Credit investing in an inflationary world

11 – 13 May 2011

Sterling powered by

strong jump in inflation

Impennata del costo del petrolio

e degli alimentari si tradurrà in

agitazione

3

M&G’s Inflation Linked Corporate Bond Funds

Source: M&G Investment Information, as at 30 April 2011. „^The M&G UK Inflation Linked Corporate Bond Fund is only authorised by the FSA in the UK. The fund has not been

authorised nor otherwise approved by a financial regulator in any other jurisdiction'.

Fund facts

September 2010

Jim Leaviss Co-fund manager

Ben Lord Co-fund manager

£231m Fund size

IMA £ Strategic

Bond Sector Sector

Inception

€29.5m

Morningstar EUR

Inflation-Linked Bond

UK^ Europe

4

95

96

97

98

99

100

101

102

103

104

105

Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11

M&G European Inflation Linked Corporate Bond Fund EU Harmonised Indices of Consumer prices

MStar PE EUR Corporate Bond (PG) MStar PE EUR Government Bond

MStar PE EUR Inflation-Linked Bond

Fund performance Since inception in September 2010

Source: M&G, Morningstar as at 30 April 2011. Pan European database, Bid-to-bid, gross income reinvested, Euro A Share class

M&G European Inflation Linked Corporate Bond Fund – performance since inception

Ind

ex

ed

to

10

0

3.90%= Fund

2.48% = EU HICP

-0.11% = € IL Bonds

-0.27%= €

Corporate Bonds

-3.67%= €

Government Bonds

5

Biography

• Jim Leaviss joined M&G in 1997 from the Bank of England. He

is Head of M&G Retail Fixed Interest

• Co Manager of the M&G UK and European Inflation Linked

Corporate Bond Funds since Sep 2010

• Has 19 years experience in fixed income markets

Co-fund managers

• Ben Lord joined M&G in 2007

• Fund manager of the M&G High Interest Fund since February

2009 and deputy fund manager for Strategic Corporate Bond

and Corporate Bond funds

• Ben previously worked at Gordian Knott as a credit analyst

covering financial institutions

Credit investing in an inflationary world Ben Lord, Fund Manager

11 – 13 May 2011

7

What is the current rate of inflation in Zimbabwe?

(as at January 2011)

Inflation Quiz 1

8

What was the rate of inflation in Zimbabwe

in July 2008?

Inflation Quiz 2

9

How much was Z$100 billion worth in Euros

in October 2008?

Inflation Quiz 3

10

How much did a roll of toilet paper cost in Zimbabwe

in May 2006?

Inflation Quiz 4

11

Agenda

• Hedging against inflation

• Macroeconomic views

• M&G European Inflation Linked Corporate Bond Fund

12

Asset class sensitivity to inflation in the short term

Source: IMF, Attie, P., and Roache, S., “Inflation Hedging for Long-Term Investors”, April 2009. 12-month returns on annual inflation using overlapping observations.

The SDR-based analysis assesses the inflation-hedging properties of broadly diversified international asset class benchmarks.

Impact on returns of a 1% increase in inflation

Commodities are an effective hedge for an increase in

inflation of 1% in the short-term

-6

-4

-2

0

2

4

6

8

10

12

U.S. 3-

month T-

bills

U.S.

Treasuries

(all

maturities)

U.S.

Corporate

bonds

SDR-

weighted

gov.

bonds

(10y+

maturities)

SDR-

weighted

equities

CRB index Gold spot SDR 60-40

equity-

bond

portfolio

Impact on returns over entire history of data

Impact on returns since exchange rates were allowed to float (1973)

Impact of a 1% rise in inflation by asset class

13

Inflation hedging over the long term Asset class reactions to an unexpected increase in inflation

Cash

Source: IMF, Attie, P., and Roache, S., “Inflation Hedging for Long-Term Investors”, April 2009. A one standard deviation shock, equivalent to about 0.2 percentage points,

was applied to inflation.

Cumulative response over 20 years to a one-time inflation „shock‟

• This model assesses how different

asset classes react to unexpected

increases in inflation

• Unexpected inflation is a rise in the

consumer price index that is not

anticipated by the model

• The model estimates the impact of a

one-time inflation shock on the

cumulative total return (or change in

price in the case of commodities),

assuming all coupons and dividends

are reinvested

Cumulative change in the level of the total

return or price index over a 20-year period.

Years Years

%

Years Years

%

%

%

Suffer short term, then recover Partial hedge

Losses, no meaningful

recovery

Effective short-term hedge,

but erodes over time

Equities Commodities

Bonds

Standard error bounds

14

Agenda

• Hedging against inflation

• Macroeconomic views

• M&G European Inflation Linked Corporate Bond Fund

15

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11

UK

US

Germany

Inflation expectations are rising

Source: Bloomberg, 04 May 2011

5 year breakeven rates for US, UK and Germany

Driven by stronger growth, higher commodity prices and

taxes, and QE fears

US Quantitative Easing 2

announced

%

16

Unit labour costs less inflation 3q-moving average, (%)

