Franklin Templeton Fixed Income
INVESTMENT INSIGHT August 2008
Global Bonds: Diversification and Enhanced Alpha
Potential in an Ever-Changing World
Faced with the recent return of volatility to financial markets, many investors and
advisors are questioning which asset classes can truly support the bulwark that portfolio
diversification is supposed to provide. With a record of low return correlations to broad
Michael Hasenstab, Ph.D. U.S. stock and bond indexes, global bonds are among those asset classes that have the
Senior Vice President, potential to support portfolio diversification while benefiting from economic conditions
Co-Director/Portfolio Manager and monetary policies that vary around the world. This ever-evolving environment
Franklin Templeton Fixed Income Group®
provides bond investors with the prospects to weather downturns in particular markets,
reduce volatility and participate in select currency or interest rate opportunities.
An actively managed global fixed income strategy also has the potential to enhance risk
adjusted returns through its ability to search beyond the traditional capital markets of the
eurozone, United Kingdom, United States and Japan—all of which are heavily
represented in global benchmarks—and offer investors new paths for pursuing
opportunities. This article provides a perspective on global bonds as an asset class by
examining the following topics:
• The Potential Benefits of Global Bonds
• Global Themes Supporting Investment Strategies
• Country-Specific Strategies within Global Bond Portfolios
• The Value of Active Investment Management
THE POTENTIAL BENEFITS OF GLOBAL BONDS
It is a well-accepted investment principle that adding bonds to a hypothetical equity
portfolio can lower the portfolio’s overall risk profile. In an analogous way, adding
international fixed income exposure can improve the diversification and returns of a
traditional fixed income allocation. Fixed income allocations that reach outside of the
U.S. should be added for three reasons:
1. The number and variety of available investments has expanded substantially in
2. International bonds have lower historical correlations to U.S. stocks than U.S. bonds
and have had a low correlation with international stocks; and
3. Global bonds have evolved as an asset class, presenting a broad opportunity set that
not only can provide excellent diversification, but also the potential to enhance alpha.
Franklin Templeton Fixed Income
Additional Capital Markets and Instruments currencies, a variety of duration exposures and a wide gamut
of country exposures. This is possible through vehicles that
The number of countries opening their capital markets in
include emerging market local currency debt, as well as credit,
recent years has significantly broadened the global fixed
interest rate and currency derivatives. Examples of relatively
income universe. There are now over 100 countries with fully
new opportunities in global securities markets include:
or partially functioning bond and/or currency markets. For
example, in 2006 Brazil repealed a double-digit withholding • Long-dated Mexican bonds that have pushed the local yield
tax on foreign investors, which effectively opened its markets. curve out to 30-year maturities.
India is in the process of opening its markets as well, and
• Corporate emerging market debt that offers extra yield over
China may improve market access in the next few years.
Although there have been recent instances of countries
moving in the opposite direction to slow their currencies’ • Credit default swaps that provide investors with insurance
appreciation against the U.S. dollar, the long-term trend that covers bondholders in the event of a default.
toward capital market integration appears to be in place.
• Cross-currency swaps that allow investors to take a relative
currency position that plays deteriorating fundamentals in
This broadening opportunity set involves not only geographic
one country against strong fundamentals in another.
expansion but also new instruments that can provide
specialised exposures. Whereas investors were once limited to
the bond markets of developed countries and a narrow range
of currencies, their options now include a broader range of
A World of Fixed Income Opportunities
(As of 31 December 2007)
External debt markets available External and domestic debt markets available
Source: The Bank for International Settlements. For illustrative purposes only.
Franklin Templeton Fixed Income
The strengthening and deepening of local fixed income only once during the past 10 calendar years—a record that
markets have supported the rollout of additional instruments. should encourage U.S. investors to reevaluate their home-
These markets now operate more efficiently than ever before country bias when considering fixed income allocations.
and are more accessible to investors around the world.
