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Investing in High Yield
June 2012
2
Fund Managers Biographies
Stefan Isaacs
• Manager of M&G High Yield Corporate Bond Fund since October 2010
• Also fund manager of the M&G European Corporate Bond Fund since 2007
• Deputy fund manager of the M&G Optimal Income Fund and the M&G European
High Yield Bond Fund
• Previously worked on the M&G high yield dealing desk
James Tomlins
• New deputy fund manager on the M&G High Yield Corporate Bond Fund
• Lead manager of the M&G European High Yield Bond Fund
• Previously worked as deputy fund manager of Cazenove Strategic Bond Fund
• CFA Charterholder
• University of Cambridge (Postgraduate Diploma in Economics and an MA in History)
Source: M&G Investments as at 31 May 2012
3
M&G High Yield Corporate Bond Fund
Source: M&G Investments, as at 31 May 2012
Fund facts
October 1998
Stefan Isaacs (since October 2010) Fund manager
James Tomlins (Since December 2011)
Deputy manager
Fund size
GRY (Gross of fees)
GBP, EUR, USD Share classes
Morningstar EUR High Yield Bond Sectors
Inception
€1,431m
8.2%
4
M&G European High Yield Bond Fund
October 1999
James Tomlins (since Dec 2011) Fund manager
Stefan Isaacs (since Dec 2011)
Deputy manager
Fund size
GRY (Gross of fees)
GBP Unhedged , EUR Share classes
Morningstar Europe High Yield Bond Sector
Inception
€62m
9.5%
Source: M&G Investments, as at 31 May 2012
Fund facts
5
Performance data
M&G High Yield Corporate Bond Fund -1.8 6.3 0.2
3 months
%
6 months
%
1 year
Source: Morningstar , Inc., Pan European database, as at 31 May 2012 , euro A-H class shares , gross income reinvested, price to price
M&G High Yield Corporate Bond Fund
(Fund sector currently under review with Morningstar)
6
M&G European High Yield Bond Fund Performance data
Source: Morningstar , Inc., Pan European database, as at 31 May 2012 , euro C class shares , gross income reinvested, price to price
M&G European High Yield Bond Fund -3.1 8.8 0.6
Morningstar Europe High Yield Bond -1.6 8.2 -0.4
Quartile 4 2 2
3 months
%
6 months
%
1 year
7
High Yield at M&G One of the largest high yield investors in the UK
M&G Retail Fixed Interest Team – High Yield AUM (£M)
Source: M&G Investments as at 31 March 2012
3,311
1,025
516 427
98 49 50
5,476
M&G OptimalIncome Fund
M&G High YieldCorporate Bond
Fund
M&G StrategicCorporate Bond
Fund
M&G CorporateBond Fund
M&G EuropeanCorporate Bond
Fund
M&G EuropeanHigh Yield Bond
Fund
Other M&G TOTAL
Investing in High Yield Stefan Isaacs, Fund Manager
June 2012
9
Agenda
• Macroeconomic views
• Importance of credit research
• Fund positioning
10
Key convictions for the year ahead Macroeconomic and credit outlook
• The eurozone is entering recession
• Political risks remain elevated
• Default rates are likely to rise in Europe
• The banking system remains starved of capital
• Credit market valuations already price in a recession and rising defaults
• Excellent environment for stock selection
11
Sp
rea
ds (
bps)
Defa
ult R
ate
%
Source: M&G Investments , Bloomberg , S&P at 31 May 2012
European high yield spreads and default rates
High yield valuations Spreads are wide but defaults remain modest
0.00
5.00
10.00
15.00
20.00
25.00
30.00
0
500
1000
1500
2000
2500
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
S&P Euro High Yield 12m Trailing Default Rate Merrill Lynch Euroe High Yield Constrained Index
12
High yield valuations Expected returns on a buy-and-hold basis
BULL CASE
BASE CASE
BEAR CASE
Yield-to-Mat. (%) Recovery rate (%) Annual default
rate (%)
10%
10%
10%
30%
30%
30%
4.25%
6.0%
14.0%
Total return
5 years (%)
40%
33%
1%
Total return
5 years (% p.a.)
