Sub Prime, Bear Market & Recession -Investment Opportunity or too much risk? Bankhall Adviser Forum – March 2009 George Pullar – Investment Development

Sub Prime, Bear Market & Recession

-Investment Opportunity or too much risk?

Bankhall Adviser Forum – March 2009

George Pullar – Investment Development ManagerGeorge Pullar – Investment Development Manager

A Stellar time for bonds, the search for extra income?

Bankhall and Prudential March 2009Graeme Abell – Partnerships Director

3

Mission control – countdown to lift off!

A tour of the universe(market update)

Mystic M&G’s predictions for 2009

How to stop being sucked intoa black hole (UCITS III)

M&G – our very own stars

4






5

Houston we have a problem

Huge bust following huge boom – prices fallingtwice as fast as during Great Depression

-25

-20

-15

-10

-5

0

5

10

15

20

25

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Source: S&P/Case-Shiller Composite-20 Index yoy, November 2008

% change, yoy

Nominal -18.2%

Real -20.2% November 2008

6

20000

25000

30000

35000

40000

45000

50000

55000

60000

65000

70000

Q11980

Q11981

Q11982

Q11983

Q11984

Q11985

Q11986

Q11987

Q11988

Q11989

Q11990

Q11991

Q11992

Q11993

Q11994

Q11995

Q11996

Q11997

5000

7000

9000

11000

13000

15000

17000

19000

21000

181% increase in average price in decade leading up to the peak

18% peak-to-trough drop

Its all gone Apollo 13

A three year crash – eight years to regain peak

Source: Datastream as at September 2008

UK house prices: the last recession

Ave

rag

e H

ouse

Pric

eA

vera

ge

Hou

se P

rice

Averag

e Annual In

com

eA

verage A

nnual Inco

me

7

50000

70000

90000

110000

130000

150000

170000

190000

Q11997

Q11998

Q11999

Q12000

Q12001

Q12002

Q12003

Q12004

Q12005

Q12006

Q12007

Q12008

Q12009

Q12010

Q12011

Q12012

Q12013

Q12014

Q12015

Q12016

17500

22500

27500

32500

37500

42500

232% increase in average price in decade leading up to the peak

55% drop to 1990s price/income lows

Its all gone Apollo 13 A long way from cheap

A ’90s style’ adjustment in affordability would bringa 55% peak-to-trough drop in the average house price

Source: Datastream as at December 2008

UK house prices: the current recession

Ave

rag

e H

ouse

Pric

eA

vera

ge

Hou

se P

rice

Averag

e Annual In

com

eA

verage A

nnual Inco

me

8

-1.0-0.50.00.51.01.52.02.53.03.54.04.55.05.56.06.5

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

UK inflation M&G UK inflation expectations

Time for re-entry

Deflation later this year?

Inflation to stay low…Inflation to stay low…

%

*Sterling overnight index minus 0.12%

3% max limit

1% min limit

2% target

M&G’s UK inflation expectations

Source: M&G, Bloomberg, 5 February 2009

10

Over the moon or in a black hole?

2009 Inflation 1.1% below 1%?

Core Food / Energy

1.6% 2.2%

(82%) (18%)

1.4% 0%

2008 Headline inflation 3.8%

Source: Bloomberg, as at 31 July 2008

11

0.00.51.01.52.02.53.03.54.04.55.05.56.06.57.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

B of E rate Interest rate futures* M&G Rate expectations

Source: M&G, Bloomberg, 06 January 2009

%

We’re in for a bumpy ride

Low interest rates and low inflation…

*Sterling overnight index minus 0.12%

3% max limit

1% min limit

2% target

Bond market interest rates expectations

UK interest rates will stay lower for longerUK interest rates will stay lower for longer

12






13

Mystic M&G…..

14

“Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value”

Warren Buffett, 17 October 2008

Space junk…Cash is trash

15

Cash burns long but dimly…

£1000 invested from 31 Dec 1969 to 31st Oct 2008 (net income reinvested)

Source: Morningstar and M&G Statistics as at end December 2008

£0

£1,000

£2,000

£3,000

£4,000

£5,000

£6,000

£7,000

£8,000

1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

UK Savings UK Savings (inflation adjusted)

£7,599

£625

16

Into the vortex - the credit crunch

Crunch time for bonds

Source: Deutsche Bank, Bloomberg, as at June 2007

June 2007: were investment grade bonds attractive?