Within this growing marketplace, the world’s best-performing
bond markets vary from year to year. As the chart below
illustrates, U.S. bonds have been the world’s top performer
Annual Total Returns of the Top 10 Global Bond Markets
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
France Japan U.S. Poland Norway Australia Poland Mexico Poland Canada
21.25% 15.53% 13.48% 30.38% 40.90% 37.35% 35.96% 21.29% 17.96% 23.83%
Spain Canada Poland U.S. New Zealand New Zealand Norway Canada Sweden Poland
21.09% 4.29% 9.64% 6.73% 37.01% 33.66% 18.02% 9.77% 17.24% 19.90%
U.K. Australia Canada Norway Switzerland Canada Sweden Malaysia South Korea Norway
20.88% 4.07% 6.77% 3.93% 35.07% 29.11% 17.45 % 4.85% 15.80% 18.90%
Belgium New Zealand Switzerland Switzerland Sweden Sweden Eurozone U.S. U.K. Australia
20.88% -1.83% 2.57% 1.32% 31.15% 26.98% 16.00 % 2.80% 14.57% 15.51%
Finland U.S. Singapore Canada Denmark Denmark New Zealand Taiwan Malaysia New Zealand
20.70% -2.45% 2.35% 1.15% 29.18% 25.05% 15.89% 2.34% 13.00% 13.41%
Netherlands Norway U.K. Denmark Eurozone Eurozone Denmark New Zealand Eurozone Denmark
20.42% -2.70% 1.02% 0.71% 29.09% 24.98% 15.68% 1.13% 12.45% 13.13%
Italy U.K. Eurozone Eurozone Poland Norway Canada Poland Denmark Eurozone
20.30% -4.30% 0.40% 0.64% 23.68% 15.67% 15.42% 0.63% 11.62% 12.86%
Germany Sweden Denmark U.K. U.K. U.K. Switzerland South Korea Eurozone Singapore
19.76% -7.50% 0.11% 0.43% 21.09% 13.52% 14.74% 0.37% 11.32% 12.31%
Austria Denmark Sweden New Zealand Australia Switzerland U.K. Australia Mexico Malaysia
19.69% -14.90% -0.74% -1.59% 20.50% 12.81% 14.34% -1.06% 10.70% 9.87%
Portugal Switzerland Norway Singapore Singapore Japan Australia Singapore Australia Japan
19.63% -16.33% -2.98% -2.04% 17.35% 9.92% 11.60% -2.65% 9.66% 9.47%
Source: Citigroup. All country and eurozone returns are from the Citigroup World Government Bond Index (WGBI) and Citigroup WGBI’s Additional Markets data. Performance
calculated in U.S. dollar terms (unhedged). Indexes are unmanaged, and one cannot invest directly in an index. Past performance does not guarantee future results and results
may differ over future time periods.
Franklin Templeton Fixed Income
Lower Correlation To U.S. Securities reduce overall portfolio volatility. Simply put, these assets
may be able to provide more diversification benefits than U.S.
Correlation, which measures the degree to which two asset
bonds when combined with U.S. equities.
classes move in tandem, is an important consideration in
constructing a well-diversified portfolio. U.S. fixed income Enhancing Alpha Potential
assets have traditionally served as a defensive allocation based
on their historically low correlation to U.S. equities, as shown An actively managed global bond portfolio that seeks to
in the table below. What many investors do not know is that exploit country-specific differences may be able to reduce
international bonds offer a historical record of even lower correlations to traditional asset classes even further and
correlation to U.S. equities, plus the potential to hedge against enhance alpha potential. For global fixed income strategies,
U.S. interest rate cycles, economic conditions and other three independent alpha sources are key: currency, duration
domestic sources of uncertainty. Such diversification does not and credit exposures. When assessing investment
assure or guarantee better performance and cannot eliminate opportunities, the expected return from each potential alpha
the risk of investment losses but should be considered when source can be isolated to ensure that only attractive risks
developing a portfolio consisting of different asset classes. are held.
