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Making the Franklin Mega-Merger Work for Fund Investors

Let's make a fund deal.

When I heard about Franklin Resources' acquisition of Legg Mason LM, my first thought was that it makes sense for a firm that is suffering the most outflows of any firm. My second thought was, "I hope it does a better job than it did with Templeton and Mutual Series."

Those deals were back in the 1990s, so most of the decision-makers at Franklin BEN will have changed since then. The deals were good for corporate shareholders, but Franklin raised fees and watched a steady stream of talented investors leave both firms. The two were among the elite in their asset specialties, but now most of the legacy Templeton funds have Morningstar Analyst Ratings of Neutral, and the legacy Mutual Series funds are rated Bronze.

Here then, I offer up a few suggestions for handling the new merger:

  • Ensure that all fund mergers result in lower costs.
  • Make sure there is buy-in and a real commitment from the top managers and analysts at ClearBridge, even if it costs you a few Benjamins.
  • Merge some mediocre funds into strong funds.
  • Be sure that fundholders benefit as much as stockholders.
  • Fund directors should focus on better management and lower fees rather than protecting their jobs. No, really, I mean it.

What should investors in funds from the merged companies expect? The good news is there won't likely be immediate change. It takes a while for a deal to be completed, and even after that there is usually some time before fund mergers happen. This is also the bad news, though, because it means you have to stay alert for changes for about a year.

Now, let's play matchmaker and look for some good opportunities for Franklin to upgrade some funds. (Look for my consulting bill in the mail, Franklin!) These are my suggestions, not something Franklin has said will happen.

Intermediate Core-Plus Bond The $5 billion Franklin Total Return FRERX rates Average for People and Process and Neutral overall. Let's merge it into the Gold-rated Western Asset Core Plus Bond WACPX, which has lower fees and High ratings for People and Process. Now that's an upgrade! No doubt Franklin was particularly interested in acquiring Western Asset, which excels in core and core-plus bond strategies--an area where Franklin is not particularly strong.

Large Blend We're not big fans of the $1.9 billion ClearBridge Value LMNVX. We give it a Negative Analyst Rating. So, let's merge it with the $6.9 billion ClearBridge Appreciation SAPYX. That Silver-rated fund is cheaper. Yes, the Franklin-Legg Mason deal didn't need to happen for this merger to take place, but why pass up an opportunity to upgrade funds? Both have the S&P 500 as their benchmark, by the way, and are in the large-blend Morningstar Category.

Large Value ClearBridge All Cap Value SFVYX is rated Negative. So let's merge that $1.6 billion fund into the $1.8 billion ClearBridge Large Cap Value LCLIX, which is rated Silver. True, the first fund is all-cap with 61% of assets under management in large caps, and I'm suggesting merging it into a fund with 93% of assets in large caps. Not a perfect fit, I admit, but an upgrade to Silver from Negative is worth it. The large-cap fund is also 20 basis points cheaper.

Allocation Franklin isn't particularly good at core equities or core bonds, so we rate its Conservative Allocation FTCIX and Moderate Allocation FMTIX funds Neutral. Franklin Founding Funds Allocation FFALX, which sounds like it was dreamed up by someone in marketing, also gets a Neutral overall but a Negative for its Process Pillar.

Legg Mason doesn't have comparable funds, so we can keep the funds but change the management sleeves. The bonds can go to Western Asset's core strategy, with maybe a little for Michael Hasenstab's Gold-rated Templeton Global Bond TGBAX. For equities, we'll spread the large-cap money across Silver-rated ClearBridge Aggressive Growth LSIFX and the aforementioned ClearBridge Large Cap Value and ClearBridge Appreciation. Then let's get some exposure to small caps via Silver-rated Royce Special Equity RSEIX and Bronze-rated Franklin Small Cap Growth FSMLX. I'd rather have ClearBridge Small Cap Growth SBPYX, but that Silver-rated fund is closed to new investors.

Now we just adjust the equity exposure to fit the benchmarks and we're all set.

Franklin Income FNCFX could probably use a similar upgrade, though with its income focus, it would require some changes to dial up the income side.

Rebranding Fund mergers often lead to the adoption of a single name for branding purposes. So, maybe FranklinTempletonWesternRoyceBridge. Better yet, no one is using RiverSource anymore.

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About the Author

Russel Kinnel

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Russel Kinnel is director of ratings, manager research, for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He heads the North American Medalist Rating Committee, which vets the Morningstar Medalist Rating™ for funds. He is the editor of Morningstar FundInvestor, a monthly newsletter, and has published a number of prominent studies of the fund industry covering subjects such as manager investment, expenses, and investor returns.

Since joining Morningstar in 1994, Kinnel has analyzed virtually every type of fund and has covered the most prominent fund families, including Fidelity, T. Rowe Price, and Vanguard. He has led studies on the predictive power of fund data and helped develop the Morningstar Rating for funds and the Morningstar Style Box methodology. He was co-author of the company's first book, Morningstar Guide to Mutual Funds: 5-Star Strategies for Success (Wiley, 2003), and was author of the book Fund Spy: Morningstar's Inside Secrets to Selecting Mutual Funds That Outperform, published in 2009.

Kinnel holds a bachelor's degree in economics and journalism from the University of Wisconsin.

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