-6

-4

-2

0

2

4

6

8

10

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

US

GD

P g

row

th

0

50

100

150

200

250

300

350

400

US

BB

B s

pre

ads

US GDP growth (left axis) US BBB spreads (right axis)

Recession

Economic boomSpreads tightest

since 1978

%

17

Oct 2008 : are investment grade corporate bonds attractive now?

Are bond spreads still in a hole?


-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

196

0

196

2

196

4

196

6

196

8

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

200

0

200

2

200

4

200

6

200

8

US

GD

P g

row

th

0

50

100

150

200

250

300

350

400

450

500

550

600

650

700

750

800

US

BB

B s

pre

ad

s

US GDP growth (left axis) US BBB spreads (right axis)

Recession

Economic boomSpreads tightest

since 1978

%

Spreads widest EVER

Source: Deutsche Bank, Bloomberg, as at 03 December 2008

18

050

100150200250300350400450500550600650700750800

19

25

19

29

19

33

19

37

19

41

19

45

19

49

19

53

19

57

19

61

19

65

19

69

19

73

19

77

19

81

19

85

19

89

19

93

19

97

20

01

20

05

20

09

BB

B s

pre

ad

s

UK BBB spreads US BBB spreads


Basis points

BBB spreads now at 1932 levels

BBB spreads since 1925

US data since 1925, Europe & UK since 1997 US data since 1925, Europe & UK since 1997

US 773

UK 758

Source: Morgan Stanley, Moody’s, The Yield Book, NBER , Bloomberg/Merrill Lynch, as at 05 January 2009

19

Heading for a ‘cash’ landingY

ield

to

mat

urit

y/in

tere

st r

ate

Cash accounts now offer close to zero, but you can receive 7.4% per year for 23 years if you buy a Vodafone bond

Yie

ld t

o m

atu

rity/

inte

rest

rat

e

7.4%

1.0%0

1

2

3

4

5

6

7

8

9

2003 2004 2005 2006 2007 2008 2009

UK interest rates Vodafone 5.9% 2032

Source : Bloomberg, 05/02/2009

20

70

80

90

100

Jul-0

7

Se

p-0

7

No

v-0

7

Jan

-08

Ma

r-0

8

Ma

y-0

8

Jul-0

8

Se

p-0

8

No

v-0

8

Jan

-09

Ma

r-0

9

Ma

y-0

9

Jul-0

9

Se

p-0

9

No

v-0

9

Jan

-10

Ma

r-1

0

Ma

y-1

0

Jul-1

0

Se

p-1

0

No

v-1

0

Jan

-11

Some Rocket Science

Source : Bloomberg, 14/01/2009

Vodafone 5.9% 2032 breakeven analysis

Bond price

Distribution yield = 7.0%

Yield to maturity = 7.4%

Price = 84.9

Return

3.0% = cash75.2

8.2% = gilt79.9

14.5% = constant84.9

15.3% = Pull to par85.6

Two years

Vodafone bond’s price has to fall 11% in the next two years just to break even with cash

YTM = 8.2%

21

7.1

9

11

0

3

6

9

12

15

Blakes 7 Deep Space 9 Apollo 11

The search for income

Source: M&G, 03 October 2008

%Investment grade bond yields

22

Assessing the gravity of the situation

Source: *Moody's 2008 annual default study. **Merrill Lynch sterling indices as at November 2008. Implied default rates

On average, only 3%of BBB rated bonds have defaultedwithin 5 years

What’s the default rate been historically?

Rolling 5 year average global default history (1920-2007)

0.2% 0.7% 1.1% 3.1%9.6%

21.4%

37.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

AAA AA A BBB BB B CCC-C

INVESTMENT GRADE

De

fau

lt R

ate

%

Bond Rating

HIGH YIELD

23

Assessing the gravity of the situation

0.2% 0.7% 1.1% 3.1%9.6%

21.4%

37.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

AAA AA A BBB BB B CCC-C

Source: *Moody's 2008 annual default study. **Merrill Lynch sterling indices as at November 2008. Implied default rates : Deutsche Bank, Oct 2008

INVESTMENT GRADE

De

fau

lt R

ate

%

Bond Rating

HIGH YIELD

Even assuming zero recovery rate, almost 30% of investment grade bonds have to default in next 5 years to not beat gilts

What are current corporate bond spreads implying?

