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M&G European Inflation Linked Corporate Bond Fund
April 2012
Ben Lord, Fund Manager
2
Biography
• Jim Leaviss is Head of Fixed Interest at M&G International
• He joined M&G in 1997 after five years at the Bank of England
• As well as heading up the team, Jim is the fund manager of the M&G
Global Macro Bond fund, the M&G Gilt and Fixed Interest fund, and co-
manager on the M&G Inflation Linked Corporate Bond funds
• Ben Lord joined M&G in 2007 and was appointed fund manager of the
M&G High Interest Fund in February 2009
• Since launch in September 2010, he has also been the co-fund manager
on the M&G UK Inflation Linked Corporate Bond Fund and the M&G
European Inflation Linked Corporate Bond Fund
• Ben previously worked at Gordian Knot as a credit analyst covering
global financial institutions
• He obtained an MA (Hons) from the University of Edinburgh and is a CFA
charterholder
Co-fund managers
3
M&G European Inflation Linked Corporate Bond Fund
Source: M&G Investment Information, as at 30 March 2012
September 2010
Jim Leaviss Co-fund manager
Ben Lord Co-fund manager
Fund size
Sector
Inception
€101.5m
Morningstar EUR
Inflation-Linked Bond
Fund facts
4 Source: M&G, Morningstar as at 31 March 2012. Pan European database, Bid-to-bid, gross income reinvested, Euro A Share class
M&G European Inflation Linked Corporate Bond Fund In
de
xe
d t
o 1
00
=
17
/09
/20
10
Performance since inception in September 2010
94.0
96.0
98.0
100.0
102.0
104.0
106.0
108.0
Chart Title
MSTAR PE EUR Corporate Bond Sector MSTAR EUR Government Bond Sector
M&G European Inflation Linked Corporate Bond Mstar EUR Inflation-Linked Bond Sector
EU Harmonized Indices of Consumer Prices
M&G European Inflation Linked Corporate Bond Fund – performance since inception
5
M&G
• Index-Linked Fixed Income
• M&G European Inflation Linked Corporate Bond Fund
• Fund positioning
Agenda
6
Comparing nominal bonds and index-linked bonds
Nominal bond: yield – inflation = real yield
Today 3% Inflation +1%
Nominal real yield -1% -2%
Linker real yield inflation-0.5% inflation-0.5%
Index-linked bonds remove future inflation uncertainty
2% - 3% = -1%
Index-linked bond: real yield = realised inflation + real yield
Inflation - 0.5%
7
Inflation (CPI) Assumption 3% 4% 5%
Nominal 2015 OAT real yield -2.0% -2.8% -3.8%
Linker 2015 OATi real yield -0.8% -0.8% -0.8%
Veolia 2016 IL corp real yield 1.9% 1.9% 1.9%
Source: M&G as at 31 March 2012
Payoff profiles
8
Long-term, global reasons to consider inflation protection
• Demographics
– Population growth
9
World population
0
1
2
3
4
5
6
7
8
9
10
1950 1975 2000 2025 2050
bn
Source: DB Research, as at. January 2012.
10
Long-term, global reasons to consider inflation protection
• Demographics
– Population growth
– Dependency ratio
11
5
15
25
35
45
55
65
75
1950
1960
1970
1980
1990
2000
2010
2020
2030
2040
2050
U.K U.S
France Germany
Italy Japan
%
Old age dependency ratio
Source: DB Research, as at. 18 January 2012.
12
Long-term, global reasons to consider inflation protection
• Demographics
– Population growth
– Dependency ratio
• Globalisation
13
Long-term, global reasons to consider inflation protection
• Demographics
– Population growth
– Dependency ratio
• Globalisation
• The end of the gold standard
14
Global inflation series re-based to 1 in December 1899 on a log scale
10,000,000,000,000
1,000,000,000,000
100,000,000,000
10,000,000,000
1,000,000,000
100,000,000
10,000,000
1,000,000
100,000
10,000
1,000
100
1
0
0
10
Germany
Italy
France
Japan
Spain
UK
US
Switzerland
1971 1913
Source: Deutsche Bank, GFD , 12 September 2011
15
-2
-1
0
1
2
3
4
5
CPI YoY
Inflationtarget
%
Does the ECB now have an inflationary bias?
Source: Bloomberg, as at 31 December 2011
%
16
Inflation expectations
Source: Bloomberg, as at 31 March 2012
Driven by stronger growth, higher commodity prices,
higher taxes, and QE fears
%
5 year breakeven rates for US, UK and Germany
0.5
1.0
1.5
2.0
2.5
3.0
Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12
UK
US
GER
17
M&G
• Index-Linked Fixed Income
• M&G European Inflation Linked Corporate Bond Fund
• Fund positioning
Agenda
18
Fund Objective
Aims to deliver CPI after fees over the medium term
19 Source: Bloomberg, as at 31 March 2012
%
10y IL and conventional yields
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12
10Y Bund
10Y IL Bund
Conventional and inflation-linked 10y bund yields (%)
20 Source: M&G as at 31 March 2012
Breakevens are exceptionally cheap at the front end
Bond = OBLi 2.25 2013
1.7
2.0
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2.0
2.1
Implied Breakeven Reasonable
Outperformance 0.3
21
2.3%
2.3% 3.7%
5.7%
Spread =
What am I buying when I purchase an inflation-linked
corporate bond?
