A bond fund with bold emerging markets exposure

With a lower fee, Silver-rated Templeton Global Bond now serves investors better.

Jeffrey Bunce, CFA 23 March, 2016 | 5:00PM
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In March 2015, Franklin Templeton Investments lowered the management fee on the A Series of  Templeton Global Bond from 1.75% to 1.25%. This followed a similar fee cut on the fund's F Series for fee-based accounts a year earlier. What was once one of the most expensive funds in the category is now more reasonably priced, and investors are the direct beneficiary. As such, its Morningstar Analyst Rating has been upgraded from Bronze to Silver to reflect the lower price tag.

Templeton also changed the risk classification on the fund in 2015 from “medium-to-low” to “low” based on recent historical volatility, but investors need to be aware that by most measures, Templeton Global Bond is among the boldest entrants in the global fixed-income category. Most notably, its high allocation to emerging-markets has caused it to display higher volatility than the average peer and sport one of the highest correlations to equities in the group over the longer term. Further, in 2007 the fund lost 6.5% and in 2008 it gained 24.1%. Funds with this return pattern don't typically behave this way by avoiding risk.

However, the risks have been well worthwhile. Manager Michael Hasenstab's investment themes and ability to find the right bargains have led to topnotch long-term performance. His experience, a skilled and generally stable analyst bench, and the fund’s consistent approach are all strengths that set this fund apart.

The fund has scant exposure to the debt of the United States, eurozone and Japan, which dominate many rivals' portfolios. It also stands out for its significant, and longtime, underweightings to the euro and yen. Instead, Hasenstab has preferred emerging-markets issues and currencies given what he views as those countries' better fiscal prospects; those exposures account for the majority of the fund's bond exposure and two-thirds of its currency exposure. Where the fund looks less daring, however, is on interest-rate risk. Hasenstab believes global inflation pressures could lead to permanent loss of capital, which has led him to reduce the fund's duration to just 0.04 years -- among the lowest in the category -- as of December 2015 While the bulk of the fund's holdings have maturities of less than one year, he further reduces interest-rate risk through the use of derivatives.

Hasenstab doesn't construct this portfolio with traditional issuance-weighted global-bond benchmarks in mind, which are skewed toward the world's most indebted developed markets. Instead, he and his team aim to identify value among currencies, sovereign credit and interest rates in countries with healthy or improving fundamentals that they think the market underappreciates.

The contrarian-minded group doesn't require fiscal perfection, just improving trends. In the depths of the eurozone crisis in 2011, it established a large position in Ireland's government debt, arguing that Irish authorities had made strides toward fiscal sustainability that were not priced in. Ireland, as of the end of December 2015, is one of Europe's fastest-growing economies, and after realizing substantial gains on its position, the team has sold the stake down to less than 1% of the fund.

The team has shown an ability to add value through currency management as well. For more than five years, Hasenstab has maintained no exposure to the Japanese yen and a short position in the euro (negative 4.1% as of Dec. 31, 2015), though that position has been used as a hedge against a group of peripheral European currencies, including the Polish zloty and Hungarian forint, countries that he believes have stronger relative fundamentals.

Arguing that the loose monetary policy maintained by the developed world's central banks should ultimately unleash inflationary pressures globally, Hasenstab has maintained the fund's duration below two years since early 2011. This focus helps the fund maintain a decent liquidity profile. Recently, around one third of the fund's assets are invested in bonds maturing within one year while its cash level has clocked in at a mid-teens to low-20% stake, providing a large buffer should the fund experience significant outflows.

For most of 2015 the fund lagged peers as its low duration and allocations to countries and currencies such as Mexico (peso), South Korea (won) and Malaysia (ringgit) weighed the fund down. These positions reversed course late in the year, enabling the fund to beat its average peer.

It's not uncommon for the fund to lag in risk-averse environments, however; it returned just 0.6% compared with a category average of 5.2% during the 2011 U.S. debt downgrade and European financial crisis. In a similar vein, the environment for emerging-markets currencies was tough during the first nine months of 2015, and especially during the third quarter, sending this fund down 1.3% while its typical rival gained 1.4%.

Conversely, the fund tends to rise to the top of the heap when emerging-markets bonds and currencies fare well, as was the case in the fourth quarter of 2015 when the fund was up 4.8%, besting the average peer by 3.3%. The fund has other levers to pull, however. In 2013, its short-duration positioning (under two years) helped land it in the category's top quartile.

Because the fund is built for total return, investors need to be ready for jolts during risk-averse markets, but Hasenstab's macro calls and patience have made the extra volatility worthwhile over the long term.

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About Author

Jeffrey Bunce, CFA

Jeffrey Bunce, CFA  Jeffrey Bunce, CFA, is a senior investment analyst for Morningstar’s Investment Management group.

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