A study recently published in the Journal of Financial New investment opportunities play a useful role here,
Planning reviewed long-term asset class correlations, plus the primarily as a risk management tool that can isolate
volatility of these correlations, with the goal of identifying particularly attractive risk components within securities. For
those asset classes that could improve diversification.¹ Along example, a strategy for a given country may keep the duration
with 17 other indexes representing different U.S. and element and hedge out the currency by using currency
international asset classes, the study examined the historical forwards. Alternatively, cross-country valuations can reveal a
returns of the Citigroup Non-USD World Government Bond currency opportunity that coexists with a country’s
Index. It found that these assets had lower correlations to U.S. unfavourable interest rate environment. The manager who can
equities, and lower standard deviations associated with those isolate one from the other can potentially enhance portfolio
correlations, compared to U.S. bonds. The study concluded performance. Before developing these types of combinations,
international bonds historically have been better able than however, a regional analysis that shows where to begin
U.S. bonds to looking for opportunities should be undertaken.
Average Annual Total Returns and Correlation of Returns
20-Year Period Ended 31 December 2007
Average Annual International
Total Return U.S. Equities Global Equities U.S. Bonds Global Govt. Bonds Govt. Bonds
U.S. Equities 11.81% 1.00
Global Equities 9.28% 0.84 1.00
U.S. Bonds 7.56% 0.18 0.10 1.00
Global Govt. Bonds 7.10% 0.04 0.23 0.53 1.00
6.78% 0.01 0.27 0.33 0.96 1.00
Source: Standard & Poor’s Micropal. Correlation is the statistical measure of the degree to which the movements of two variables are related: 1=perfect positive correlation; 0=no
correlation; -1=perfect negative correlation. U.S. equities are represented by the S&P 500 Index; global equities by the MSCI World Index; U.S. bonds by the Lehman Brothers U.S.
Aggregate Index; global government bonds by the Citigroup World Government Bond Index; and international bonds by the Citigroup Non-USD World Government Bond Index.
Indexes are unmanaged, and one cannot invest directly in an index. Past performance does not guarantee future results and results may differ over future time periods.
1. William J. Coaker II, “Emphasizing Low-Correlated Assets: The Volatility of Correlation,” Journal of Financial Planning (September 2007): 52–70.
Franklin Templeton Fixed Income
Global Bonds: A Dual Opportunity Set
One-Year Period Ended 31 December 2007
Local Currency Currency Return Unhedged US$
Bond Return (Against US$) Total Bond Return
Citigroup World Govt. Bond Index 3.72% — 10.95%
Citigroup Global Emerging Market Sovereign Bond Index 6.24% — 6.24%
Australia 3.69% 11.40% 15.51%
Canada 5.02% 17.91% 23.83%
Eurozone 1.79% 10.87% 12.86%
Japan 2.64% 6.66% 9.47%
Malaysia 2.99% 6.68% 9.87%
Mexico 4.39% -0.80% 3.55%
Norway 3.69% 14.67% 18.90%
Poland 1.54% 18.08% 19.90%
Singapore 5.37% 6.59% 12.31%
South Korea 2.08% -0.65% 1.42%
Sweden 1.79% 5.88% 7.77%
Switzerland -0.89% 7.82% 6.86%
United States 9.00% — 9.00%
Sources: Citigroup and IDC/Exshare. All country and eurozone returns are from the Citigroup World Government Bond Index (WGBI) and Citigroup WGBI’s Additional Markets data.
The local currency return of the WGBI reflects multiple foreign currencies; the local currency return of the ESBI is in U.S. dollars. Indexes are unmanaged, and one cannot invest
directly in an index. Past performance does not guarantee future results and results may differ over future time periods.
GLOBAL THEMES SUPPORTING INVESTMENT and Asian structural rebalancing.