An inflation-linked corporate bond is a combination
of duration risk and credit risk, plus inflation
Source: Bloomberg, M&G as at 31 March 2012
BT I/L 2025 BBB
PURE INTEREST RATE RISK (Duration)
Risk-free yield =
2024 gilt linker
PURE CREDIT RISK (Spread)
REALISABLE YIELD
= + +
=
Risk-Free + Spread + Realised Inflation =
-0.3%
-0.3%
22
Some issuers of inflation-linked corporate bonds
23
1.5%
CDS + government linker = synthetic inflation linked corp
Synthetic Vivendi linker
Credit default swap (Pure Credit Risk):
Vivendi CDS 5y =
Source: Bloomberg, M&G as at 31 March 2012
Synthetic inflation-linked corporate bonds
Pure interest rate risk (duration):
UKTI gilt 2.5% 2016 “Risk free” yield =
= Risk Free + CDS spread + RPI
= + +
=
1.5%
3.7%
How to create one
-1.8%
-1.8%
3.4%
24
M&G
• Index-Linked Fixed Income
• M&G European Inflation Linked Corporate Bond Fund
• Fund positioning
Agenda
25 Source: Bloomberg, M&G as at 31 March 2012
Overall fund duration: 1.3 year
M&G European Inflation Linked Corporate Bond Fund
Core of fund in index linked credit,
Fund positioning
Asset Allocation (Fund %) Credit Split incl. Derivatives (Fund %)
Synthetic IL Bonds 33.2
Index Linked Government
Bonds 15.9
Index Linked Corporate
bonds 21.5
Fixed 19.9
FRN 8.8
Cash 0.6
15.4
13.8
38.2
23.3
3.6
3.7
0.0
1.3
0.6
AAA
AA
A
BBB
BB
B
CCC & Below
NR
Cash
26
We have been flexible and taken advantage of recent
volatility
Built up cash before summer, and quickly deployed cash
after spreads widened.
Source: Bloomberg, M&G as at 31 March 2012
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
50
150
250
350
450
550
650
750
850
Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12
iTraxx Main (LHS) iTraxx Xover (LHS) M&G UK Inflation Linked Corporate Bond risk free cash level (RHS)
27 Source: M&G as at 31 March 2012
Fund duration Duration positioning since inception in September 2010
Fund duration (LHS) Vs. 5y bund linker and 10y conventional bund (RHS)
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
0.0
1.0
2.0
3.0
4.0
Fund 10y Bund 5y IL Bund
28
Financials sector exposure
Source: M&G as at 31 March 2012
Financials Exposure Feb12 Financials Exposure Dec 11
M&G European Inflation Linked Corporate Bond Fund
ML EMU Corporate index
6.0 4.6
45.1
4.0
Banks Insurers
20.1
5.4
44.7
4.3
Banking Insurance
29
Conclusions
• Long-term demographics and global factors support inflation
• Central banking: risks growing, inflationary bias a fact
• Credit is cheap. A combination of (cheap) inflation protection and
(cheap) credit could be a very wise strategy
30
Appendix
31
Banking exposure
Source: M&G as at 31 March 2012
Capital Structure breakdown Feb 12 Capital Structure breakdown Dec 11
Senior unsecured
4.5
Lower Tier 2
1.5
Senior Unsecured
13.8
Lower Tier 2 6.4
32
Fund facts
Top 15 holdings
Rank Issuer Issue(s) Fund %
1 Bundesrepublik Deutschland Bundesobligat Multiple 22.6
2 United Kingdom Gilt Inflation Linked Multiple 20.7
3 United States Treasury Inflation Indexed Tii 0 5/8 04/15/13 4.1
4 Severn River Crossing Plc Sevriv 6 1/8 06/30/13 3.9
5 Toyota Motor Credit Corp Toyota 2.413 05/30/17 3.7
6 Tesco Plc Tscoln 4 09/08/16 3.0
7 Oresundsbro Konsortiet Orekon 3.4 09/28/14 2.3
8 Jpmorgan Chase Bank Na Jpm 5 3/8 09/28/16 2.2
9 Sweden Government Bond Sgb 3 1/2 12/01/15 #3105 1.7
10 Wells Fargo Bank Na Wfc 5 1/4 08/01/23 1.6
11 Asif Iii Jersey Ltd Aig 5 3/8 10/14/16 1.5
12 Deco Series Deco 2005-uk1x A1 1.4
13 Hannover Finance Luxembourg Sa Hanrue 5 3/4 02/26/24 1.4
14 Royal Bank Of Scotland Plc/the Rbs 6 3/8 04/29/14 1.3
15 Bank Of America Corp Bac 5 1/4 11/09/16 1.0
Source: Bloomberg, M&G as at 31 March 2012
33
Fund facts Top 15 CDS Positions
Source: Bloomberg, M&G as at 31 March 2012
Rank Company Fund %
1 Allianz Finance Ii Bv 2.0
2 Edf Sa 2.0
3 E.on International Finance Bv 2.0
4 Hsbc Bank Plc 1.9
5 Procter and Gamble Co/the 1.7
6 Itrx Xover S16 5 Year 1.5
7 Anheuser-busch Inbev Nv 1.5
8 Imperial Tobacco Finance Plc 1.4
9 US Bancorp 1.3
10 Heineken Nv 1.3
11 Telefonaktiebolaget Lm Ericsson 1.3
12 Vivendi Sa 1.2
13 Baa Funding Ltd 1.1
14 Wesfarmers Ltd 1.1
15 Ppr 1.0
34
0.0%
5.0%
10.0%
15.0%
Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12
30 day VaR @99% Upper Limit Lower Limit
Source: M&G, as at 31 March 2012
Value at Risk Well below 10% upper limit
Value at Risk (VaR)
Daily monitoring of global exposure using VaR with methodology 99% one month with an equally weighted
observation period (history) of 250 business days.
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