investing March 2015 M&G Retail Fixed Interest

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1 M&G Retail Fixed Interest in March 215 investing High yield bonds can form a valuable part of a well-diversified portfolio. A powerful generator of income, these instruments have historically delivered impressive total returns. They also have a relatively low sensitivity to interest rates and, in this respect, offer useful diversification benefits for fixed income investors. As one of the largest and most experienced high yield investors in Europe, M&G boasts impressive expertise in this highly specialised asset class. M&G s high yield heritage M&G is one of the largest and most experienced investors in high yield bonds in Europe, having invested in these assets since the 199s. In 1998 we introduced the first high yield bond fund in the UK. The following year, we launched a dedicated European high yield bond fund to focus on what was then a niche, but fast-growing, market. Since then, we have continued to invest extensively in high yield bonds, not only in our dedicated high yield bond funds, but also in many of our other fixed interest funds, such as the M&G Optimal Income Fund. In 214, we launched the M&G Global Floating Rate High Yield Fund, believed to be the first retail fund in Europe to focus exclusively on high yield floating rate notes (FRNs). Our long-term presence in the market is complemented by our major commitment to credit research; M&G s large and experienced team of analysts is a crucial resource in this most credit intensive of markets. Today M&G has more than 5 billion 1 invested in high yield across a range of funds. As longstanding high yield investors with experience across the entire economic cycle, we believe our fund managers and credit analysts have built up a level of expertise which is amongst the best in the industry. Why invest in high yield bonds? When held within a carefully selected and well-diversified portfolio, high yield bonds can provide an attractive source of income, while offering the potential for robust total returns. Historically they have generated returns that have been superior to investment grade corporate bonds. High yield bonds also bring useful diversification benefits for asset allocators, tending to be less sensitive to interest rates than investment grade bonds, but less volatile than equities. High yield bonds have a shorter average maturity compared to more highly rated government or corporate bonds. As a result, When held within a carefully selected and well-diversified portfolio, high yield bonds can provide an attractive source of income, while offering the potential for robust total returns Figure 1. Innovations in corporate bond and high yield investing First corporate bond fund M&G European High Yield Bond Fund M&G UKInflation Linked Corporate Bond Fund M&G Global Floating Rate High Yield Fund First high yield corporate bond fund 1998 M&GOptimal Income Fund 26 M&GGlobal Corporate Bond Fund As as 3 September 214 1

2 Figure 2. Comparing yield and duration of index, sector and asset class % 8% 6% 4% 2% % -yr US Treasuries Yield Duration EM sovereign BBB & lower US investment grade US Treasury Index US$ EM Corporates European investment grade Source: Bloomberg, Bank of America Merrill Lynch indices, 31 January US high yield EM high yield European high yield Floating rate high yield Duration (years) High yield bonds offer significant diversification benefits; on average, they have a shorter maturity compared to more highly rated government or corporate bonds, and hence, a lower sensitivity to interest rate changes they have a lower sensitivity to movements in interest rates, which can be measured by their lower average duration (see figure 2). Furthermore, most of a high yield bond s overall yield consists of a credit spread, reflecting its additional level of credit risk compared to risk-free investments, such as a highly rated government bond. Since a high yield bond s credit spread is only partly affected by movements in interest rates, these assets should be relatively well insulated against any rise in rates. These characteristics partly explain why high yield bonds have historically performed well during periods of rising interest rates. However, they have also performed on a longer-term basis, producing equity-like returns, but with lower levels of volatility (see figures 3 and 4). They are a powerful generator of income, and it is these income streams that have provided the bulk of their returns over the years. The fixed, predictable nature of the coupon also acts as a cushion against any fall in capital value, helping to smooth their returns and reduce their overall volatility. When would high yield bonds normally perform well? Unlike traditional safe-haven