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Will Templeton Global Bond Conquer China Next?

The world's biggest global bond fund takes its one-of-a-kind show to Asia.

Miriam Sjoblom, 08/30/2011

One mutual fund has emerged in recent years as investors' go-to choice for global-bond exposure. Since flows into world-bond funds turned positive in May 2009, Templeton Global Bond TPINX has taken in $41.3 billion in new money according to Morningstar's estimates, which represents nearly 60% of total flows into the world-bond category during this stretch. The $61.5 billion Templeton Global Bond now accounts for 40% of the total assets in the world-bond category.

Clearly the fund's popularity owes much to its outstanding record. In the past five years, it gained 11.6% per year on average, beating every other fund in the category and outlegging the Citigroup World Government Bond Index by an average of 360 basis points a year without producing additional volatility. Analytics such as the Sharpe Ratio give the edge to a handful of U.S.-dollar-hedged world-bond funds that don't take any currency risk, but this fund has otherwise produced an excellent risk/reward profile. Meanwhile, investors craving diversification have also enjoyed a very modest correlation to the Barclays U.S. Aggregate Bond Index in the past five years that's lower than all but one other fund in the category.

Many investors who've piled into this fund, however, may be surprised to learn just how offbeat it is. Even as it has nearly quadrupled in size during the past two years, its portfolio has shown no sign of shedding its idiosyncratic qualities. By betting on China's economy and shedding interest-rate risk, the fund could be taking its boldest stance yet.

How This Fund Stands Out
The world-bond category contains a hodgepodge of strategies that can result in a wide dispersion of returns in any given year. Some funds stick to investment-grade government debt; some hold a sizable amount in corporates and other credit sectors; some hedge all of their currency exposure back to the dollar; some sync up their currency exposure to global bond benchmarks; some include the U.S. in the mix while others exclude it; and a few forge their own path while paying little heed to traditional guideposts.

From the start, manager Michael Hasenstab's investment style has fallen into the last camp. Unlike managers who construct their portfolios relative to traditional issuance-weighted benchmarks, Hasenstab argues that those indexes don't make good investment sense. By design, they're heavily skewed toward the world's most indebted countries. The JPMorgan GBI Broad Index's largest country weightings, for example, are Japan (30%), the United States (29%), and the eurozone (27%). Given that many of those countries' gross debt-to-GDP ratios now approach 100% or greater, it's understandable why he's looking elsewhere. The ongoing sovereign debt crisis in Europe and this summer's U.S. debt ceiling negotiation debacle have only brought these long-festering problems front and center.

Other fund managers have caught on to this story in recent years, but when it comes to ignoring benchmarks, Hasenstab was ahead of his time. He has avoided U.S. and Japanese government bonds for years; the fund's exposure to eurozone debt has fluctuated around just a few percentage points, and hasn't included any of the eurozone's less fiscally responsible actors, including big benchmark constituents Spain and Italy. Instead, Hasenstab has favored the debt and currencies of countries with strong or improving fundamentals--such as low levels of indebtedness, prudent fiscal and monetary policy, and good growth prospects--where he thinks the market doesn't fully appreciate their worth, regardless of whether they're in the index. These days that includes the likes of South Korea and Australia in Asia, and Poland and Sweden in Europe.

China Looms Large
The fund's rapid growth in recent years hasn't tamed any of its eccentricities. Unlike in 2008, when Hasenstab thought slumping growth and deleveraging in the largest developed economies would affect the emerging world, he's no longer convinced that the sovereign debt crisis in Europe or the U.S. economy's torpor pose the same challenge to the rest of the globe. Indeed, much of the current portfolio hinges on continued economic strength in China, and its gradual opening to foreign capital flows.

Hasenstab is expressing that view indirectly through the bonds and currencies of China's close trading partners in Asia, but that doesn't make it any less pronounced. The fund's 44% stake in Asian-government bonds and 57% long exposure to Asian currencies show how important China is to the fund's continued success. The contrast with most bond indexes is stark. Again, because of the region's low level of indebtedness outside of Japan, these countries represent just a few percentage points in traditional global-bond indexes; developing Asian countries are also the minority in emerging-markets bond indexes.

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