We believe the bulk of this decoupling effect has been
A broad evaluation of regional investment conditions is a
realised, and prospects looking forward seem to favour some
logical first step in eventually selecting global fixed income
degree of global “recoupling.” In Asia, a long-term structural
investments. Our research in this area has identified several
shift in economic growth, with rising regional trade and
themes that give rise to multiple country-specific strategies.
improving domestic consumption, continues to be an
insulating factor. However, cyclical factors linked to tighter
U.S. Economic Slowdown: Second-Round Effects
and Implications monetary conditions could prove influential. For example,
China has tightened lending conditions more aggressively
Against a backdrop of slowing U.S. economic growth and through various administrative measures. India has also
concerns about a potential recession, a debate continues over tightened interest rates and allowed sizable currency
the degree to which the wide-ranging forces of globalisation appreciation. Although Asia is likely to continue reporting
have strengthened various countries’ independence from U.S. economic outperformance and long-term structural trends
economic conditions. Global economic performance in 2007 remain intact, there is a risk that policy tightening in major
tended to align with the “decoupling” side of this debate. emerging market countries, along with a protracted period of
Global growth remained strong in 2007—and in some areas subtrend U.S. growth, could lower global growth on the
even accelerated—even as a housing slump checked U.S. margin. Additionally, European growth faces headwinds given
growth. Strong growth performance outside the United States past interest rate tightening, significant currency strengthening
was underpinned by an extended period of favourable and underlying liquidity tensions.
financing conditions, increased trade with emerging markets
Franklin Templeton Fixed Income
Positioning for Global Recoupling Asia vs. Europe: Positioning for Value Relative to
Within this environment, fundamentals and valuations suggest
ways an active manager can take advantage of interest rate Foreign currency returns from roughly 2002 through 2007
and currency risk. In terms of global government bond market were, in our opinion, largely a function of a weakening U.S.
positioning for 2008, we see value in countries where yields dollar that served as a mechanism for correcting America’s
have lagged the late-2007, early-2008 rally in U.S. Treasuries. unsustainably large current account deficit. The U.S. current
We believe bond markets in Asia and Europe have mispriced account deficit measured 5.28% as a share of U.S. gross
the consequences of linkages between global financial and domestic product (GDP) in 2007. It is symptomatic of broader
capital markets, creating investment opportunities based on a global imbalances seen in the flow of goods and capital
potential recoupling in market pricing. European markets, in between different regions, where the eurozone ran a balanced
particular, could experience a larger recoupling effect, given current account and Asia significant surpluses. We believe the
the constraints on a quick fiscal policy response and the next phase of unwinding in these imbalances continues to
limited ability of consumers to pick up any slack. We also see favour Asian currencies, but no longer favours the euro due to
value in peripheral bond markets, particularly those that the differences in regional fundamentals and
backed up from risk aversion in the second half of 2007 and valuation barriers.
where a macroeconomic backdrop favours lower yields
through potential interest rate easing. In 2007, America’s bilateral balance against Pacific Rim
countries widened another US$5.08 billion, bringing the
Additionally, we seek to identify opportunities where we deficit to -US$366.46 billion—over three times the size of
believe the market is mispricing medium-term inflation risks. America’s deficit with eurozone countries and more than two
We do not see all inflation as equal—or rather, inflation times the size of its trade deficit with the North American
limited to certain sectors of the economy amid subtrend region. Additionally, Asian currencies appreciated less against
growth has different medium-term consequences than the U.S. dollar than European currencies. Asian countries
inflation that is broad based in an economy growing above partly engineered this prevention of currency appreciation by
trend. In the former, while short-term yields may rise as accumulating U.S. dollar-denominated foreign currency
central banks raise reference rates to manage inflation reserves. For example, China’s stockpile of foreign currency
expectations, these increases can often be quickly reversed. reserves rose from US$212 billion to US$1.5 trillion between
However, in the latter, rate hikes may be more extensive and 2002 and 2007. These foreign currency reserves, in turn, help
last longer. finance the U.S. current account deficit through holding
reserves in “risk-free” instruments such as U.S. Treasuries.
