July 25, 2003
Benefiting from a Weaker Dollar
Quick Take: As the three-year bear market sent droves of equity investors to the relative safe havens of bonds, funds investing in foreign fixed-income securities have flourished.
Among the best-performing global bond funds, the $517.5-million Templeton Global Bond Fund (TPINX), invests in sovereign debt in both developed and emerging markets as it keep a close eye on credit quality and currency strength.
For the three-year period ended June 30, the fund rose an average annualized 13.6%, versus 9.5% for its peers. That put it in second place among global bond portfolios over that time. For the five years ended in June, Templeton Global bond returned 7.7%, versus 6.6% for its peers.
Michael Hasenstab and Alex Calvo are the portfolio’s co-managers. Though the fund began operations in September, 1986, Hasenstab joined the management team in late 2001, and the firm in 1995.
The Full Interview:
S&P: How do you select securities?
HASENSTAB: Our process is research driven and uses rigorous macroeconomic analysis to evaluate growth, inflation, interest rate outlook, and long-term currency strength and valuation. From our research, we identify which countries offer the most attractive value and upside.
We typically insist on debt with high credit in order to minimize risk. We may, however, invest in lower-rated debt as long as we are comfortable that future returns will be significant on a risk-adjusted basis. The fund currently has an average credit rating of AA-. This particular fund does not invest in corporate bonds.
S&P: Where are your largest allocations?
HASENSTAB: On a regional basis, we have about 39.4% of our assets in ‘EMU-Europe’; 15.3% in ‘periphery Europe’ (primarily Scandinavia and the U.K.); 19.0% in the ‘dollar bloc’ (New Zealand, Australia, Canada), 0% in the U.S.; 0% in Japan, 9.5% in Eastern Europe/Africa (primarily Russia, Ukraine, Bulgaria); 8.2% in Latin America (mostly Mexico, Venezuela, Colombia); and 7.6% in Asia (mostly in Philippines, Thailand, South Korea). Our portfolio is spread out over about 30 countries.
S&P: How has your regional allocation changed over the past year?
HASENSTAB: Over the past 12 months, we have been buying up bonds issued by the dollar bloc and Scandinavian countries, as well as some smaller Asian countries like Thailand and South Korea. We have trimmed back some of our European holdings, but we still maintain an overweight position in the euro zone.
S&P: Must you by mandate limit your emerging markets exposure?
HASENSTAB: We have no limits on how much we can invest in the emerging markets. However, we have typically kept a ‘strategic allocation’ of between 15% to 20% there.
Within the emerging markets, we place heavier emphasis on nations with strong fundamentals and good credit profiles, like Mexico and Russia. We tend to minimize our exposure to highly volatile and credit-distressed markets like Argentina and Uruguay.
S&P: Some emerging markets’ debt have been upgraded to investment-grade status (e.g., Mexico, Poland). Any thoughts?
HASENSTAB: Although a number of emerging markets have been upgraded, for the sector, as a whole, credit risk remains highly dispersed with respect to sovereign credit, and sensitive to such elements as domestic political crises, and fluctuations in the global markets, etc. Therefore, country-specific selection and research is extremely important when investing in these markets.
However, an increasing number of cross-over investors have become more comfortable buying emerging markets securities. For one thing, the asset class has grown in size. Ten years ago, emerging markets essentially meant Mexico, Brazil and Argentina, and that was it. Now, you can invest across the globe since the breadth of possible investments has deepened. Also, the investor base has broadened: Aside from hedge funds, we are seeing pension funds, mutual funds, and insurance funds purchasing emerging markets securities.
S&P: What do you attribute the fund’s recent outperformance to?
HASENSTAB: I would cite the strong contribution of our emerging markets allocation. But, more importantly, I would cite our deft country and currency selection among the developed world. For example, we have had an overweight position in New Zealand, which isn’t even in most global bond indices.
We’ve also prospered from having little or no positions in Japanese and U.S. bonds.
S&P: Why do you have no exposure in U.S. bonds?
