Templeton Global Bond Is No Ballast

Benz: So, Miriam, Templeton Global Bond assets have gone from something like $20 billion to $62 billion in a short period of time. Do you think investors are responding mainly to performance?

Sjoblom: Well, it's tough to say exactly, but this fund has really just been dominating, not only the world bond-fund category, but all other funds so far this year in terms of the amount of inflows it's been getting.

It's hard to imagine that investors aren't looking at what is a great record. During the past five years alone, the fund is the top-performing fund in the world-bond category, gaining 11.6%, and it has shown very impressive results. Not only that, but Michael Hasenstab, the manager, has been very good at managing the risk of the fund, as well. So, you've got moderate volatility plus a great total return. I think, it's hard to imagine investors aren't just seeing great returns and piling in.

Benz: Right, but you've also noted that the correlation with other asset classes that people might hold has also historically been pretty low, so it's been a good diversifier?

Sjoblom: That's right. Especially lately, people are concerned about the U.S. Treasury market, even though it's continued to do very well again this year, especially in recent months. But this correlation with the Barclays U.S. Treasury Index, for example, has been zero during the last couple of years.

Benz: One thing that you've been talking about, you want investors newly arrived in this fund to know how different it is and also they should be aware that the fund is taking some pretty big bets that put it at odds with some of its competitors. Let's talk about some of those?

Sjoblom: Sure. Well, just to start, I think, whenever we see a huge amount of inflows into a fund very quickly, we get a little concerned that investors might not be in it for the long term, and they are just kind of chasing that great record, and if there is a bout of underperformance that they might not stick around. And I think understanding its idiosyncratic style is really important to be able to be a successful long-term investor in this fund.

So, I think, the big benchmark constituents for a global-bond fund, and you're talking about Japan, the U.S., countries in the eurozone, especially Italy, France, Germany…

Benz: U.K.

Sjoblom: …these are the world's most indebted countries. So, a more traditional approach tends to manage against this benchmark which might be flawed in some way, and that's a principle that Hasenstab has applied to running this fund. He doesn't want to have exposure to the most indebted economies in the world.

So, as a result you see positions that aren't very big in the index. They are very small in the index or not in the index at all, such as South Korea, Australia, Malaysia, Poland, and Scandinavian countries. These don't have very large representations in indexes and in many peers, and there's good fundamental sense for that. These are not highly indebted countries. They have responsible fiscal and monetary policy, yet it can still mean that the fund may not always act the way other funds do.

Benz: Right, and it sounds like a lot of the positions that you mentioned converge around the theme of trying to make a play on China and China's long-term growth. What's the thesis there?

Sjoblom: That's right. Well, he's a big believer in China and in the growth story there that even as growth is slowing and some commentators are concerned about a hard landing in China, Hasenstab doesn't see that happening. He thinks growth does need to moderate in China and other parts of Asia and he thinks that that's a good sign to the extent that policymakers can stay ahead of the curve in terms of fighting off inflation or what have you. He really thinks that so far what he's seeing there is promising.

So, the fund has a lot of exposure to Asian currencies, not to China directly, but to China's trade partners, such as South Korea, Malaysia, and Australia , that will benefit from the growth in China. And he's also been very concerned about interest-rate risk globally, not just here in the U.S. where Treasuries offer absolutely no value and have a lot of risk right now. He really thinks interest rates across the globe are set to rise at some point, and so he has taken the interest-rate exposure really low. So, he owns a lot of short-term bonds, and when rates rally as we’ve seen them do recently, this fund is going to lag.

Benz: So it’s almost like he’s trying to do a pure reflection of his view on the direction of these currencies but not pick up the interest-rate fluctuations?

Sjoblom: Even in short-term bonds in some of these countries, you can get a decent yield, better than what you get here in the U.S., Europe, or Japan. So, he is still getting some yield, but you're seeing the currency take more of a front stage.

Benz: So, the big risk with any fund that is idiosyncratic like this, it can give you good returns, but the big risk is that the fund, as you said, could get caught leaning the wrong way. And we’ve seen a little bit of that at various points in time. Even very recently, it appeared that the fund had underperformed when Treasuries were rallying during this recent stock market weakness. What are the risks for investors in the fund?

Sjoblom: Right. So, yes, one thing we've noticed, he did a really great job in 2008 and 2009. I think investors might look at a year like 2008 which would have been a really tough year for emerging-markets currencies, bonds, and for other risky assets like high-yield corporates, those types of things. So, in the world-bond category, generally, funds that pursue those types of securities underperform, but he did a great job. And the fund posted comfortably positive gains that year. I think investors might look at a record like that, and if you don’t understand what the moves being made and what’s behind it, you might think, "Oh, this is a great defensive fund."

Actually, he also did a great job positioning into 2009 to benefit from the rally in emerging-markets currencies. So, the record looks great, but we've also noted that the correlation with equities and other risky-type assets of the fund has risen. So, when there are bouts of risk aversion--and there might not be a fundamental reason that currencies like the Australian dollar are selling off--the fund has tended to underperform during these bouts of risk aversion as when equities sold-off recently. Think back to May 2010; the fund also lost some ground then.

So, I think, that's something for investors to be really cognizant of because you think of your bond fund as being a ballast in your portfolio. If your equities are selling off, you might expect your bonds to hold you up, and this fund won't really serve that purpose for the time being.

Benz: So Miriam, even though you have a few concerns about short-term volatility, you still like the fund quite a bit for the long term?

Sjoblom: That’s right. Hasenstab's own style is to be very long term. So, during periods of where the fund might be struggling, he's actually looking for where he can be adding to positions that have sold off beyond where he thinks is reasonable.

Benz: He's a value-conscious bond manager.

Sjoblom: Yes, exactly. And that type of style has paid off for the fund over the long term, and we really think that it will continue to do so. We've been very impressed meeting with him and meeting with his analysts and comanager. They do very in-depth country research. I feel like this is a team that is well-equipped to stay on top of all the risks going on in these countries.

However, there is a chance they can be wrong, and the fund can experience some short-term setbacks. I think it's important that all the new investors, especially those who have piled into the fund, need to really understand what they are getting given how the fund is positioned today.

Benz: Yeah, and be able to share mangers' long-term mind-set. OK, well, Miriam, thank you for sharing your insights.

Sjoblom: Thank you, Christine.

Benz: Thanks for watching. I’m Christine Benz for Morningstar.com.