In the first half of 2021 financial markets focus changed from considering the risks associated with the shock caused by the global spread of the COVID-19 pandemic, to those posed by the huge fiscal and monetary stimulus which central banks provided as a response to that initial shock. Asset purchasing programmes succeeded in keeping borrowing costs low and corporate issuers of varying credit quality continued to have access to cheap levels of investor capital. Investors looking for increased returns were forced along the credit curve into 'riskier' sectors and in many cases, out of investment grade and into high yield credit. Against this backdrop, we continued to adopt a patient and prudent approach to deploying capital, with a focus on ensuring that returns were commensurate to underlying credit risk.

Portfolio activity and positioning

The focus in markets during the early part of the year was the rise of inflation and the reaction of sovereign debt markets. The yield on the 10 year US Treasury almost doubled over the first quarter, whilst that of the 10 year UK gilt widened to approximately four times the level seen at the end of 2020 - at one point spiking to a near two-year high. In the Eurozone, the yield on the German 10 year bund touched its highest level since the onset of the pandemic. Whilst risk-free rates climbed higher, corporate credit spreads continued to tighten. Against this backdrop, the Company began the year cautiously positioned and continued to reduce risk over the period. The Company's short position in the 10 year gilt future successfully offset any depreciation in the value of the portfolio's holdings resulting from the change in interest rates.

By contrast, volatility in credit markets remained subdued with central banks committed to providing monetary stimulus in the short term. Investment grade and high yield credit spreads continued to tighten over the period, reaching multi-year lows and finishing inside pre-COVID levels, testament to the success of central bank asset purchase programmes in suppressing corporate yields. Whilst this limited our ability to invest in large parts of the public market, we were able to sell into this strength and realise notable capital gains in the portfolio, whilst reinvesting proceeds into higher yielding private assets.

Despite elevated volumes of new issuance in both investment grade and high yield credit, portfolio activity in the second quarter of the year slowed. A high appetite for yield in public markets limited the amount of attractively priced deals, with most offering yields well inside the target return of the Company. However, the pipeline of potential private transactions has remained strong since the start of the year and in total over the period we added a further 9.2% of private and illiquid assets to the portfolio.

As at 30 June 2021, the funded private asset portion of the portfolio had increased to 50.9% (versus 44.1% at 31 December 2020) with an additional investment of 6% in Private Assets transacted after the period end, or committed to be drawn down beyond the date of this report. Further commitments of GBP2.9m (c.2%) since the period end are expected to take the Company's overall private asset exposure to approximately 58.9%.

Outlook

As inflation continues to ramp up, fundamental credit analysis of issuers and their cash flow profiles will become more important than ever in assessing relative value. In such an environment, our extensive research capabilities of over 100 analysts covering public and private credit means we are well positioned to continue to seek the right investment opportunities for the portfolio.

There remain many risks on the horizon as we enter the second half of the year. Most notable of these is the spread of a more transmissible strain of the COVID-19 virus, the Delta variant, which is already leading to economic growth forecasts being revised. In some countries there remain heightened geopolitical risks, particularly discord between the US and China, recent cyber security attacks and continued friction between the UK and EU following the former's official exit from the European Union.

We view the main threat to market stability as the tapering of economic stimulus by central banks and how it is signalled to investors. Economies have rebounded more swiftly than anticipated and inflation in the UK and US has spiked notably beyond the long term target of 2%, with the latter far more pronounced due to its outsized fiscal stimulus. However, the recovery has been uneven with employment remaining below pre-pandemic levels and a premature pullback of accommodative monetary policy could damage the longer term economic recovery. The issue is complicated in that the risk is double edged, as continuing to provide fiscal stimulus to an already overheating economy could lead to undesirably high inflation for years to come, which may prove difficult to reverse. Therefore, the predominant theme in markets as we enter the second half of the year is the discussion on whether the current levels of inflation are 'transitory' (resulting from pent-up demand caused by social restrictions but expected to reduce over time) or 'persistent' (a structural shift indicating longer term inflationary trends.) The action of central banks in response to the challenge of the evolving inflationary environment looks set to have the biggest bearing on the path of the economic recovery as we continue through 2021 and into 2022.