Implied default rate - average recovery

Implied - average recovery

Rolling 5 year average global default history (1920-2007)

24






25

• 2002: UCITS III wider powers, enables the use of new instruments within UCITS funds

• 2004: FSA remodels NURS regime

• Underlying must be eligible and derivatives may not be usedto circumnavigate the rules

• February 2007: All groups must indicate if complying with UCITS or NURS

How to stop being sucked into the black hole

European and UK regulators have become morecomfortable with derivative use in retail funds

(UCITS III) - an expanded universe

26

Iceland’s banking system – utter lunarcy!

Source: Prudential M&G

Buying protection on Kaupthing generated a profit for the fund

27

How does a CDS work?

We think KAUPTHING will default so we buy protection from investment bank

28

How does a CDS work?

KAUPTHINGdefaults, we

receive payoff

29






30

The stars in our constellation

Source: M&G Investment Information, as at February 2009

FUM£78bn

1st HY corporate bond fund 1998

1st UK corporate bond fund

1994

1st leveraged loan fund, Europe 2005

52analysts

M&G for a galaxy of stars in the bond fund market

31

The AnalystsOver 2000 Lehman bonds in the galaxy!Over 2000 Lehman bonds in the galaxy!

32

Galactic performance across every single bond fund we manage

M&G Corporate Bond Fund* 1 1 1 1 Richard Woolnough

M&G Strategic Corporate Bond Fund* 1 1 1 N/A Richard Woolnough

M&G Optimal Income Fund* 1 1 N/A N/A Richard Woolnough

M&G Gilt & Fixed Interest Income Fund* 1 1 1 2 Jim Leaviss

M&G High Yield Corporate Bond Fund* 1 1 1 2 Jim Leaviss

M&G Global Macro Bond Fund* 2 2 2 2 Jim Leaviss

M&G Emerging Markets Bond Fund** 1 1 1 1 Jim Leaviss

M&G Index-Linked Bond Fund* 1 1 1 3 Jim Leaviss

M&G International Sovereign Bond Fund* 1 1 1 1 Jim Leaviss

M&G European Corporate Bond Fund*** 2 1 1 1 Stefan Isaacs

M&G European High Yield Bond Fund*** 1 1 1 1 Stefan Isaacs

6m 1y 3y 5y Fund manager

Performance relates to quartile positions

Source:* IMA sectors** Morningstar Fixed Income Global Emerging Markets, as at 31 December 2008, A share class, bid to bid, net income reinvested*** Morningstar Spanish database (Fixed Income EUR – Corporate sector/Europe High Yield, as at 31 December 2008, C share class, bid to bid, net income reinvested

33

A meteoric rise to fameFund manager - Richard ‘Wookie’ Woolnough

Number one fund 2000-03*

31.2

22.4

0

5

10

15

20

25

30

35

Old Mutual CorporateBond Fund*

IMA UK Corporate Bondsector average

Total return (%)

Total return (%)

*Morningstar, 07/07/2000 (Old Mutual Corporate Bond Fund launched) to 30/6/2003 (Richard Woolnough resigns from old Mutual), bid-bid, net of tax ** Morningstar, 20//02/2004 (Richard Woolnough takes over M&G Corporate Bond Fund) to 31/12/2008, bid-bid, net income reinvested, A share class

Outperformed by 13.6% since 2004**

14.4

0.80

5

10

15

20

M&G Corporate BondFund**

IMA £ Corporate Bondsector average

34

Bonds the brightest stars in the galaxy?

• Low interest rates, low inflation

• Spreads at all time high

• Cash has crashed

• Bond opportunity of a lifetime?

It is a stellar time for bonds!

35

Light years ahead of the competition!

WINNERBest Fixed

Interest Group

Best Fixed Interest Group

www.bondvigilantes.comwww.bondvigilantes.com

FOR INVESTMENT PROFESSIONALS ONLY.This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The company’s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England number 90776. This document is not intended as an offer to acquire or dispose of any security. Information given in it has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. This information is not intended to constitute a basis for any specific investment decision.

Documents

Sub Prime, Bear Market & Recession -Investment Opportunity or too much risk? Bankhall Adviser Forum – March 2009 George Pullar – Investment Development