7.0%
5.8%
0.2%
Current YTM on
ML Euro HY Index
Average recovery
rate for unsecured
bonds 36.8%
2000-2004 6.5%
2006-2010 4.7%
1920-2010 3.3%
Source: M&G Investments , Bloomberg , Merrill Lynch at 31 December 2011
Itraxx Crossover index at
700 bps
= 45% of these companies will default
in the next 5 years
15
Agenda
• Macroeconomic views
• Importance of credit research
• Fund positioning
16
0 1 2 3 4 5 6 7 8 9 10
0
200
400
600
800
1000
1200
1400
1600
0 1 2 3 4 5 6 7 8 9 10
European high yield spreads
BB+ BB BB- B+ B B- CCC+ CCC CCC- CC+
Sp
rea
ds (
bp
s)
CREDIT RATING
Exceptional spread dispersion is the stockpicker’s dream
Source: M&G Investments , Bloomberg at 31 December 2011
30 June 2007
17
0
200
400
600
800
1000
1200
1400
1600
0 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10
European high yield spreads
BB+ BB BB- B+ B B- CCC+ CCC CCC- CC+
Sp
rea
ds (
bp
s)
CREDIT RATING
Exceptional spread dispersion is the stockpicker’s dream
Source: M&G Investments , Bloomberg at 31 December 2011
30 December 2011
18 Source: M&G, as at 30 December 2011.
5 Private placement
16 Leveraged finance
8 Asset Backed Securities
4 Restructuring
10 Industrials
7 Financials and sovereigns
5 Project & infrastructure finance
1 Quantitative analysis
137 fixed income investment professionals
including 56 credit analysts
Market leading credit analyst teams Analysing global companies and sovereigns
19
Examples Stock selection
Source: M&G Investments, as at 31 May 2012
Good Bad
Business risk Diversified Non-Cyclical One product, price taker, cyclical
Balance sheet Appropriate leverage and falling Appropriate leverage and falling
Structure Secured Robust legal system,
Good covenants
Unsecured, scope for fraud,
expropriation, no covenants
Ownership & Strategy Publically listed Very aggressive ; private equity
Valuation Cheap Rich
20
Examples Stock selection
* Direct claim over assets Source: M&G Investments, as at 31 May 2012
21
Examples Stock selection
• Swedish cable operator
• Stable and cash generative business
• Unsecured, Caa1/CCC+
• M&G Rating: CCC+
• Yield-to-Maturity = 10.3%
• CCC-rated but strong fundamentals
BUY AVOID
BUY AVOID
• German/US healthcare company
• Very stable business
• Unsecured, Ba1/BB+
• M&G Rating: BB
• Yield-to-Maturity = 3.1%
• Great company but no value – just
downside
• French mass-market OEM
• Weak margins and market
• Unsecured, Ba1/BB+
• M&G Rating: BB
• Yield-to-Maturity = 5.6%
• Poor company offering little value
• German cable network operator
• Stable and cash generative
• Unsecured, B3/B
• M&G Rating: B+
• Yield-to-Maturity = 8.6%
• Good value
* Direct claim over assets
EUR 10.75% 2019 EUR 8.75% 2015
EUR 9.625% 2019 EUR 5.625% 2017
Source: M&G Investments, as at 31 May 2012
22
Red Screens at Night , Stock Pickers Delight Stock selection still crucial
Source: M&G, Bloomberg, as at 31 March 2012. Rebased to 100
%
50
60
70
80
90
100
110
120
Ziggo
Virgin Media
Seat
PagesJaunes
23
Agenda
• Macroeconomic views
• Importance of credit research
• Fund positioning
24
Key portfolio themes Rationale for fund positioning
• BB and B-rated European high yield looks attractive
• Preference for defensive cash generative industries
• We are underweight cyclical sectors such as automotive
• Peripheral credit: generally cautious but will take risk selectively
• We remain cautious on financials
25
One process – two products M&G High Yield Corporate Bond Fund M&G European High Yield Bond Fund
Fund manager Stefan Isaacs (Lead)
James Tomlins (Deputy)
James Tomlins (Lead),
Stefan Isaacs (Deputy)
Description A diversified, global high yield fund that
invests across the non investment grade
universe, predominantly in Europe &
North America
A focused, high conviction, high yield fund
that predominantly invests in non
investment grade bonds denominated in
European currencies
Peer group IMA Sterling High Yield
Morningstar EUR High Yield