bonds, such as gilts or highly rated corporate bonds, high yield bonds will usually perform best when the economy is growing strongly, including during periods of rising interest rates. In a healthy economic environment, companies should be better placed to grow their revenues and to reduce their levels of debt. With stronger balance sheets, companies should be in a better position to meet their financial obligations and corporate default rates should fall as a result. Unlike traditional safe-haven bonds, high yield bonds would normally perform best during periods of rising interest rates Figure 3. High yield has delivered attractive returns over the long term 33 Lehman crash Index progression, rebased to Dec 98 Dec 99 Dec Dec 1 Dec 2 Dec 3 Dec 4 Dec 5 Dec 6 Dec 7 Dec 8 Dec 9 Dec Dec 11 Dec 12 Dec 13 Dec 14 EURO STOXX 5 S&P 5 FTSE US high yield European currency high yield Source: M&G, Bloomberg, 31 December

3 Figure 4. High yield risk/return characteristics over the past 25 years Returns (%) S&P 5 Index High yield Investment grade -year US Treasuries 5-year US Treasuries FTSE Index Gold CAC 4 Index DAX Index The high yield bond market has seen rapid growth over the past 15 years, especially in Europe 3 US inflation rate 2 5 Volatility (%) 15 2 Source: M&G, JPMorgan, 31 March 213. While the wider high yield market is largely driven by broader macroeconomic factors, at an individual issuer level, the key driver will be the business performance of the company. For example, companies which have been judged to have made good progress whether through increased profitability, reductions in debt or changes in management/operations should see this reflected in a higher credit rating. This can translate to significant capital gains for bondholders and can occur even if the wider high yield market is experiencing weakness. For these reasons, individual bond selection following an extensive credit analysis is a key part of investing in high yield. An increasingly global market The high yield bond market has seen rapid growth over the past 15 years, especially in Europe where volumes of issuance have grown from close to zero in the late 199s to over US$4 billion today (see figure 5). Much of the recent growth has been driven by the transformation of the European banking sector since the financial crisis, where regulatory changes have forced banks to scale back their lending activities. Cut off from their traditional sources of funding, many European companies have turned to the capital markets to meet their liquidity requirements. Compared with the US-dominated market of the 8s and 9s, today s high yield market is genuinely global in nature and is well represented by issuers across the US and Europe, and increasingly in many emerging markets in Asia and Latin America (see figure 6). The high yield market has also become far better diversified by sector over this period. Whereas a decade ago the market had a strong Compared with the US-dominated market of the 8s and 9s, today s high yield market is genuinely global in nature Figure 5. Evolution of high yield markets: comparing face value growth by rating band over time 14 US high yield 5 European currency high yield 12 4 US$ billion 8 6 US$ billion BB B CCC BB B CCC Source: M&G, Bloomberg, Bank of America Merrill Lynch, indices 31 January

4 Figure 6. Global High Yield Index, by region and sector Region 2.8% 1.5% 4.7% 5.4% 27.4% Northern America Europe LATAM Asia European Emerging Markets Other 58.1% Top countries Weighting % US UK 6.69 Italy 5.1 France 4.8 Germany 3.11 Canada 2.49 Luxembourg 2. China 1.93 Brazil 1.89 Russia 1.8 Sector 2.5% 3.1% 3.6% 3.6% 4.1% 4.2% 4.3% 4.5% 4.5% 5.3% 6.5% Source: Bloomberg, Bank of America Merrill Lynch index, 31 January % 1.2% 13.3% 9.8% 7.8%.4%.1% Basic industry Energy Banking Telecommunications Media Healthcare Capital Goods Financial Services Retail Automotive Utility Services Consumer Goods Technology & Electronics Leisure Real Estate Transportation Insurance For active investors, the evolution of the high yield market brings enormous benefits, not least by providing them with the flexibility to perform in a variety of economic conditions bias towards TMT (telecommunications, media and technology) issues providing limited scope for sector positioning today it covers a broad range of industry sectors (see figure 6). For active investors, the evolution of the high yield market brings enormous benefits, not least by providing them with the flexibility to perform in a variety of economic conditions through stock selection, country allocation and sector positioning. An example of how we have been able to actively adjust our sector positioning can be seen in figure 7. The M&G European High Yield Bond Fund was able to significantly alter its financials