Long-Term Treasury Yields (1 October 2007–31 March 2008)
125 Consequently, we believe the normalisation of global
100 imbalances favours Asian currencies given two supportive
75 factors: the magnitude of the bilateral trade deficit and a level
of reserves sufficient for macroeconomic management. Such
reserves could allow Asian countries to use the exchange rate
as a policy instrument rather than a stabilisation instrument.
10/07 11/07 1/08 2/08 3/08 This situation also signals the relative undervaluation of
South Korea Mexico Germany United States Asian currencies.
Source: Bloomberg. Yield data is indexed to 100 as of 01.10.07 and reflects each
country’s 10-year treasury, except for Mexico, which reflects a nine-year treasury.
U.S. Bilateral Trade Deficit by Region (10-Year Period Ended 31 December 2007)
Rolling 12-Month Trade Balance
1997 1999 2001 2003 2005 2007
Eurozone OPEC North America Pacific Rim
Source: Department of Commerce and U.S. Census Bureau, Foreign Trade Division. In billions of U.S. dollars.
Franklin Templeton Fixed Income
European currencies have appreciated strongly over the weak attractiveness of a country’s sovereign debt. If a manager has
U.S. dollar cycle, even though America’s bilateral imbalances the added flexibility to construct strategies focused solely on
with Europe were significantly lower. From the beginning of duration, they could hedge away the currency risk inherent in
the weak U.S. dollar cycle in early 2002 through March 2008, this falling rate environment.
the euro appreciated 84% against the U.S. dollar, or more than
twice the rate the U.S. dollar fell against the basket of Another country may offer conditions conducive to future
currencies of its major trading partners (39%). As a result, we currency appreciation. Exposure to this currency opportunity
believe European currencies are broadly overvalued against can be accessed either by owning an unhedged position in
the dollar. Notably, we view non-euro European currencies as bonds or by using currency forwards overlaid on a hedged
having more attractive valuations than the euro, particularly bond position.
relative to fundamentals.
Franklin Templeton’s Fixed Income Group develops various
Consequently, in spring 2008 we repositioned our portfolios global strategies including those that can hold duration and
for what we think could be the next significant theme to hedge out currency exposure, or those that consist of currency
influence the near-to-medium term investment environment: exposure without duration, or those that can maintain exposure
the relative performance and valuation adjustment of Asia vis- to both. Examples of such tactics are described below.
à-vis Europe. Our first step in this repositioning was to hedge
Case Study One: SOUTH KOREA¹
out the implicit euro risk in the portfolios’ peripheral
European currencies, such as those of Switzerland,
Our active management approach allows us to isolate interest
Scandinavia and Eastern Europe.
rate and currency opportunities seeking optimal risk/reward
tradeoff. It also gives us the flexibility to position for gains
The next step was to add cross-regional exposures, such as
during both the acceleration and deceleration phases of a
taking a long Singapore dollar or Japanese yen position
country’s growth cycle. For example, we may have a
against the euro. This currency strategy allows our funds to
favourable view of a country’s long-term prospects and
isolate opportunity sets based on the relative fundamentals and
fundamentals, but a cyclical slowdown may benefit its bonds
valuations identified in the previous discussion of 1)
while weakening its currency. Hedging instruments let us take
imbalances in the U.S. current account versus Asia, rather
exposure to the interest rate risk in the bond market while
than Europe and 2) headwinds to European growth that imply
hedging out the currency risk that could materialise with
Europe could slow before Asia. While this strategy has also
slower economic growth and lower interest rates.
resulted in a higher exposure to the U.S. dollar, it represents
our view that we are near a bottoming in the valuation of the Growth Cycle Opportunities
dollar against the euro, although we remain cautious on the
Accelerating Growth Decelerating Growth
U.S. dollar against Asian and other currencies.
