The Appeal of a Multiasset Approach to Income

Jeff Holt: Hi, I'm Jeff Holt from Morningstar. Today we're here live at the Morningstar Investment Conference, and today I'm joined with Ed Perks, portfolio manager of Franklin Income.

Thanks, Ed, for joining us today.

Ed Perks: It's good to be with you.

Holt: Ed, before we jump into the specifics of Franklin Income, I want to talk a little bit about multiasset income in general. What is the purpose or why would investors be interested in a multiasset income portfolio rather than just buying a portfolio and taking withdrawals, from a total return perspective?

Ed Perks: I think it certainly broadens your perspective a little bit in terms of the kind of securities and assets that we can put in a multiasset income vehicle. That's really kind of core to our approach in Franklin Income, particularly if your objective is to generate that reliable stream of income, distribute it in a consistent manner, which is really the hallmark of our approach. We think it really creates a very broad opportunity set for us to build a portfolio with. We're also then really looking at the relative value between these very different at times types of investments that we can put in the security in the broader portfolio. Ultimately, we think that adds diversification, that adds to your longer-term objective of delivering that income.

Jeff Holt: As you mentioned, specifically for Franklin Income, you have a lot of flexibility to move in and out of asset classes. I want to focus specifically on the equity side for a moment. Within Franklin Income, the last few years, you've actually been near a historic high in terms of the fund's history of equity exposure. What are your current views in the equity market at this point, and what kind of equities are you looking to hold in Franklin Income?

Ed Perks: Yeah, that is correct that this last five years in particular, and that did follow a period where we actually had more fixed-income exposure. After we came out of the 2008 recession, yields were very high, lot of opportunities in fixed income. That gradually was replaced by more dividend content, and obviously, it was a big part of monetary policy to really bring down long-term interest rates. To us, that made some fixed-income securities less attractive. It's not just been about the dividend opportunity in stocks, it's been about the path forward in dividends.

Dividend growth's been an important component of what we've been trying to do on the equity side of the portfolio. We think that's also ... We've seen that opportunity set broaden. More companies in the S&P 500 pay a dividend today than we've seen over the last decade. By sector, it's also really broad. That's probably the healthiest thing that we've seen, is that even non-traditional sectors ... Everybody knows utilities can generate a lot of income, but even technology stocks today are very active dividend-payers and are committed to dividend growth. We think that that's a real benefit to yield-oriented investing in general.

In terms of where we think we are today with the equity markets, I think it's natural for many investors to focus on the new highs being reached by stocks and to worry about valuations, but I think you also have to balance that and take a bit of a longer perspective. From the middle of 2015 to the early part of 2016, we actually saw a pretty substantial decline in equities, both in the U.S. and globally. Actually, the broad global indices were down more than 20% from their highs to the ultimate lows they saw in February of 2016. Now, coming out of that, we've seen improvement but the thing that we like about it is that it's actually been rooted in a number of different themes. Yes, kind of a period of potential reflation or higher growth in the economy, that's very beneficial. We've also seen more recently, particularly in the U.S. with the election and the new administration, potential positives that can ultimately drive earnings growth, which has been fairly lackluster. We'll see as we move forward.

We're obviously right in the middle of earnings season this week. We've got a lot of companies reporting earnings in the U.S., but I think we're encouraged by what we've seen to date and, more importantly, the expectations that we see companies continue to set for earnings going through the remainder of 2017 into next year also remain relatively robust. Despite stocks being relatively high, we think our opportunity set's very broad across a wide range of sectors and that we're actually seeing a bit of an inflection in earnings growth.

Holt: OK, now let's take a flip on the flip side over into the bond portfolio. Within Franklin Income, you've consistently held quite a bit in high-yield bonds. Where are you finding the opportunity within the high-yield bond market and are there any concerns with risk in that market at this point?

Perks: Yeah, now in the context of the overall portfolio, fixed-income weighting has been down a little bit. More recently our exposures have been largely focused on high-yield. We have started to find a little bit more opportunity in investment-grade corporates and in floating-rate term loans in particular, but in the pure high-yield part of the portfolio, I think it's also ... To take a little bit of a step back, we saw a period of not just the declining long-term Treasuries, which that asset class really bases itself of, but credit spreads really contracting. In the fall of 2015, early part of 2016, we saw a very substantial move wider in spreads. That gave us a nice opportunity to get more exposure to high yield, but it was very targeted, so we want to be very specific about the type of companies that we're lending to or purchasing the debt of, but we also want to be very targeted in where in their capital structure we're positioning.

Our bias has really been, the last 18, 24 months in particular, has really been to own shorter and intermediate maturities. At the time of the last significant sell-off in that asset class, those bonds were 2019 to 2022 maturities. Fast forward to today, they're that much closer. We think companies really become pretty laser-focused on any of their upcoming maturities, so even in a period of volatility those shorter maturities, we think, will perform better. Once again, it lets us express a very specific view that we have about the fundamentals of that specific business and ultimately, that will be the driver of that bond's returns as opposed to the broader credit market movements or interest-rate movements.

Holt: OK, and then taking a step back and looking at the fund from an investor standpoint, you mentioned that it holds equities and right now is holding quite a bit of equities. It can hold high-yield bonds, so there's some volatility built into the Franklin Income fund. What should investors expect from both a yield perspective for Franklin Income and also from a risk/returns perspective going forward?

Perks: Well, certainly from a yield perspective, right now on our A shares at NAV, the fund's yield is about 5.1%. We do pay a monthly dividend. That monthly dividend has not changed since the early part of 2014, so there's been a lot of consistency in our dividend. In terms of returns, really it's a broader conversation around the asset mix in the portfolio. Clearly, the tilt more to equity securities, while we sacrifice a little bit of yield from some other sources, we do have the potential for dividend growth. I think that's an important component right now in terms of what kind of return opportunity we have going forward, particularly if the backdrop is a general increase in longer-term interest rates. We think bonds as an asset class, fixed income as an asset class, will be fairly challenged to generate attractive total returns. We're kind of seeing that in both the performance the second half of last year and a little bit so far this year, that total return opportunity is just limited in that asset class. By combining other securities, we think we can continue to deliver the attractive level of income in a consistent manner, but also still have some potential for positive total return above that.

Holt: All right. Thanks, Ed, for joining us today.

Perks: It's good to be with you.

Holt: All right. This is Jeff Holt from Morningstar. Thank you.