exposure in response to changes in the economic and market environment. The fund minimised its financial exposure during the height of eurozone crisis in 211/212 amid grave concerns over the health of the eurozone economy and the future of single currency. More recently, this allocation was increased as the much stricter regulatory environment has encouraged European banks to strengthen their balance sheets. M&G s High Yield Bond team High yield fund managers Stefan Isaacs and James Tomlins form a central part of the M&G Retail Fixed Interest team (see figure 8). In addition to managing three dedicated high yield portfolios, they are also involved with the high yield allocations for several of the team s other funds, such as the M&G Optimal Income Fund. While both managers have considerable expertise across all areas of high yield investing, James specialises in individual credit selection and sector positioning, while Stefan focuses on wider macroeconomic themes such as duration management, asset allocation and geographic positioning. Stefan and James frequently exchange ideas with the other fund managers in the team, drawing on their collective expertise in macroeconomics and bond markets. They will also regularly seek the team s specialist knowledge in other areas of the market where they may occasionally invest, such as emerging market bonds and asset-backed securities (ABS). M&G is one of the largest and most experienced investors in high yield bonds in Europe, with more than 5 billion invested in the asset class across our range of funds % of fund weighting Figure 7. Evolution of financials exposure in the M&G European High Yield Bond Fund Banking Insurance Financial services Source: M&G, 3 June

5 Figure 8. M&G s extensive resources in high yield investing Fund Managers Macro GLOBAL CREDIT ANALYSIS TEAM London Chicago Other Resources Dealing desk TOP-DOWN Duration strategy Regional allocation Liquidity Investment specialists Risk team Emerging markets BOTTOM-UP Credit selection Sector positioning Fund manager assistants Source: M&G, 215 M&G Global High Yield Bond Fund M&G European High Yield Bond Fund M&G Global Floating Rate High Yield Fund Global Credit Analysis team Extensive credit analysis is a critical part of successful high yield investing. We believe that high yield bonds are a relatively inefficient asset class, containing a large number of under-researched issues which can often be mispriced by the market. Furthermore, there can often be a considerable delay before the public rating agencies officially upgrade or downgrade a company s credit rating in response to developments that are likely to affect its business. In our view, high yield investors with the capability and resource to carry out their own independent credit analysis, and the ability to react to events as they unfold, will enjoy a considerable advantage in this highly specialised market. M&G benefits from having one of the largest and most experienced teams of credit analysts in Europe (see figure 9). In addition to the London-based analysts, the fund managers are also supported by PPM America, an affiliate of M&G and a well-resourced and established fixed income manager based in Chicago. Stefan and James have full access to the team s credit views and proprietary research and visit them in Chicago up to four times a year. In our view, high yield investors with the capability and resource to carry out their own independent credit analysis will enjoy a considerable advantage in this highly specialised market Figure 9. M&G s extensive credit research resource Public Credit Research Restructuring Financials & Sovereigns Asset-backed Industrials Paul Taylor (15) Head of Fixed Income Restructuring Rob Marshall (16) Head of Financials & Sovereigns and ABS Chris Saysell (2) Head of Corporate Credit Edward Felstead (9) Alex Giles (17) Mark Robinson (5) Tolani Benson (3) Hannah Godwin (2) Alexander Radon (2) Jaimin Shah () Elsa Dargent (6) Anuj Babber (13) Matthew O'Sullivan (8) Claire Schoeman (14) Josephine Meertens (12) Tim Morris (6) James O Prey (9) Michael Coady (6) Othman Eli Iraki (6) Eoin O Shaughnessy (5) Simon Duff (16) Rachita Patel (12) Orlando Finzi (18) Vladimir Jovkovich () Stephen Wilson-Smith (22) Michael Posnansky (13) Miriam Hehir (2) Saul Casadio (16) Lu Yu (6) Chris Money (7) Yin Wu (3) Dominic Rose (1) Andrew Amos (12) Mustafa van Hien (5) Andy Bishop (6) Rafael Cerezo (11) Richard Booth () Nick Karelis (11) Biliana Sourlekova (1) 5