Rising interest rates and increased Falling interest rates can create
production often lead to currency long duration opportunities.
COUNTRY-SPECIFIC STRATEGIES WITHIN GLOBAL appreciation and credit spread
2002: Long-duration Swedish bonds, 2008: Long-duration Korean bonds,
With the global themes described above as a foundation, long Swedish krona hedged into Swiss franc
individual country circumstances provide the next framework
for identifying investment opportunities primed for interest
rate and currency strategies. As mentioned previously, these
strategies can combine global fixed income instruments with
derivatives to isolate an investment opportunity within a
country’s yield curve, currency or both the yield curve and
2003: Short-duration Korean bonds, 2005: Short-duration Swedish bonds,
long Korean won long Swedish krona
For example, interest rate analysis may identify conditions
where potential interest rate cuts would increase the Source: Franklin Advisers, Inc. For illustrative purposes only.
1. All case studies are provided solely to illustrate some of the techniques we may use as part of our active management approach in seeking enhanced alpha opportunities. They
are not all indicative of any current strategy, nor holdings. There is, of course, no assurance that the employment of any technique or active management strategy will prove to
Franklin Templeton Fixed Income
South Korea provides one example of global strategies based Case Study Two: SWEDEN
on an economy in transition. Between 2004 and 2007, South
Korea’s central bank increased its policy rate from 3.25% to Sweden’s growth cycle stage provided a different set of
5.00% as aggregate GDP growth rose on the back of opportunities. In recent years, Sweden has enjoyed growth
continued strong trade. Strength in the local economy outperformance relative to its neighboring eurozone
generated inflationary pressures, and rising incomes translated economies. The country’s GDP rose 4.1% in 2006—compared
into higher real estate prices. To manage inflationary to 3.3% in the eurozone—as an improving labour market and
pressures, policy authorities adopted a more flexible currency rising incomes fueled private consumption. Sweden also has
relative to certain Asian countries. The South Korean won exhibited strong fiscal and balance-of-payment fundamentals.
appreciated 44% against the U.S. dollar from the beginning of The 2006 election of a center-right government whose agenda
the weak dollar cycle in 2002 through the first half of 2007. supports tax cuts, employment mobilisation and asset sales
During this period, the shorter maturity South Korean bonds enhanced the prospects for ongoing expansion and
protected against rising interest rates. The unhedged position fiscal surpluses.
also benefited from the won’s appreciation.
Sweden’s Current Account and Fiscal Surpluses
First Quarter 1997–Fourth Quarter 2007
In the second half of 2007 and first half of 2008, one could 10%
extend duration in South Korean bonds and hedged out Surplus as a % of GDP
currency risk based on expectations that the country would
participate in global recoupling. Not only were monetary
conditions relatively tight and restraining, but South Korea
also seemed vulnerable to weaker U.S. growth, cyclical
undercurrents in China following policy tightening, and tail
risk based on asset price corrections. Additionally, bond and 1Q97 4Q99 3Q02 2Q05 4Q07
currency markets did not appear to be pricing in sufficient risk Current Account as a % of GDP
of this global recoupling scenario, leaving bond valuations Central Government Fiscal Balance as a % of GDP
attractive but currency prospects unfavourable. Sources: Bloomberg, Statistics Sweden and Swedish National Debt Office (NDO).