-2.5

-1.5

-0.5

0.5

1.5

2.5

3.5

4.5

5.5

6.5

Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10

Workers getting richer

Workers getting poorer

It’s rare to get inflation with such weak wage growth

But a stronger labour market should ring alarm bells

Source: Bloomberg, M&G, 28 February 2011

Germany

Eurozone

Spain

Europe

17

It’s rare to get inflation with such weak wage growth

But a stronger labour market should ring alarm bells

-6

-4

-2

0

2

4

6

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

UK average earnings less RPI (y/y)

Workers getting richer

Workers getting poorer

Source: Bloomberg, M&G, 31 March 2011

UK

18

The demographic case for inflation is strong

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1950

1957

1964

1971

1978

1985

1992

1999

2006

2013

2020

2027

2034

2041

2048

70.00%

80.00%

90.00%

100.00%

110.00%

120.00%

130.00%

US inflation Non-working age to working age ratio (RHS)

But the Japanese ageing experience has been

non-inflationary

Very unproductive

workforce

Very

productive

workforce

Source: Barclays Equity-Gilt Study, M&G, January 2011

19

Eurozone HICP all items and HICP ex-tobacco (YoY)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11

%

Ex-tobacco

All items

European Inflation

Source: Bloomberg as of 31 March 2011

20

The make-up of EU HICP

15%

4%

7%

16%

7%4%

15%

3%

10%

1%

9%

9% Food & non-alcoholic beverages MoM: 0.5%, YoY: 2.0%

Alcohol & tobacco MoM: 0.2%, YoY: 3.7%

Clothing & footwear MoM: 15.1%, YoY: 1.2%

Housing & household services MoM: 0.6%, YoY: 5.1%

Furniture & household goods MoM: 0.6%, YoY: 0.9%

Health MoM: 0.1%, YoY: 1.3%

Transport MoM: 1.3%, YoY: 5.6%

Communication MoM: -0.2%, YoY: -0.6%

Recreation & culture MoM: -0.2%, YoY: -0.3%

Education MoM: 0.1%, YoY: 1.7%

Restaurants & hotels MoM: 0.2%, YoY: 1.8%

Miscellaneous goods & services MoM: 0.5%, YoY: 2.8%

HICP weightings

Source: Eurostat as at 31 March 2011

21

Agenda

• Hedging against inflation

• Macroeconomic views

• M&G European Inflation Linked Corporate Bond Fund

22

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11

DBRI 1.75%2020

DBRI 1.5%2016

OBLI 2.25%2013

Is there value in government inflation-linked bonds?

Source: Bloomberg, 04 May 2011

German inflation linked real yields

Medium dated real yields are thin

and short dated real yields are negative

%

23

A fund should be short (or negative) duration if you

expect yields to rise

• The average European government bond has a duration of 6 years

• The average European inflation-linked government bond has a duration of 8 years

• The average European corporate bond has a duration of 4 years

If interest rates rise by 1%

• The average European government bond will fall in price by 6%

• The average European inflation-linked government bond will fall in price by 8%

• The average European corporate bond will fall in price by 4%

• If a bond portfolio has a negative duration of say, -2 years, it will increase in value by 2%

Source: Barclays Capital Indices, M&G as at 31 March 2011

Innovation 1: A short duration fund with ability to go negative

24

What am I buying when I purchase an inflation-linked

corporate bond?

Inflation-linked corporates are a combination of duration risk and

credit risk. Principal and coupons are uplifted by EMU HICP

Pure interest rate risk

(duration)

“Risk free” yield

= 0.4% pa (2015 OATi)

Veolia I/L 2015

Yield = 1.3%

+ inflation

Pure credit risk

= 0.9% pa

+

Source: Bloomberg, M&G 31March 2011

25

-1

0

1

2

3

4

5

6

7

Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11

Re

al

Yie

ld (

%)

Veolia 1.75% 2015

France IL 1.6% 2015

Real yields on Veolia IL 1.75% 2015 Vs. France IL 1.6% 2015

Money yield = 3.7%

Current HICP ex-

tobacco = 2.4%

YTM = 1.3%

+

=

How do inflation-linked corporate bonds perform?

Corporate bond returns plus inflation protection over

the long term

Source: M&G, Bloomberg 31 March 2011

26

Some issuers of Euro and UK inflation-linked corporate bonds

27

CDS + government linker = synthetic inflation linked corp

Synthetic Glencore linker

Credit default swap (Pure Credit Risk):

Glencore 5y = 1.7%

Source: Bloomberg, M&G as at 31 March 2011

Innovation 2: synthetic inflation-linked corporate bonds How to create one

Pure interest rate risk (duration):

UKTI gilt 2.5% 2016 “Risk free” yield = -0.17%

= 1.5% + RPI (currently 5.5%)

= Money yield of 7.0%

28

100

130

160

190

220

250

280

Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11

Bp

s

Glencore 5y SR CDS spreads (Bps)

