M&G Fixed Income: Shining a light in the cracks
M&G can claim to be the first European non-bank institution to invest in leveraged loans. As a big investor in high yield for Prudential’s with-profits life fund back in the late 1990s, investment staff wondered why they should be happy to take a position in high yield but not leveraged loans when there was no spread between the two and loans were senior in the capital structure with better information to boot. “Loans were superior in every respect and you were not paid to invest in high yield. So why not invest in leveraged loans?” recalls Simon Pilcher, CEO for fixed income at M&G.
The answer, Pilcher and his colleagues concluded at the time, was because no-one else was doing it: “There was an institutional market in the US, so why not here?” M&G still manages money in leveraged loans for Prudential, M&G’s parent since 1999 but also on behalf of third party pension fund clients and other insurers.
And aside from managing £70bn (€84bn) of Prudential’s assets, the M&G fixed income division manages third party money across a range of credit asset classes, including public fixed income, private placements, leveraged finance, structured credit, real estate finance and project and infrastructure finance through both debt and equity.
For the fixed-income division, the sweet spot is adding value in active management of credit across those categories. As Pilcher puts it, adding just 10 basis points a year in investment performance is £70m of better performance for the insurer and its shareholders. Following the financial crash of 2008, Pilcher and his team similarly saw an opportunity in collateralised loan obligations (CLOs), when banks were deleveraging and institutional investors could garner a healthy return as reward for their patience.
As M&G’s largest client, the Prudential’s own investment team is also a sparring partner. If an investment idea meets Prudential’s needs, M&G will typically establish a team and look for third-party investors who are receptive to the ideas as first mover. This helps to market ideas more rapidly.
Prudential remains M&G’s largest client and the strategies M&G devises are also typically sold to third parties as well. “The Pru controls the purse strings but is receptive to ideas,” says Pilcher. “It’s a strong working relationship whereby we are exchanging investment thinking and we are looking to help them. We have freedom within boundaries to do things but if it’s something new we have to talk.”
As a manager of external institutional assets, M&G is interested in what Pilcher calls “smarter ways of running money”, focused on credit rather than rates, adding value in public and private debt rather than through swaps and government bonds. “From a third-party perspective we are not interested in passive, which is a low-margin, low value-add for us. We’re not interested in high assets under management for the sake of it”.
Different teams of fund managers service in-house and third-party clients to give separation and clear accountability in serving each set of clients, and to remove potential conflicts.
M&G will turn down business if it doesn’t think it’s right for the client, Pilcher says, because that is in the interest not only of the client but also of the shareholder in the long run. Sales teams are set to work understanding clients’ problems and devising solutions for them, which leads to a lot of bespoke mandates to cater for particular needs.
Increasingly, the value-add fit for both the Prudential and other institutional investors is in cross-asset-class investments. M&G’s £1.5bn Secured Property Income Fund, launched in 2007, derives from a cross-asset property strategy that M&G devised for Prudential around 13 years ago. The first property was let to the UK government for 28 years, with rent that could rise but not fall.
“Being miserable fixed-income people, we said let’s assume we never get a rent increase and the building is worthless in 28 years’ time.” Plugging the cashflows into the bond calculator gave a worst-case return of Gilts plus 80 basis points. “Why would we invest in Gilts when we could buy a government-backed income stream that was delivering 0.8% per annum on worst case basis and more like government bonds plus 2.5% per annum in a less conservative environment?”
Aside from the fund, M&G has acquired around £2bn-worth of similar buildings for Prudential, working with M&G’s property investment division: “We bring a fixed-income mindset and our colleagues from M&G Real Estate bring a property mindset.”
The bulk of the money is now focused on commercial property, where inflation-linked rent rises effectively create an inflation-linked corporate bond income stream that is safer than a regular corporate bond portfolio because of the property aspect. Here, Pilcher points to significant capital queue and “almost limitless demand”, in assets once derided as “dull as hell” by property types who saw racier returns elsewhere in the real estate market.
The downturn in the commercial property market made such strategies a difficult sell. “For the first couple of years we had very little take-up,” recalls Pilcher. “It was the time of the crisis and property was not the flavour of the month. But recently people have seen that it does exactly what they want and need, and as long-term buy-and-hold investment it will deliver cashflows that funds want and need to pay pensions.
“This is your classic intersection between fixed income and real estate but I don’t care about the label. If it’s good quality and cheap we should be buying it.”
Regulation is clipping insurers’ wings in terms of the capital buffers needed to invest in risk assets. But future success for M&G, both for internal and external clients, will still depend on doing more of the same in terms of the cross-fertilisation of ideas. Pilcher sees the firm’s culture as the paramount element. “An organisation reflects its people,” he concludes. “Its about having the right people and a culture that says, fundamentally, we are investors and we seek to serve our clients.”
“We want to be trusted. We want our people to feel proud of what they are doing and that means doing things that make sense in the medium to long term and not being short-term profit maximisers.”