In the first half of 2021, the attention of financial markets shifted from taking into account the risks associated with the shock caused by the global spread of the COVID-19 pandemic to those posed by the enormous fiscal and monetary stimulus that central banks provided in response to this first shock. Asset purchase programs were successful in keeping borrowing costs low and issuers of variable credit quality continued to have access to inexpensive levels of investor capital. Investors looking for increased returns have been forced along the credit curve into “riskier” sectors and, in many cases, from investment grade to high yield credit. Against this backdrop, we continued to take a patient and cautious approach to deploying capital, focusing on ensuring that returns were commensurate with the underlying credit risk.

Portfolio activity and positioning

At the start of the year, markets focused on rising inflation and the reaction of sovereign debt markets. The 10-year US Treasury yield nearly doubled in the first quarter, while the 10-year UK gilt yield widened to around four times the level seen at the end of 2020 – at one point, reaching a peak of almost two years. In the eurozone, the yield on the German 10-year Bund has hit its highest level since the start of the pandemic. As risk-free rates increased, corporate credit spreads continued to tighten. Against this backdrop, the Company started the year cautiously and continued to reduce risk during the period. The Company’s short position in the 10-year gilt future successfully offset any depreciation in the value of portfolio holdings resulting from changes in interest rates.

In contrast, volatility in credit markets remained subdued as central banks pledged to provide short-term monetary stimulus. Investment grade and high yield credit spreads continued to tighten over the period, reaching multi-year lows and ending in pre-COVID levels, testifying to the success of the Bank’s asset purchase programs. central bank in suppressing corporate returns. Although this limited our ability to invest in much of the public market, we were able to sell on this strength and achieve significant capital gains in the portfolio, while reinvesting the proceeds in higher yielding private assets. .

Despite high volumes of new high yield and investment grade credit issues, portfolio activity in the second quarter of the year slowed. A high appetite for performance in the public markets limited the number of attractively priced trades, with most offering returns well below the Company’s return target. However, the pipeline of potential private transactions has remained strong since the start of the year and in total over the period we have added an additional 9.2% of private and illiquid assets to the portfolio.

As of June 30, 2021, the proportion of private assets financed in the portfolio increased to 50.9% (compared to 44.1% as of December 31, 2020) with an additional investment of 6% in Private Assets processed after closing, or committed to be fired beyond the date of this report. Further commitments of £ 2.9million (around 2%) since period end are expected to bring the Company’s overall exposure to private assets to around 58.9%.

Outlook

As inflation continues to rise, fundamental analysis of issuer credit 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 mean that we are well positioned to continue to seek out the right investment opportunities for the portfolio.

Many risks loom 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 revised economic growth forecasts. In some countries, heightened geopolitical risks remain, particularly discord between the United States and China, recent cybersecurity attacks and continued friction between the United Kingdom and the EU following the official release of the first of the l ‘European Union.

We consider the main threat to market stability to be the weakening of economic stimulus measures by central banks and the way they are reported to investors. The economies rebounded faster than expected and inflation in the UK and US significantly exceeded the long-term target of 2%, the latter being much more pronounced due to its oversized fiscal stimulus. However, the recovery has been uneven, with employment remaining below pre-pandemic levels and a premature withdrawal of accommodative monetary policy could hurt the longer-term economic recovery. The question is complicated as the risk is a double-edged sword, as continuing to provide fiscal stimulus to an already overheated economy could lead to unwanted high inflation for years to come, which could prove difficult. to reverse. Therefore, the predominant theme in the markets as we move into the second half of the year is the discussion of whether current levels of inflation are “transient” (resulting from pent-up demand caused by social restrictions but which is expected to decline over time) or “persistent” (a structural change indicating longer-term inflationary trends.) The action of central banks in response to the challenge of the changing inflation environment is expected to have the greatest impact on the path to economic recovery as we continue through 2021 and 2022.

If current market conditions persist, we will continue to increase the return on the portfolio by selling government bonds, realizing capital gains and reinvesting the proceeds in new private investment opportunities. This rotation towards higher yielding private assets with more solid structural protections will further improve the credit quality of the portfolio. There is currently a strong portfolio of private opportunities offering returns in line with our long term goal.

M&G Alternatives Investment Management Limited

September 16, 2021

Portfolio analysis

20 main titles

 
                                                          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 of June 30, 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.

Breakdown of credit scores

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.

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September 16, 2021 10:43 am ET (2:43 pm GMT)