In a challenging interest-rate environment and at a time when bond valuations are at all-time highs in many sectors, it's getting harder to find high-yield bargains, according to Eric Takaha, co-lead manager ofFranklin High Income andFranklin Strategic Income.
As director of corporate credit and director of high yield for San Mateo, Calif.-based Franklin Advisers, Inc., Takaha has shared portfolio management responsibilities on both funds with Chris Molumphy since the funds were launched in 2003. Franklin High Income is a dedicated high-yield corporate bond fund, and Franklin Strategic Income's portfolio may invest in any type of fixed income securities, including high-yield issues. Over the past three or so years, good credit fundamentals have helped the performance of both funds.
But more recently, high valuations have compelled Takaha to be more selective. "Over the last few quarters we have been pulling back a little in our beta and getting the overall credit quality up a little bit," he says.
In fact, one of the biggest overall challenges for global fixed income investing over the past couple of years has been strong bond performance in many of the "spread" sectors. These include high yield, investment grade, emerging markets dollar-based, and agency issues, all of which have yields above high-quality government paper. "We are still constructive on the overall fundamental outlook for many of those sectors but, at the same time, valuations are fairly rich and reflect the good news," says Takaha.
He says this environment makes it more important to find "individual pockets of opportunities" in sectors and individual securities. Because of Takaha's continuing bearishness on the U.S. dollar, for example, one of the biggest exposures currently in Franklin Strategic Income's multi-sector portfolio is in Asian government bonds. "Given the surpluses in some of those countries versus the U.S., we believe we could see some pretty good currency moves that could really drive performance," says Takaha.
A California native, Takaha has spent most of his 39 years living and working close to home. He joined Franklin Advisers Inc. in 1989 after earning a bachelor of science degree from the University of California, Berkeley, and an MBA from nearby Stanford University. In 1993, he earned his CFA designation.
Drawn to the intriguing combination of true fixed-income and true equity analysis that defines high-yield investing, he started as an analyst covering high-yield corporate bonds, then became a portfolio manager in the same area. So far in his career, a summer job in Morgan Stanley's New York equity research department as he completed his MBA has been Takaha's only stint from away Franklin Templeton's San Mateo offices.
But staying close to home hasn't stopped Takaha from taking a global approach to high-yield investing. To stay abreast of geographical and sector developments, he relies heavily on the wide-ranging fixed income team, which comprises more than 100 portfolio managers, analysts and other support staff, and includes research from Franklin Templeton's London and New York offices. "The folks who are making the recommendations for the non-U.S. bonds we're investing in, they travel more than they are here in the office," says Takaha.
Conforming to the company's investment philosophy, macroeconomic trends overlay a fundamentally driven, bottom-up investment approach. Weekly meetings with senior members of the various dedicated groups -- including high yields, global bonds, bank loans and emerging markets -- are at the centre of the investment process. "We discuss the global economic environment, and every other week we discuss overall sector valuation and trends," says Takaha.
He cites the emergence of corporate bank loans as an asset class as one significant development in the global fixed income arena over the last decade. These floating rate loans have benefited from rising short-term rates lately and, thanks to the dedicated corporate bank loans group at Franklin Advisers, Takaha has capitalized on this innovation. "Looking back two years ago, we had no exposure; now, we're approaching 10% in the Strategic Income Fund," he says.
Increasingly sophisticated investors are also affecting the global fixed income market. For example, Takaha says, it's important to understand how the use of credit derivatives -- which have "ballooned" in the past five or six years -- by hedge funds and other players can affect relative values and drive bond prices.
For the 2-star Franklin High Income and the 1-star Franklin Strategic Income, both of which are unhedged, the weakening U.S. dollar has been a serious drag on Canadian-dollar returns over the past few years.
But although he acknowledges the company is considering hedged versions of the funds, Takaha does not plan to hedge currencies within the existing funds. "We try to really run true to where we're seeing the investment opportunities, and we don't want to start doing partial hedges."
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