6 M&G s high yield funds M&G Retail Fixed Interest offers three dedicated high yield bond funds to meet a variety of investment needs: M&G Global High Yield Bond Fund Fund managers Stefan Isaacs and James Tomlins A globally diversified portfolio with the ability to invest across the entire global high yield market. Focuses predominantly on the European, US and UK high yield bond markets, but may also take positions in other areas, such as Latin America and Asia. An unconstrained fund, with the flexibility to adjust duration and geographic positioning based on valuations and the fund managers economic outlook. The fund is available in sterling, US dollar and euro hedged share classes, thereby removing foreign exchange risk for investors in these share classes. M&G European High Yield Bond Fund Fund manager James Tomlins Invests primarily in European high yield bonds, although it may take modest allocations in other regions if valuations appear attractive. As a more focused portfolio, it will tend to be slightly more concentrated and hold fewer individual issues than the global high yield fund. The fund is hedged to euros, so will not contain any currency risk for investors in the euro share classes. However, investors in the sterling share classes will be affected by foreign exchange movements between the euro and sterling. The fund is also available in a US dollar hedged share class. M&G Global Floating Rate High Yield Fund Fund manager James Tomlins Launched in September 214, this is the most recent addition to the team s high yield range. Invests in high yield floating rate notes (FRNs), this innovative fund contains virtually no interest rate risk, while its income streams are linked to movements in interest rates. Designed for investors seeking an attractive source of income but who are concerned about the negative impact of rising interest rates. The fund s base currency is US dollars, although it is also available in a variety of other currency hedged share classes, including sterling, euros, Swiss francs and Singapore dollars. Please note that the same share classes are not necessarily registered for sale in all countries. 6

7 EXAMPLES OF HIGH YIELD BONDS Company: Sprint Region: US Sector: Telecommunications NORTH AMERICA Example bond: 6% 222 Senior Unsecured One of the four big players in the high margin and growing US wireless telecom market. The company produced revenues of more than US$35 billion in 213. Sprint is undergoing a major capital expenditure programme to upgrade its network. In 213, Japanese telecommunication company SoftBank acquired a 79% stake in the business and will use Sprint as its vehicle for its US growth strategy. Company: Ardagh Group Region: Northern Europe Sector: Packaging CORE EUROPE Example bond: 4.25% 222 Senior Secured Global metal and glass packaging company with over US$4 billion in revenue. Extensive operations across Europe, the US and Asia. Stable end demand, with a focus on food and beverages. The company has grown through acquisitions in recent years, and a possible initial public offering could be a positive for bondholders. Company: Virgin Media Region: Northern Europe Sector: Media-Cable CORE EUROPE Example bond: 6.25% 229 A leading provider of telephone, television and broadband services in the UK. Major issuer in both sterling and US dollar markets. A potential future M&A target given the consolidation taking place in the telecom industry. Company: VTR Region: Latin America Sector: Telecommunications Example bond: 6.875% 224 Senior Secured EMERGING MARKETS VTR is the leading provider of cable television in Chile. Chile is seen as one of the most successful and stable economies in Latin America. The company has shown consistently strong growth and cashflow generation in recent years. The group is owned by Liberty Global a major player in both the European and US cable markets. The value of stockmarket investments will fluctuate, which will cause Fund prices to fall as well as rise and investors may not get back the original amount invested. For Investment Professionals, Institutional Investors, and Professional Investors only. Not for onward distribution. No other persons should rely on any information contained within. FOR USE IN THE UNITED KINGDOM AND THE COUNTRIES MENTIONED BELOW: For Switzerland: Distribution of this document in or from Switzerland is not permissible with the exception of the distribution to Qualified Investors according to the Swiss Collective Investment Schemes Act, the Swiss Collective Investment Schemes Ordinance and the respective Circular issued by the Swiss supervisory authority ( Qualified Investors ). Supplied for the use by the initial recipient (provided it is a Qualified Investor) only. In Spain the M&G Investment Funds are registered for public distribution under Art. 15 of Act 35/23 on Collective Investment Schemes as follows: M&G Investment Funds (1) reg. no 39, M&G Investment Funds (2) reg. no 61, M&G Investment Funds (3) reg. no 391, M&G Investment Funds (5) reg. no 972, M&G Investment Funds (7) reg. no 541, M&G Investment Funds (8) reg. no 