HASENSTAB: We were buying U.S. Treasuries in early 2002 when yields backed up. But since then our assessment of the U.S. dollar became increasingly negative. Also, we feel that due to relative yield levels, interest rate conditions, and currency valuations, Europe and the dollar-bloc bonds will outperform their U.S. counterparts.
S&P: What is the advantage to investing in foreign bonds relative to U.S. fixed income?
HASENSTAB: In the U.S., interest rates are at 40-year lows, but many central banks around the world are still cutting interest rates. With respect to global treasuries, yields are still significantly higher than what you can earn in the U.S., plus you have a stronger currency. As long as the U.S. dollar remains weak, and U.S. bond markets are in a low yield environment, foreign bond markets should continue to outperform.
S&P: What is the fund’s currency exposure?
HASENSTAB: As of June 30, 2003: euro, 42.1%; U.S. dollar, 18.9%; Swedish krona, 7.8%; New Zealand dollar, 8.1%; and Australian dollar, 6.2%.
S&P: You have a significant exposure to the U.S. dollar when you have no investments in U.S. bonds.
HASENSTAB: Our exposure to the U.S. dollar is through dollar-denominated emerging market sovereign bonds. We have actually scaled back our exposure here by purchasing some euro-denominated bonds issued by emerging market nations like Mexico.
Recently we increased our exposure to such Asian currencies as the Thai bhat and the Korean won. We feel these currencies are significantly undervalued.
S&P: What is your premise for investing in Russian bonds?
HASENSTAB: The political landscape in Russia has dramatically improved under Putin, whose reform agenda has been quite aggressive. That is very positive for long-term growth potential and short-term market sentiment. Russia is in a very unique position for an emerging market economy: They presently have a fiscal surplus, a current account surplus and now a capital surplus. This means that there’s a large supply of dollars and cash in the economy as illustrated by a enormous growth in reserves to about $63.9 billion. This will provide a nice cushion should the Russian oil economy suffer some kind of unforeseen shock.
Moreover, the country’s debt-to-GDP ratio has declined from more than 50% a few years ago to about 30% now.
S&P: Why do you have no exposure to Brazil?
HASENSTAB: Although we are optimistic about the steps the government has taken with respect to tax and pensions reform and debt restructuring, we are not invested in Brazil because we need more tangible guarantees that President Lula’s reforms will be effective and that interest rates will decline. In this fund, we are taking a conservative stance on Brazil.
S&P: But isn’t there high political risk in places like Colombia and Venezuela?
HASENSTAB: Colombia had a dramatic turnaround with the recent election of President Uribe. He can execute bond-friendly measures with respect to fiscal reform, and he has a lot of support from the U.S. to fight drug smuggling and terrorism. Colombia’s political stability has improved, and we felt the market was not crediting them enough for their progress.
Earlier this year, Venezuela was a cauldron of political crises, as exemplified by the oil strike. However, even during all that turbulence, they continued to service their debt. This sent the signal that President Hugo Chavez is committed to keeping debt payments current. Therefore, we felt the market was unfairly penalizing them on the perception of political instability.
S&P: If you have such a conservative investment approach, why invest in Venezuela, which has a credit rating of only CCC+?
HASENSTAB: We are getting good risk-adjusted returns in Venezuela, and our position there is only about 2%-3%. We are taking some risk here, but we feel the projected rate of return in Venezuela is high enough to compensate for that credit risk.
S&P: If the U.S. and global economies rebound by the end of this year, will that spell the end of the bull market for bonds?
HASENSTAB: We think that even if U.S. stocks perform well, foreign currency-denominated global bonds can also deliver strong returns. If the U.S. leads a global economic recovery, certain Asian countries with high sensitivity to the U.S. economy will also perform well.
S&P: If the U.S. dollar unexpectedly strengthened later this year, how would that affect your fund?
HASENSTAB: Our fund definitely benefits from a weak dollar, and we have been positioning the portfolio for a weakening dollar for the past few years. In June, the dollar actually strengthened against the euro, but this was, in our view, a short-term technical phenomena. Fundamentally, on the basis of U.S. current account deficit and trade data, the dollar should remain weak for the long-term.