,135 766,703 Closing NAV percentage of total fund NAV (%) 11.14 11.32 15.95 Number of shares 664,216,712 773,805,749 1,240,996,096 Highest share price (UK p) 70.07 65.67 65.14 Lowest share price (UK p) 66.07 61.38 58.99 13 14
Financial highlights Fund performance Financial highlights Operating charges and portfolio transaction costs Sterling Class I Accumulation share performance The share class was launched on 2 July 2007. for the year to 30 June 2017 2016 2015 Change in NAV per share UK p UK p UK p Opening NAV 68.09 63.81 61.05 Return before operating charges and after direct portfolio transaction costs 4.73 5.18 3.65 Operating charges (0.47) (0.43) (0.42) Return after operating charges 4.26 4.75 3.23 Distributions (2.27) (2.34) (2.34) Retained distributions 2.04 1.87 1.87 Closing NAV 72.12 68.09 63.81 Direct portfolio transaction costs UK p UK p UK p Costs before dilution adjustments 0.00 0.00 0.00 Dilution adjustments [a] 0.00 0.00 0.00 Total direct portfolio transaction costs 0.00 0.00 0.00 Performance and charges % % % Direct portfolio transaction costs [b] 0.00 0.00 0.00 Operating charges 0.66 0.66 0.66 Return after operating charges +6.26 +7.44 +5.29 Distribution yield 3.02 3.36 3.58 Effect on yield of charges offset against capital 0.00 0.00 0.00 Other information Closing NAV ( 000) 618,336 654,547 502,975 Closing NAV percentage of total fund NAV (%) 14.98 14.58 10.46 Number of shares 857,427,451 961,297,408 788,288,187 Highest share price (UK p) 72.98 68.09 67.16 Lowest share price (UK p) 68.62 63.39 60.69 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. [a] In respect of direct portfolio transaction costs. [b] As a percentage of average net asset value. 15 16
Financial highlights Operating charges and portfolio transaction costs 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. 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 in 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 30 June 2017 2016 2015 Average [a] Indirect portfolio transaction costs % % % % Average portfolio dealing spread 0.70 0.85 0.70 0.75 [a] Average of first three columns. 17
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. 55235_SR_310818