Performance

We sold protection on Glencore senior debt in Oct 2010

Innovation 2: synthetic inflation-linked corporate bonds

Source: Bloomberg as at 31 March 2011

29

M&G European Inflation Linked Corporate Bond Fund

Fund positioning

Source: Bloomberg, M&G as at 30 April 2011

overall fund duration: 1.5 years Core of fund in index linked credit,

4.5%

1.3%

1.8%

4.4%

30.7%

39.0%

13.4%

4.9%

0% 10% 20% 30% 40% 50%

Cash

NR

B

BB

BBB

A

AA

AAA

Credit split incl. derivatives Asset allocation

IL corporates &

PFI, 41.4%

IL governments,

1.1%

IL governments

with derivative

overlay, 35.0%

FRNs, 11.5%

Short dated

corps, 6.5%

Cash, 4.5%

30

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11

% VaR Upper Limit Lower Limit

Source: M&G, as at 31 March 2011

Value at Risk

VaR limits

Plenty of headroom to add risk

Upper Limit: Greater of: 70% Euro BBB Securities 15+ year duration / 30% Euro High Yield B rated and 20 year

European Inflation Linked Govts

Lower Limit: Euro 3 Month Treasury Bill

0.96%

9.86%

0.09%

31

Summary

…then add inflation protection to your portfolio

If you or your clients fear inflation…

• Inflation expectations have been rising in 2011

• Investors need to protect their portfolios

– But traditional asset classes are an imperfect hedge

• Inflation linked corporate bonds can offer protection against inflation

• The M&G European Inflation Linked Corporate Bond Fund is an

innovative product allowing investors to protect against inflation

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 (7) reg. no 541, M&G Investment Funds (9) reg. no 930, M&G Global

Dividend Fund reg. no 713 M&G Global Dynamic Allocation Fund reg. no 843 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.

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. This prospectus, simplified prospectus, 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, Bleidenstraβe 6-10, D-60311

Frankfurt am Main, the German paying agent J.P. Morgan AG, Junghofstraβe 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, 90 avenue des

Champs Elysées, 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., Bleidenstraβe 6-10, D-60311 Frankfurt am Main. 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 (12.5%) on capital gains.

33

Appendix

34

Fund facts

Top 10 holdings

Source: Bloomberg, M&G as at 30 April 2011

Germany

Germany

Oresundsbro Konsortiet

Severn River

BT

Tesco

Tesco

Veolia Environnement

Anglian Water

Cades

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

2.25%

1.5%

3.40%

6.125%

3.5%

4.0%

3.32%

1.75%

4.125%

1.5%

29.1%

7.1%

4.6%

3.9%

2.7%

2.5%

2.1%

2.1%

2.1%

2.1%

2013

2016

2014

2013

2025

2016

2025

2015

2020

2021

Maturity Fund % Coupon

35

Using futures to manage duration The maths…

• The fund sold 20 10yr Bund future contracts at launch 16th Sept

• Reduced fund duration by approx 1.8 years

• 10yr bund yields rose 84bps

• On a €10m fund that results in a loss of €151,200

• The value of the futures contract fell by 5.31% over the period – therefore we

gain €129,967

• Overall effect: 129,967 – 151,200 = - €21,233

• The futures roughly neutralise the movement in the yield

Source M&G, Bloomberg as at 28 February 2011

36 Source M&G, Bloomberg as at 28 October 2010 *maturity date 20/3/12

• Nov 26 the fund sold £500k 5yr protection on Glencore at 265bps*

• We receive 265bps a year = (0.0265*£500k= £13,250)

• Today priced at 170bps

• 265 - 170 = 95

• Spread change: 95 * £500k = £4,750 (+ premia received per qtr)

• PV of Spread change = value of position

• £4,750 * 4.7yrs = £22,325 (small number but adds 22bps to a £10m fund)

Synthetic inflation-linked corporate bonds The maths…

37

Oil Shocks

Source: Fathom Consulting as at 28 February 2011

Effect on inflation measures of an oil price increase

Oil Price

$/Barrel UK RPI

EA CPI

Ex-Tobacco US CPI

90

100

110

120

130

140

150

160

170

180

0.00

0.16

0.32

0.48

0.63

0.79

0.95

1.11

1.27

1.43

0.00

0.17

0.34

0.51

0.68

0.86

1.03

0.20

1.37

1.54

0.00

0.54

1.08

1.63

2.17

2.71

3.25

3.80

4.34

4.88

38

Counterparty risk

M&G European Inflation

Linked Corporate Bond

Fund

J P Morgan

BNP Paribas

Credit Suisse

Deutsche Bank

J P Morgan

UBS

AAA

Government

Bonds

Cash

AAA

Government

Bonds

Cash

Fund Custodian

Counterparty

39

What is the current rate of inflation in Zimbabwe?

(as at January 2011)

3.3%

Inflation Quiz 1 Answer

Source: Reserve Bank of Zimbabwe, as at 6th May 2011

40

What was the rate of inflation in Zimbabwe

in July 2008?

23,11,50,888.9%

Inflation Quiz 2 Answer

Source: Reserve Bank of Zimbabwe, as at 6th May 2011

41

How much was Z$100 billion worth in Euros

in October 2008?

€0.10

Inflation Quiz 3

Source: The Guardian

Answer

42

How much did a roll of toilet paper cost in Zimbabwe

in May 2006?

Z$145,750

Inflation Quiz 4

Source: NY Times

Answer