If current market conditions persist, we will continue to increase the yield of the portfolio by selling public bonds, realising capital gains and reinvesting proceeds into new private investment opportunities. This rotation into higher yielding private assets with stronger structural protections will further improve the credit quality of the portfolio. There is currently a healthy deal pipeline of private opportunities offering yields in line with our long term target.

M&G Alternatives Investment Management Limited

16 September 2021

Portfolio analysis

Top 20 Holdings 


 
                                                          Percentage of portfolio of investments 
                                                          (including cash on deposit and derivatives) 
As at 30 June 2021 
M&G European Loan Fund                                    12.16 
Sonovate Limited Var. Rate 12 Apr 2022                    1.80 
Atlas 2020 1 Trust Var. Rate 30 Sep 2050                  1.65 
Westbourne 2016 1 WR Senior Var. Rate 30 Sep 2023         1.59 
Delamare Finance FRN 1.279% 19/02/2029                    1.59 
Finance for Residential Social Housing 8.569% 4 Oct 2058  1.54 
Hall & Woodhouse Var. Rate 30 Dec 2023                    1.53 
Signet Excipients Var. Rate 20 Oct 2025                   1.42 
Newday Partnership Funding 2017-1 FRN 0.8053% 15 Dec 2027 1.39 
Regenter Myatt Field North Var. Rate 31 Mar 2036          1.35 
Hammond Var. Rate 28 Oct 2025                             1.32 
Project Driver TL Var. Rate                               1.32 
RIN II 1.778% 10 Sep 2030                                 1.26 
Dragon Finance FRN 1.3665% 13 Jul 2023                    1.14 
Finance for Residential Social Housing 8.369% 4 Oct 2058  1.12 
Lewisham Var. Rate 12 Feb 2023                            1.10 
NewRiver REIT 3.5% 7 Mar 2028                             1.09 
Marston's Issuer FRN 1.7083% 15 Oct 2031                  1.07 
Ripon Mortgages FRN 1.2814% 20 Aug 2056                   1.05 
Hammerson 6% 23 Feb 2026                                  1.04 
Total                                                     37.53

Source: State Street.

Geographical exposure 


                   Percentage of portfolio of investments 
As at 30 June 2021 
                   (excluding cash on deposit and derivatives) 
United Kingdom     60.06% 
United States      7.40% 
France             3.09% 
European Union     2.80% 
Australia          2.23% 
Other              24.42%

Source: M&G and State Street as at 30 June 2021

Portfolio overview 


As at 30 June 2021       % 
Cash on deposit          3.20 
Public                   46.22 
Asset-backed securities  22.12 
Bonds                    24.10 
Private                  50.86 
Asset-backed securities  6.72 
Bonds                    2.45 
Investment funds         12.16 
Loans                    19.03 
Private placements       0.99 
Other                    9.51 
Derivatives              (0.28) 
Debt derivatives         (0.17) 
Forwards                 (0.11) 
Total                    100.00

Source: State Street.

Credit rating breakdown 


As at 30 June 2021                       % 
Unrated                                  (0.28) 
Derivatives                              (0.28) 
Cash and investment grade                77.29 
Cash on deposit                          3.20 
AAA                                      5.52 
AA+                                      1.85 
AA                                       3.94 
AA-                                      3.38 
A+                                       0.21 
A                                        0.65 
A-                                       2.30 
BBB+                                     8.71 
BBB                                      12.94 
BBB-                                     25.11 
M&G European Loan Fund (ELF) (see note)  9.48 
Sub-investment grade                     22.99 
BB+                                      4.33 
BB                                       5.39 
BB-                                      2.55 
B+                                       1.77 
B                                        2.96 
B-                                       1.95 
CCC+                                     0.64 
CCC-                                     0.48 
D                                        0.24 
M&G European Loan Fund (ELF) (see note)  2.68 
Total                                    100.00

Source: State Street.

(MORE TO FOLLOW) Dow Jones Newswires

September 16, 2021 10:43 ET (14:43 GMT)