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A Downgrade for a Distinctive Bond Fund

Templeton Global Bond's high-conviction approach amplifies the potential risk as well as reward in the short run.

The following is our latest Fund Analyst Report for

Templeton Global Bond TPINX

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Templeton Global Bond's distinct process works over the long term because of the manager's patience and the team's expertise. But its high-conviction approach amplifies the potential risk as well as reward in the short run, supporting a Morningstar Analyst Rating downgrade to Silver from Gold on its cheaper share classes. Its most expensive share class receives a Bronze.

Michael Hasenstab, CIO of the firm's global macro group and manager here since 2002, pioneered its distinctive process. Longtime analyst and co-head of research, Calvin Ho, became comanager in late 2018. The duo has the support of five macro analysts who have solid resumes for the task at hand, as well as ample support on its trading and quantitative analyst squads.

Hasenstab plies a patient, benchmark-agnostic approach, building the portfolio based on the team's meticulous fundamental sovereign and currency research. The strategy has stood out for its general avoidance of low-yielding developed-markets debt and preference for emerging-markets countries where it sees better fiscal prospects. Some of the resulting themes have been on the extreme side of the nontraditional bond Morningstar Category, such as a short on U.S. Treasuries from 2016 to early 2020 that led to a negative overall duration as well as increased concentration among its emerging-markets bond positions, including Mexico, Brazil, and Indonesia.

Missteps in these areas, including the now-removed U.S. Treasury short as well as its stakes in Brazilian and Argentine bonds, have stung in the past few years. Anticipating tougher markets, the team began shifting the portfolio's short yen position to a long stake in May 2019 along with other safe-haven currencies. These moves didn't blunt the pain of the early 2020 sell-off as much as the team had hoped, and it has kept to a more conservative posture in anticipation of more market turmoil (and buying opportunities). While this recent stretch has been disappointing, the strategy has recovered lost ground quickly in the past, and the manager's patience and knack for finding value should continue to pay off over the long term.

Process | Above Average The strategy's distinctive, patient, and thoughtfully researched approach is a positive, but its ample emerging-markets and concentration risks support an Above Average Process Pillar rating.

Hasenstab and his team aim to identify value among sovereign credit, interest rates, and currencies in countries with healthy or improving fundamentals that they think the market underappreciates. The portfolio is benchmark-agnostic and built on the team's meticulous fundamental research with feedback from local market participants. The contrarian-minded group attempts to find those opportunities early on and then watch as their theses unfold over several years. Successful calls have included Indonesian local debt and a large position in Irish government debt bought during 2011's eurozone crisis.

Some of the team's multiyear themes have been on the extreme side within its peer group, such as a short on U.S. Treasuries from 2016 to early 2020 because of its view that the market underappreciated inflation as well as increased concentration among its emerging-markets bond positions, including Mexico, Brazil, and Indonesia. The team's developed-markets currency shorts, which have included the euro, yen, and Australian dollar, are meant to provide insulation when its emerging-markets local-currency bond positions are under pressure but are also sizable and at times volatile.

People | High Seasoned managers and a well-resourced group of analysts and traders support this strategy's High People Pillar rating. Hasenstab, CIO of the firm's global macro group, makes the final calls for this and other funds under that team's purview. Hasenstab began his career at the firm in 1995 as an emerging-markets sovereign credit analyst, then left to get a doctorate in economics from Australian National University. He rejoined the firm in 2001 as a manager on this strategy and has since built out the supporting team.

When Sonal Desai, this strategy's comanager since 2011, stepped down to take over as CIO of the firm's fixed-income group at the end of 2018, longtime team member Ho stepped into the comanager role. Ho was the first macro researcher that Hasenstab hired in 2005 and had been promoted to co-lead the research team in 2018. In addition to strong leadership, the supporting five analysts, who are also economists, have solid resumes for the task at hand. Four of these analysts average more than 20 years with this team, and the overall group has been relatively stable (two analysts left within the past five years and both were replaced). They also have the support of six skilled traders who average more than a decade of experience as well as four dedicated risk management professionals.

Parent | Average Publicly traded but family managed, Franklin Resources BEN is parent to Franklin Templeton Investments. The firm closed its acquisition of Legg Mason for USD 4.5 billion on July 31, 2020, creating a USD 1.4 trillion asset manager (assets under management as of June 30). The merged firm will operate under the Franklin name. Given some uncertainty surrounding the integration of the seven Legg Mason investment boutiques Franklin acquired (Entrust Global went private, and RARE merged into ClearBridge in 2019), Franklin's Parent rating remains Average.

The firm has historically grown through acquisitions, but this one is large by Franklin's and industry standards. The new entity has a much heavier focus on fixed income (nearly half of assets) because of Western Asset Management's significant platform, with roughly one third in equities. Franklin is getting some strong equity and fixed-income investment teams, which may minimize the outflows Franklin has suffered. The merged firm also has a more even split between its institutional and retail businesses.

Franklin has let its acquired boutiques operate autonomously with success, but there has been a shift in recent years in response to its struggling lineup. The firm has emphasized centralized risk management and research and has made changes to its investment leadership. Reportedly, Legg Mason's affiliates will operate autonomously, a prudent choice.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category's middle quintile. That's not great, but based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we think this share class will still be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Silver.

Performance The strategy has been a top performer since Hasenstab started managing it in 2002 thanks to strong currency and rates calls, but with ample volatility. Given the team's contrarian style and concentrated portfolio, relative performance can shift dramatically over shorter periods. Its heavy emphasis on emerging-markets local debt has lofted it to the top of the heap when risk appetite is strong (2012 and 2016), but that has also stung when those bonds nosedive (third quarter of 2011 and 2015). It's also struggled mightily in the past few years owing to missteps, including a short on U.S. Treasuries (which the team removed in early 2020) as well as hard-hit positions in Brazilian and Argentine local debt, which have sunk its five-year record.

Anticipating tougher markets, the team began shifting the portfolio's short yen position to a long stake in May 2019 along with adding more developed-markets currencies that it considered safe. The long yen position didn't do as well during the early 2020 sell-off as the team had hoped, but the advisor share class' 4% loss from Feb. 20 through March 23 was less severe than four fifths of distinct rivals'. The strategy lagged in the rebound because of its heavier focus on Latin American local debt, which did not bounce back as quickly as other emerging-markets local bonds, and because of its short on the rallying euro.

Portfolio Sensing fragility in the markets, the team started adding some protection to the portfolio in the spring of 2019 by switching the longtime short on the yen to a long position. (It clocked in at 48% as of February 2020 when the coronavirus-sparked sell-off got underway.) The team added smaller positions meant to insulate, including the Swiss franc (6%), Norwegian krone (8%), and Swedish krona (6%), and dialed back some Mexican peso (2%) and Indian rupee (0.5%) exposure. It also doubled its short on the Australian dollar (20%) to protect against slower growth in China. The team maintained its roughly 35%-40% short on the euro given its dour view on growth in the eurozone.

As the sell-off got underway, the team neutralized its U.S. Treasuries position, which in years past contributed to a negative overall duration. The team then continued cutting emerging-markets rates and currency exposure broadly, partly because of the desire to reduce that overall risk in the portfolio but also given challenges it saw cropping up with leadership in Brazil and India. The team completely cut the Brazilian real exposure as of July 31 while keeping a much-reduced stake in local rates (5%), and cut its India rates position as well (the team had sold down its rupee position in early 2019).

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