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					                                                    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
                                            recent years;
                                         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.
                                                                                                   sovereign bonds.
   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
   (1998–2007)

       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


                                       20-Year
                                    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

           International Govt.
                       Bonds
                                         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

     INDEX

     Citigroup World Govt. Bond Index                                                                3.72%                                —                       10.95%

     Citigroup Global Emerging Market Sovereign Bond Index                                           6.24%                                —                         6.24%

     COUNTRY/REGION

     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.
   STRATEGIES
                                                                                                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
                                                                                                          Fundamentals
        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
             50
                                                                                                          of reserves sufficient for macroeconomic management. Such
             25
                                                                                                          reserves could allow Asian countries to use the exchange rate
                                                                                                          as a policy instrument rather than a stabilisation instrument.
                        0
                                    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)
                                     0
  Rolling 12-Month Trade Balance




                                   -100

                                   -200

                                   -300

                                   -400
                                                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
                                                                                                   compression.
   BOND PORTFOLIOS
                                                                                                  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
   the currency.
                                                                                                  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
      be profitable.
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
                                                                        Rolling 12-Month


                                                                                              5%
   participate in global recoupling. Not only were monetary
   conditions relatively tight and restraining, but South Korea
                                                                                              0%
   also seemed vulnerable to weaker U.S. growth, cyclical
   undercurrents in China following policy tightening, and tail
                                                                                              -5%
   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
      medium term
                                                                         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
    Strategy:
    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
                                                                                                                    130                                                       250




                                                                                                                                                                                    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




                                                                                                                                                                                                  Increased Volatility
                                                    Outlook




                                                                                1 Jan. 2005 = 100
     • Continued current account and                                                                                110                                                       150
       fiscal surpluses
     • Government reform agenda and                                                                                 100                                                       100
       planned asset sales/privatisations
                                                   Currency
     • Monetary tightening                         Outlook*                                                          90                                                       50


      Strategy:                                                                                                                                                               0
                                                                                                                     80
      Short-duration positioning, long currency                                                                            1/05    10/05         8/06    6/07          3/08
      exposure*
                                                                                                                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
                                                                                                                                                                   Outlook
                                                                                                              • 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
                                                                                                                                                                   Outlook
   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
   these appreciated.
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
  United Kingdom.

  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



                              Important Information
                              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
                              persons.
                              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
                              investment advice.
                              Franklin Templeton Investments (Asia) Limited. Investment involves risk. This article has not been reviewed by the HKSFC.




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