1, M&G Investment Funds (9) reg. no 93, M&G Investment Funds (14) reg. no 1243, M&G Global Dividend Fund reg. no 713 M&G Dynamic Allocation Fund reg. no 843, M&G Global Macro Bond Fund reg. no 56 and M&G Optimal Income Fund reg. no 522. The collective investment schemes referred to in this document (the Schemes ) are open-ended investment companies with variable capital, incorporated in England and Wales. In the Netherlands, all funds referred to are registered with the Dutch regulator, the AFM. For Hong Kong only: Some of the Funds referred to in this document may not be authorised by the Securities & Futures Commission of Hong Kong ( the SFC ) and may not be offered to the retail public in Hong Kong. The Funds may only be offered to Professional Investors (as defined in the Securities and Futures Ordinance). If you have any questions about this financial promotion please contact M&G Investments (Hong Kong) Limited. For Singapore only: The Funds referred to in this document are not authorised by the Monetary Authority of Singapore (MAS) and are not registered for public distribution in Singapore. M&G Investments (Hong Kong) Limited and M&G International Investments Limited and the Funds referred to in this document may not be authorised, recognised or regulated by the local regulator in your jurisdiction. This information is not an offer or solicitation of an offer for the purchase or sale of investment shares in one of the Funds referred to herein. Purchases of a Fund should be based on the current Prospectus. The Instrument of Incorporation Prospectus, Key Investor Information Document, the, annual or interim Investment Report and Financial Statements, are available free of charge, in paper form, from the ACD: M&G Securities Limited, Laurence Pountney Hill, London, EC4R HH, GB, or one of the following: M&G International Investments Limited, German branch, mainbuilding, Taunusanlage 19, 6325 Frankfurt am Main, the German paying agent J.P. Morgan AG, Junghofstraße 14, D-6311 Frankfurt am Main, the Austrian paying agent, Raiffeisen Bank International A.G., Am Stadtpark 9, A-3 Wien, the Luxembourg paying agent, J.P. Morgan Bank Luxembourg S.A., European Bank & Business Center, 6 c route de Treves, 2633 Senningerberg, Luxembourg, the Danish paying agent, Nordea Bank Danmark A/S Issuer Services, Securities Services, Hermes Hus, Helgeshøj Allé 33, Postbox 85, DK-9, Copenhagen C, Denmark, Allfunds Bank, Calle Estafeta, No 6 Complejo Plaza de la Fuente, La Moraleja, 289, Alcobendas, Madrid, M&G International Investments Limited, the French branch, or from the French centralising agent of the Fund: RBC Dexia Investors Services Bank France. For Switzerland: Please refer to M&G International Investments Switzerland AG, Bahnhofstrasse, 81 Zurich, for Sweden, from the paying agent, Skandinaviska Enskilda Banken AB (publ), Sergels Torg 2, 6 4 Stockholm, Sweden. For Italy, they can also be obtained on the website: Before subscribing investors should read the Prospectus, which includes investment risks relating to these funds. This financial promotion is issued by M&G Securities Limited (registered in England 9776).and M&G International Investments Ltd. Both are authorised and regulated by the Financial Conduct Authority in the United Kingdom and have their registered offices at Laurence Pountney Hill, London EC4R HH. This financial promotion is further issued by M&G Investments (Hong Kong) Limited. Office: Unit 4628, Level 46, The Center, 99 Queen s Road, Central, Hong Kong. M&G International Investments Ltd is registered in England, No It also has a branch located in France, 6 rue Lamennais, Paris 758, registered on the Trade Register of Paris, No and a branch in Spain, with corporate domicile at Plaza de Colón 2, Torre II Planta 14, 2846, Madrid, Spain, registered with the Commercial Registry of Madrid under Volume , sheet 3, page M , inscription 1, CIF W B and registered with the CNMV under the number 79. In Switzerland, this financial promotion is published by M&G International Investments Switzerland AG, Bahnhofstrasse, 81 Zurich, authorised and regulated by the Swiss Federal Financial Market Supervisory Authority. FOR USE IN ALL OTHER JURISDICTIONS NOT MENTIONED ABOVE (EXCLUDING THE USA): This financial promotion is issued by M&G International Investments Ltd. Registered Office: Laurence Pountney Hill, London EC4R HH, authorised and regulated in the United Kingdom by the Financial Conduct Authority. M&G International Investments Ltd and the funds referred to in this document may not be authorised, recognised or regulated by the local regulator in your jurisdiction. This information is not an offer or solicitation of an offer for the purchase or sale of investment shares in one of the funds referred to herein. MAR 15 / 254_3368