Templeton Emerging Markets Bond Fund‧Morningstar Fund Awards 2010 Special Editorial

Templeton Emerging Markets Bond Fund

Emerging markets bonds did better than global bonds during the past two years. Helped by the stronger fundamental and currencies, emerging markets bond outperformed global bond significantly. During 2010 and 2009, the Global Emerging Markets Bond fund category gained 11.37% and 32.31% respectively on average, while the Global Bond fund category rose comparatively less, with gains of 5.59% and 9.24% respectively. This difference also applied to the winning bond funds in these two fund categories. Templeton Emerging Markets Bond Fund, the champion of Global Emerging Markets fund category, fared better than Templeton Global Bond Fund, its sibling in the Global Bond category.

Performance

Both winning funds are managed by the same team led by Michael Hasenstab. And this emerging markets bond offering is co-managed by Laura Burakreis and Marco Freire. Templeton Emerging Markets Bond Fund grew 13.11% in 2010. Although it is not a great step ahead of its rivals, its longer term performance made up this minor deficiency. The fund’s 3- and 5-year annualized returns were 12.50% and 11.70% as at June-end 2011, placed in the fourth and second percentile rank.

Key to Success

Similar to Templeton Global Bond Fund, the local currencies tilted, sovereign credit preference and defensive duration positioning paved the way for the success of Templeton Emerging Markets Bond Fund in 2010. The investment process is robust. Hasenstab seeks to identify market inefficiencies through the team’s detailed fundamental research over currencies, duration and interest rate targets for different countries, and invests in countries that are undervalued in his view. This approach may lead to significant off-benchmark bets. And it is not unusual to see the portfolio with over 50% non-USD exposure. Morningstar Analyst commented that the investment process, together with the presence of management team, is very comfortable as it has been followed for many years, and it has resulted in very strong performance.

Thanks to the long term horizon, Hasenstab and the team can stick to their conviction and to be contrarian. Hasenstab agreed that they were very aggressive in adding to the emerging market assets while others were selling them during the recent global financial crisis. “We expect emerging markets to continue leading the global recovery going forward.” Hasenstab commented.

Focuses

Generally speaking, investors are expecting a rising interest rate across the emerging world. Hence the fund maintained its defensive duration strategy. “We continue to favor short maturity bonds in places like South Korea where yields between 3% and 5% are currently available on bonds with less than two years of duration and strong creditworthiness, in our assessment.” Hasenstab added, “These positions are exposed to currency risk, but we expect this to enhance returns as we anticipate the currencies of these fast growing economies to appreciate against the currencies of slower growing developed economies over the medium term.”

Hasenstab believed that strong economic growth, relatively low debt levels, and healthy external balances should continue to support the performance of emerging market assets. However, high commodity prices have become a growing concern to policymakers in emerging economies. If the commodity prices stand at high levels, there will be an increasing number of countries that implement a tightening policy through a variety of tools. “Currency appreciation can play a particularly important role in tightening financial conditions in the current environment as it eases some of the imported inflationary pressures.”

It is no doubt that tensions over currency valuations, after rising sharply in 2010, have abated slightly as higher commodity prices have become an increasing concern to policymakers in emerging markets. Thus Hasenstab expected that “more currency appreciation to be tolerated by emerging market policy makers.” 

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We can find that the currency exposure and strategy is one of the key factors contributing to the fund’s performance. And it is true that currency exposure is the main reason of the underperformance relative to its benchmark and peers in 2008. However, the fund still outperformed its Morningstar category over the year and recovered exceptionally strongly in 2009, supported by the manager’s high conviction that emerging-markets currencies and bonds would rebound sharply from undervalued levels. Investors should be aware of the risk from its currency exposures, and higher volatility due to the manager’s high-conviction approach.