Sweden’s economic growth persisted in 2007 with an
South Korea accompanying rise in inflation. Improvement in the country’s
Case Study Summary labour market and cyclically slowing productivity produced
rising cost inflation. Seeking to maintain price stability near an
• Monetary policy in transition from inflation target of 2.00%, Sweden’s central bank, the
tightening to easy stance over the Riksbank, has continued raising its policy interest rate. From
the start of the current tightening cycle in January 2006
• Domestic business cycle declining Yield
through July 2008, the repo rate has climbed from 1.50% to
from cyclical peak Outlook
4.50%. Although global recoupling effects could reduce
• Potential recoupling: Weakening demand for Swedish exports and weigh on Swedish growth,
export environment whose
consequences may not be the domestic economy—and households in particular—remain
sufficiently priced into local markets in a favourable position because rising disposable income has
Currency been underpinned by employment growth and government
• Shift from current account surplus to Outlook
current account deficit policy. The composition of economic growth and rising
inflationary pressures relative to the inflation target could
Long-duration positioning, currency make it difficult for the Riksbank to follow the U.S. Federal
exposure hedged out Reserve in lowering interest rates in the near term. This
suggests to us a strategy of a long currency/short duration
position in Swedish government bonds and treasury bills, plus
supranationals denominated in krona, seeking to access
potential appreciation in the currency while limiting exposure
to Sweden’s interest rate cycle.
Franklin Templeton Fixed Income
Rising Equity Volatility and Appreciation of the
Sweden Japanese Yen and Swiss Franc
1 January 2005–31 March 2008
Case Study Summary
S&P Volatility Index (VIZ), Jan. 1, 2005 = 100
Indexed Appreciation versus the U.S. Dollar
• Growth outperformance compared 120 200
Japanese Yen, Swiss Franc,
to eurozone economies Yield
1 Jan. 2005 = 100
• Continued current account and 110 150
• Government reform agenda and 100 100
planned asset sales/privatisations
• Monetary tightening Outlook* 90 50
Short-duration positioning, long currency 1/05 10/05 8/06 6/07 3/08
Swiss Franc Japanese Yen VIX
* With hedging of implicit euro risk.
Sources: IDC/Exshare and Chicago Board Options Exchange.
Case Study Three: JAPAN & SWITZERLAND Current Account Surpluses in Japan and Switzerland
Fourth Quarter 1997–Fourth Quarter 2007
Flexible active management strategies can also take advantage 20%
Current Account Surplus as a % of GDP
of opportunities provided solely by currencies. Within the
current weak U.S. dollar cycle, depreciation of the dollar was 15%
accompanied by a period of greater leverage utilisation within
currency markets. Investors borrowed in currencies of 10%
countries with low interest rates and invested in currencies of
countries with higher rates. Very low interest rates in Japan 5%
and Switzerland made the Japanese yen and Swiss franc
favoured funding vehicles for this carry trade, which exerted 0%
4Q97 2Q00 4Q02 2Q05 4Q07
downward pressure on these currencies. From the beginning
of 2005 through the first half of 2007, the yen depreciated Switzerland Japan
17.02% against the U.S. dollar, and the franc fell 7.22%. Source: Bloomberg.
By the summer of 2007, concerns over the strength of the U.S.
and global economy brought about a new currency paradigm
of deleveraging. However, with policy interest rates at 0.50%
Japan & Switzerland
Case Study Summary
in Japan and 2.75% in Switzerland, yields remained
unattractive. Consequently, we looked to currencies through
supranationals or foreign exchanged forwards in countries • Heightened risk aversion causing an
other than Japan and Switzerland. unwinding of the carry trade Yield
• Meaningful current account surpluses
Fundamentals also supported the attractiveness of the yen and
the franc. For example, as the U.S. ran a current account • Low central bank policy rates
deficit worth 5.28% of its GDP in 2007, Japan generated a
current account surplus of 4.81% of its GDP, and Switzerland Currency
ran a surplus of 16.81% of its GDP. Amid the risk aversion Strategy:
environment of late 2007 and early 2008, currencies of No exposure to Japanese or Swiss
government bonds, long currency exposure
countries with large current account surpluses such as
Franklin Templeton Fixed Income
THE VALUE OF ACTIVE INVESTMENT MANAGEMENT
The country-specific strategies highlighted above illustrate
some of the methods that Franklin Templeton’s Fixed Income
Group may utilise to explore the deep fixed income
opportunity set available in global markets. These types of
currency and duration strategies ultimately reinforce the
importance of active management that can pursue alpha
opportunities by continually analysing economic fundamentals
and assessing exchange and interest rate environments. To do
so, our team takes advantage of Franklin Templeton’s global
footprint. Local asset management teams in India, China,
South Korea, the United Arab Emirates and Brazil exchange
insight and information on a regular basis with our
international fixed income teams in the United States and
Our team utilises this firm-wide knowledge to inform a
research-driven approach to investment strategy development.
