In their global search for yield, investors are pouring assets into a one-of-a-kind fund they might not understand.
Yields on all types of high-quality U.S. bonds have hovered near all-time lows for the past couple of years. U.S. Treasuries continue to defy expectations, their yields sinking still lower this summer on concerns about the health of the U.S. economy, political wrangling over the debt ceiling, and no end in sight to the eurozone's sovereign debt crisis.
In an effort to get away from these low yields and the threat of rising interest rates in the United States, some investors have turned to world-bond funds. One in particular has emerged as investors' go-to choice for global-bond exposure. Since flows into world-bond funds turned positive in May 2009, Templeton Global Bond
The fund's popularity clearly owes much to its outstanding record. In the past five years, it gained 11.7% per year on average, beating every other fund in the category and outlegging the Citigroup World Government Bond Index by an average of 380 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.
Not Just Another Pretty Face
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 United States 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/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 debt ceiling negotiation debacle in the United States 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 bloc'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.
Hasenstab and his team try to spot these opportunities early, however, and are willing to watch the thesis unfold over several years. The fund held a double-digit-sized stake in South Korea's government bonds going as far back as 2004, for example. That stake was recently as high as 16% of assets, even though the solidly investment-grade-rated country isn't included in the Citigroup World Government Bond Index; other top bond and currency holdings--including Australia, Malaysia, Poland, and Sweden--either take up a sliver of real estate in the benchmark or none at all. But they're all longtime holdings that fit a similar pattern.