Morningstar Europe High Yield
Base currency & hedged
share classes
GBP
EUR Hedged
USD Hedged
EUR
GBP Unhedged
Investment universe Global High Yield Pan European High Yield
Typical credit ratings BB+ to CCC- BB+ to CCC-
Key restrictions Min 50% in sub investment grade
Max Single Issuer Exposure:
AAA – A 5%
BBB – B 4%
CCC 3%
Min 70% in European currency
denominated debt
Max Single Issuer Exposure:
AAA – CCC 5%
Target # of issuers 125 +/- 25 75 +/- 15
GRY* 8.2% 9.5%
* Internal estimate, as of 31 May 2012
26
Credit rating breakdown - fund (%) including derivatives
Source: M&G Investments as at 31 May 2012
Fund positioning I
M&G High Yield Corporate Bond Fund M&G European High Yield Bond Fund
2.5
0.0
0.7
1.7
37.6
44.8
12.0
0.4
0.3
0.0
AAA
AA
A
BBB
BB
B
CCC
CC & Below
NR
Cash
27
Fund positioning II Top overweight positions - fund (%) including derivatives
M&G High Yield Corporate Bond Fund
ML European Currency High Yield Index
M&G High Yield Corporate Bond Fund M&G European High Yield Bond Fund
M&G European High Yield Corporate Bond Fund
ML Euro High Yield Constrained Index
Source: M&G Investments as at 31 May 2012
20.5
7.7
11.3
8.8
3.0
6.9
Media Utility Capital Goods
28
Fund positioning III Top underweight positions – fund (%) including derivatives
M&G High Yield Corporate Bond Fund
ML European Currency High Yield Index
M&G European High Yield Corporate Bond Fund
ML Euro High Yield Constrained Index
M&G High Yield Corporate Bond Fund M&G European High Yield Bond Fund
Source: M&G Investments as at 31 May 2012
3.1 2.9
0.0
17.5
13.3
2.6
Banking Automotive Technology &Electronics
29
Sector breakdown, physical positions (Fund %)
Rank Issuer Issue Fund %
1 Bundesrepublik Deutschland Bundesobligat Obli 2 1/4 04/15/13 3.0
2 Norcell Sweden Holding 2 Ab Norcel 10 3/4 09/29/19 2.8
3 Smurfit Kappa Acquisitions Mdpac 7 1/4 11/15/17 2.4
4 Virgin Media Finance Plc Vmed 8 7/8 10/15/19 2.1
5 Kabel Deutschland Vertrieb Und Service G Kabegr 6 1/2 06/29/18 1.9
6 Edcon Pty Ltd Edcon 0 06/15/14 1.7
7 Upcb Finance V Ltd Upcb 7 5/8 01/15/20 1.7
8 New World Resources Nv Nworld 7 7/8 05/01/18 1.7
9 Kinove German Bondco Gmbh Kinove 10 06/15/18 1.7
10 Intergen Nv Intgen 8 1/2 06/30/17 1.6
11 Bormioli Rocco Holdings Sa Bormio 10 08/01/18 1.6
12 Ziggo Bond Co Bv Ziggo 8 05/15/18 1.5
13 Catalent Pharma Solutions Inc Ptsac 9 3/4 04/15/17 1.5
14 Rexam Plc Rexln 6 3/4 06/29/67 1.5
15
Unitymedia Hessen Gmbh and Co Kg /
Unityme Unity 8 1/8 12/01/17 1.5
Top 15 Issues
M&G European High Yield Bond Fund
Source: M&G Investments as at 31 May 2012
30
Top 15 Issues
Sector breakdown, physical positions (Fund %)
M&G High Yield Corporate Bond Fund
Rank Issuer Issue Fund %
1 GERMANY(FED REP) 2.25% IDX/LKD 15/04/13 EUR 8.0%
2 UK(GOVT OF) 2.5% I/L STK 16/04/20 GBP 2.3%
3 UNITY MEDIA GMBH 9.625% SNR 01/12/19 EUR1000 1.9%
4 NORCELL SWEDEN H 2 10.75% NTS 29/09/19 EUR'REG 1.8%
5 GERMANY(FED REP) 1.5% I/L 15/04/16 EUR0.01 1.7%
6 NORDENIA VERPACKUN 9.75% A/BKD 15/07/2017 EUR 1.5%
7 ARDAGH PACKAGING F 7.375% SNR 15/10/17 EUR'REG 1.4%
8 CODERE FIN(LUX)SA 8.25% SNR 15/06/15 EUR'REGS 1.4%
9 EDCON HOLDINGS FRN SNR 06/14 EUR1000'REGS' 1.3%
10 REXAM 6.75%-FRN SUB 29/06/67 EUR 1.3%
11 SMURFIT KAPPA ACQ 7.25% SNR 15/11/17 EUR'REGS 1.3%
12 UNITY MEDIA GMBH 9.5% SNR NTS 15/03/21 EUR 1.2%
13 SMURFIT KAPPA ACQ 7.75% SNR 15/11/19 EUR1000 1.2%
14 BAKKAVOR FINANCE 2 8.25% EMTN 15/02/18 GBP'REG 1.2%
15 INTERGEN NV 9.5% SNR 30/06/2017 GBP1000 1.1%
Source: M&G Investments as at 31 May 2012
31 Source: M&G as at 31 May 2012
M&G European High Yield Bond Fund
Peripherals = 10.2%
Spain 5.18
Italy 4.64
Greece 0.01
Portugal 0.37
United Kingdom 25.32
Germany 18.04
USA 11.29
Ireland 7.44
Switzerland 6.68
Netherlands 5.42
South Africa 4.14
Sweden 3.19
Poland 2.17
Czech Republic 2.06 other
4.05
32 Source: M&G as at 31 May 2012
M&G High Yield Corporate Bond Fund
Portugal 0.25
Italy 3.76 Greece
0.82
Spain 4.07
United Kingdom 24.73