We maintain a medium-term, fundamentals-driven approach
that seeks to profit from global trends and attractive valuations
rather than market momentum. Both local experts and global
analysts offer reviews that form the knowledge base for our
portfolios and consider (but are not limited to) growth,
monetary, fiscal, external, and political dynamics and
vulnerabilities. Results from proprietary macroevaluation
models are combined with this input from country analysts.
While various factors can lead markets to trade independently
of the underlying fundamentals over the short term, over the
medium term such imbalances should correct, and short-term
volatility can actually provide significant opportunities.
The results of our work are investment strategies that invest in
a wide array of global bond markets and that can be used to
develop diversification while potentially reducing volatility
and enhancing alpha potential within client portfolios.
Franklin Templeton Fixed Income
This article reflects the analysis and opinions of Franklin Templeton Fixed Income Group, an affiliate of Franklin Templeton
Institutional, as of August 2008. Because market and economic conditions are often subject to rapid change, the analysis and
opinions provided may change without notice. The analysis and opinions may not be relied upon as investment advice.
References to particular securities are only for the limited purpose of illustrating general market or economic conditions, and are not
recommendations to buy or sell a security, or an indication of the author’s holdings. Statements of fact are from sources considered
reliable, but no representation or warranty is made as to their completeness or accuracy. Although historical data is no guarantee of
future results, these insights may help you understand our investment management philosophy.
This document is issued by:
Franklin Templeton Investments Australia Limited (ABN 87 006 972 247) (Australian Financial Services License Holder No.
225328) issues this document for the benefit of the category of person described below with the intention to provide general
information only and not investment or financial product advice. It is not addressed to any other person and may not be used by them
for any purpose whatsoever. It expresses no views as to the suitability of the services or other matters described herein to the
individual circumstances, objectives, financial situation or needs of any recipient.
This document has been prepared for circulation to persons who are wholesale investors within the meaning of the Corporations Act
2001 (Cwlth) or to whom this document may otherwise lawfully be communicated to give preliminary information about the investment
propositions described herein. It is a confidential communication to, and solely for the use of, and may only be acted on by, such
Franklin Templeton Investment Management Limited (FTIML), The Adelphi, 1-11 John Adam Street, London WC2N 6HT. FTIML
is authorised and regulated by the Financial Services Authority. This publication is intended for professional investors, institutional
investment consultants, and eligible counterparties only. It is not directed at retail investors and in no way does it constitute
Franklin Templeton Investments (Asia) Limited. Investment involves risk. This article has not been reviewed by the HKSFC.
THE AMERICAS UK/EUROPE ASIA
600 Fifth Avenue The Adelphi 17/F, Chater House
New York, NY 10020 1-11 John Adam Street 8 Connaught Road Central
London WC2N 6HT Hong Kong
One Franklin Parkway
San Mateo, California 94403 Kanematsu Building, 6th Floor
AUSTRALIA 14-1, Kyobashi 2-chome
500 East Broward Boulevard
Level 25, 360 Collins Street Chuo-ku, Tokyo 1040-0031
Fort Lauderdale, Florida 33394
Melbourne, Victoria 3000 Japan
200 King Street West Australia
Beijing Representative Office
Suite 606, China Life Center
Toronto, Ontario M5H 3T4
No. 17, Jinrong Street
Xicheng District, Beijing
FTIN INVI 08/08