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Concerns About Franklin Templeton Spur a Downgrade

Franklin's Parent rating drops to Neutral.

Alec Lucas, 03/30/2017

Concerns about its investment lineup and firm leadership have caused a downgrade of Franklin Templeton's Parent Pillar rating to Neutral from Positive.

Massive outflows in the past few years have made Franklin an extreme example of the challenges facing active management. Between mid-2014 and early 2016, the firm's assets under management fell by more than one fifth as investors opted for passive strategies, and flagships like Franklin Income FKINX suffered outflows amid poor performance. Franklin responded by cutting 300 personnel worldwide and launching seven exchange-traded funds in the United States, four of which passively track customized benchmarks built using a proprietary multifactor model for each.

The step toward passive strategies highlights the firm's tendency to add to its investment lineup rather than foster excellence across it. While few firms can match Franklin's diverse array of investment capabilities, which include equity, fixed-income, multiasset, and alternative strategies offered by at least 12 different investment teams, quality is not necessarily guaranteed. The firm's U.S. strategies are the most wide-ranging, and of the 36 U.S. open- and closed-end funds with a Morningstar Analyst Rating, half are now rated Neutral.

Not as Robust
There are pockets of strength, but the overall U.S. lineup looks less robust than in the past. The Mutual Series Team on the equity side and the Global Macro Team, run by Michael Hasenstab, on the fixed-income side, are still noteworthy. Hasenstab's Templeton Global Bond TPINX, for example, has posted strong long-term results, albeit with high volatility. Franklin's other taxable- and municipal-bond strategies, however, haven't stood out. Ill-timed concentrations in energy hurt the former in 2015, particularly Franklin High Income FHAIX, and Puerto Rico debt stung the latter. These troubles, and turnover affecting some of the U.S. taxable funds, caused five former Morningstar Medalists to be downgraded to Neutral since early 2015. Additionally, three muni funds' ratings were downgraded to Bronze from Silver.

Franklin has sought to increase collaboration between investment teams. During the past two years, they've fostered interaction between the fixed-income investment teams via regular macroeconomic discussions by its Fixed Income Policy Committee and more frequent strategy-focused meetings. Equity and fixed-income teams are also collaborating on a sector-focused basis. On the fixed-income side, these efforts have emphasized the dissemination of the Global Macro Team's views. But that can be problematic, as the team's extreme positions on interest rates and currencies are not appropriate in core bond portfolios. Careful implementation of shared views is the key to success, but there is no evidence yet to suggest this will add value over time.

A Family Affair
Franklin remains firmly in control of founder Rupert Johnson Sr.'s family members. As of late 2016, they owned at least 40% of the company. Their leadership has provided continuity but has also kept outsiders from rising to the top. From early 2004 to mid-2005, Greg Johnson and Martin Flanagan served as co-CEOs before Flanagan left for another firm, leaving the sole CEO role to Greg Johnson. That pattern recently repeated itself. In October 2015, Jennifer Johnson, Greg's sister, and Vijay Advani became co-presidents, charged with overseeing investment management and such related support services as trading and risk management. Then in late 2016, Advani left for another firm, leaving the sole president role to Jennifer Johnson. These short-lived co-tenures, while more than a decade apart, suggest that there's insufficient room for the fresh perspective an outsider might bring to a top executive-level post.

A fresh perspective could help, as Franklin's investment culture can be given to complacency. Managers sometimes remain named on strategies long after they've had any day-to-day involvement, as is the case with Bruce Baughman on Franklin Rising Dividends FRDPX. When the firm makes a manager change, it's not always straightforward. For example, in February 2016 Franklin replaced Eric Takaha, who had managed Franklin High Income since 2005, with Glenn Voyles, who had been the lead energy analyst, a move that was curious because the fund's bottom-quintile calendar-year finishes in 2014 and 2015 were largely attributable to its outsize energy stake.

Encouraging Signs
Amid a challenging period for Franklin, there are encouraging signs. In March 2016, the firm improved its Templeton Emerging Markets Group, which had struggled during the prior decade, by combining it with the Franklin Local Asset Management Team that was capably led by firm veteran Stephen Dover. Dover now oversees the newly combined group, and the change looks promising as Dover is taking a hard look at the emerging-markets investment personnel. Time will tell whether Dover can improve the investment outcomes of the Templeton emerging-markets strategies, but the initial signs are positive.

Beginning in 2015, the firm started to define risk parameters for its 20 biggest funds. That effort has now been extended to more than 200 offerings and has the potential to help them more deftly navigate choppy parts of the market, such as energy of late, leading to better risk-adjusted results for investors.

Should bright spots like these materialize and even multiply, Franklin's overall investment culture could once again gain a vote of confidence. For now, though, it simply meets rather than exceeds industry standards.

 

is an analyst of active strategies on the manager research team for Morningstar.

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