USA 22.22
Germany 17.29
Ireland 6.40
Switzerland 3.82
France 3.39
Netherlands 2.94
South Africa 2.71
Sweden 2.04 Poland
1.81
Czech Republic 1.11
Other 2.64
Peripherals = 8.9%
33
• Economic and political risk to remain elevated through 2012
• BB – B rated valuations are attractive
• Spread dispersion remains elevated: it’s a stock pickers’ environment
Investing in high yield in 2012 Key takeaways
34
www.bondvigilantes.com
www.twitter.com/bondvigilantes
35
Appendix
36
Investment process Bottom-up stockpicking
Analysis
• Market position • Cash flow
• Product analysis • Growth
• Management • Balance sheet
Output
• Internal credit rating of over 700 issuers
• All research is published on our intranet
• Continuous credit risk monitoring
Recommendation
• Daily meeting with fund manager
• Recommendation based on fundamentals
Investment Decision
High yield dealer M&G Risk Team
• Daily Value at Risk
• Liquidity, credit and interest rates stress tests
• Continuous risk monitoring
• Market Insights: liquidity, new issues etc.
Prices may fluctuate and you may not get back your original investment.
This document is designed for investment professionals’ use only, not for onward distribution to any other person or entity. 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 35/2003 on Collective Investment
Schemes as follows: M&G Investment Funds (1) reg. no 390, M&G Investment Funds (2) reg. no 601, 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 (9) reg. no 930, M&G Global Dividend Fund reg. no 713 M&G Dynamic Allocation Fund reg. no 843, M&G Global Macro
Bond Fund reg. no 1056 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, with the exception of M&G Investment Funds (2), M&G Investment Funds
(5), M&G Investment Funds (9) and the M&G Dynamic Allocation Fund, are registered with the Dutch regulator, the AFM. This information is not an offer or solicitation of an offer for the
purchase of investment shares in one of the Funds referred to herein. Purchases of a Fund should be based on the current prospectus. The prospectus, Key Investor Information
Document (KIID), annual report and subsequent semi-annual report, are available free of charge, in paper form, from the ACD: M&G Securities Limited, Laurence Pountney Hill, London,
EC4R 0HH, GB, or one of the following: M&G International Investments Limited, German branch, Bleidenstraße 6-10, D-60311 Frankfurt am Main, the German paying agent J.P. Morgan
AG, Junghofstraße 14, D-60311 Frankfurt am Main, the Austrian paying agent, Raiffeisen Bank International A.G., Am Stadtpark 9, A-1030 Wien, the Luxembourg paying agent, J.P.
Morgan Bank Luxembourg S.A., European Bank & Business Center, 6 c route de Treves, 2633 Senningerberg, Luxembourg, Allfunds Bank, Calle Estafeta, No 6 Complejo Plaza de la
Fuente, La Moraleja 28109, Alcobendas, Madrid, M&G International Investments Limited, 34 Avenue Matignon, 75008, Paris, France or from the French centralising agent of the Fund:
RBC Dexia Investors Services Bank France. For Switzerland: Please refer to M&G International Investments Ltd., Bleidenstraße 6-10, D-60311 Frankfurt am Main or, for Sweden, from
the paying agent, Skandinaviska Enskilda Banken AB (publ), Sergels Torg 2, 106 40 Stockholm, Sweden. For Italy, they can also be obtained from one of the appointed paying agents,
details of which can be found by visiting the contact section on the following website: www.mandg-investments.it. Before subscribing you should read the prospectus, which includes
investment risks relating to these funds. This financial promotion is published by M&G International Investments Ltd. Registered Office: Laurence Pountney Hill, London EC4R 0HH,
authorised and regulated by the Financial Services Authority and registered with the CNMV in Spain. Past performance is not a guide to future performance. Performance stats are
quoted gross of Italian tax on capital gains