When you are running a global bond portfolio, there is no substitute for having truly global inputs to the strategy. Just ask the likes of Pimco and Franklin Templeton. Michael Hasenstab, senior vice president, portfolio manager and co-director of the global fixed income team at Franklin Templeton, believes this is a major factor in their success: “The team seeks to gain perspectives on how policy-makers approach economic decisions and their differing agendas. We believe that meeting with central bankers and ministers of finance enables us to identify trends the data cannot show. We have found that the best way to pursue potential alpha is to really understand each country independently. Having a global context is good, but country specifics provide the next leg to add more value. Time and experience have taught us that travel is the only way to get a real sense of the activity in a country.”
The global team’s weekly call combines the research efforts of San Mateo, London, New York, Brazil, Korea, India and China. The portfolio managers use the information in different ways, depending on risk positioning and constraints. Hasenstab says, “We find that some public institutions prefer a constrained strategy that typically follows its benchmark, whereas other institutions seeking higher sources of alpha prefer a strategy less benchmark-constrained.”
As a group that made its name internationally on the back of Templeton’s emerging markets capability, the group has long-established operations around Asia. Hasenstab sees Asia as a big area of opportunity at the moment: “The dynamics of global growth are really shifting to an Asian centre. You’re seeing domestic demand drive Asian growth, inter-regional trade in Asia, and the result is that Asian currencies are providing a great opportunity. On the one hand you have the US imbalances, with a large current account deficit and then on the other hand you have Asia running large surpluses and the demand for Asian currencies increasing.”
The Global Bond Plus strategy opportunity set includes well-diversified sources of potential alpha including currency, duration, and country exposure. Unconstrained by its benchmark, Global Bond Plus may deviate considerably from the index. At this time, more than 90% of the JP Morgan Global Government Bond Index is made up of four regions - US, Japan, Euro-zone and the UK. The Franklin Templeton team sees broader diversification as a benefit. As emerging markets dipped in May and June 2006, its strategy maintained a more consistent return profile while some other global managers spent the rest of the year trying to compensate for the shift in valuations.
Structurally, Global Bond Plus remains an investment grade-focused strategy. In terms of the mix, its weighted average credit quality stays steady between A and AA. Although sub-investment grade positions may be utilised, the managers strive to maintain their usage at less than 25% of the portfolio.
Overall, the team feels it has a lot of flexibility within a defined set of parameters. Hasenstab says, “Markets do not all move in the same direction, which is what I think really justifies and motivates an active management approach. If you look at the variance of returns between the best and worst performing countries on a 12-month basis, the spread is often hundreds of basis points, which we believe creates possible value opportunities.”
Here he explains the role of currency in the portfolio. “When reviewing currency and interest rates over time, the return from each source of potential alpha varies. The strategy is structured to change positions to take advantage of value as it is discovered. We recently shifted towards local currencies, because we believed they were undervalued, and added an opportunity to take advantage of a weaker dollar. For instance, as of 4 March 2007, the strategy held relatively little interest rate exposure due to a weighted average duration of around 2.5 years - which we considered a barbell between some very long durations in select countries with attractive interest rate opportunities, and everything else where we expect rates to rise or valuations are expensive.”
When the team discusses specific currencies, it uses a fundamental-based, top-down, bottom-up approach. Both global currency and country analysts offer reviews that consider, but are not limited to, budget and trade deficits and surpluses, relative interest rates, vulnerabilities, and growth. Results from proprietary, fundamental macro-evaluation models are combined with input from country analysts. When both methodologies show attractive fundamental valuation and a catalyst for re-valuation exists, they may make the decision to increase exposure to a currency.
The managers do not leverage the strategy, but derivatives can be used, including currency forwards, which allow the strategy to isolate the exact source of alpha opportunity. Hasenstab says: “The strategy sometimes holds duration and hedges out currency, sometimes it holds currency with no duration exposure, and sometimes it’s both. For example, the portfolio may have exposure to the local bond market in Mexico, but not to the currency. Simply put, we keep what we think offers value and hedge out what we find expensive. We use derivatives as a risk management tool, offering exposure to parts of the capital structure we believe should continue to retain the most value.”
As with other managers focused on the Asian region (see IPA December 2006), Japan is more in favour with Franklin Templeton now. Hasenstab comments: “Japan’s lower interest rate environment led many investors away from the yen into other investment opportunities offering what they believed were greater potential yields. During this period, our strategy also sought a more diversified exposure throughout the region. More recently, however, our investment outlook for Japan has begun to shift. Valuations, which had been attractive in yen for some time, and an improved macro-catalyst combined to show more sustained growth dynamics in Japan than have existed for over a decade.”
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