Income & growth

When a client’s primary goal is income from their portfolio, there are a number of options to choose from: dividends are popular because of the favorable tax treatment that many now enjoy, but with interest rates creeping up from what were historically low levels there are opportunities there, too. And what of capital growth? Does an income-producing portfolio have to rule out capital growth? Not necessarily, says Edward Perks, senior vice president of San Mateo, California-based Franklin Advisors, and co-lead portfolio manager of the $25.2 billion Franklin Income Fund (FKINX): “I jokingly say they should think about it as ‘INCOME’ in capital letters, and ‘growth’ in lower case letters. I think it’s one of the things that really differentiates our style and our approach.”

Under the leadership of Perks and Charles B. Johnson, chairman of Franklin Resources and manager of this fund since 1957, the fund has achieved a consistent and impressive record, receiving Standard & Poor’s highest ranking of five stars overall and in the one-, three-, five- and 10-year periods. As of July 31, the fund had 10-year annualized total returns of 9.54% versus 5.45% for its Hybrid U.S. Income peer group; and five-year annualized total returns of 10.07% versus 3.67% for its peer group. If one had invested $10,000 in this fund on its August 31, 1948 inception date, and had reinvested all capital gains and dividend distributions, as of June 30 that holding would hypothetically be worth $4,011,723.

How much money do you manage in the Income portfolio?

The Franklin Income Fund is up to about $44 billion. We have five income-related funds that I lead-manage and the total is about $49 billion; there are three Franklin portfolios and two sub-advised portfolios. My lead management roles are limited to the Franklin Income strategies as well as the new Franklin Balanced Fund. I also oversee the hybrid group within the Franklin Equity Group, given the hybrid nature of these products, which also includes our Convertible Securities Fund, which is a little over $900 million.

What makes the Income Fund different from its peers?

The primary difference is the commitment that we’ve had to maintaining stable, attractive income. If you look at the Income Fund’s distributions, they’re monthly. It’s consistently in the top decile of its peer group from a distribution standpoint. We seek to maintain stable distributions and that’s reflected in a lot of ways. Despite a significant amount of interest rate volatility over the last 10 years, the Income Fund’s distribution has changed only three times.

Would you tell me about your investment process?

It’s highly flexible, and that’s the real key to our historical success–we have a significant amount of resources that we can deploy to look across a very wide range of asset classes: on the equity side, predominantly common stocks, but also the ability to actively participate [in] the convertible securities market, leveraging off of our expertise in that area; on the fixed-income side everything from government, agency, and mortgage-backed securities, where we have a very strong, dedicated group, all the way into the credit universe from investment grade corporate credit down into non-investment grade corporate credit. The process is really to be very open-minded. We don’t manage from a top down basis running screens; we really try to leverage the research, and leverage what the investment professionals in their unique areas are doing. Then it’s my job to evaluate the relative attractiveness of one opportunity to another in helping us meet the objectives.

Will the return of the 30-year Treasury have an effect on the portfolio?

It’s a little bit of a non-event, to the extent that it increases supply and potentially moves interest rates up a little bit. Certainly that kind of action can have an impact on a portfolio. In general, the way we’ve been positioned–the Income Fund portfolio’s changed over the last year; it’s changed fairly significantly and normally we don’t have these kind of changes, so it’s kind of a timely conversation. In general, I’ve been about the happiest guy in the building to see interest rates moving up.

It was a very difficult environment a year ago–we were flirting with below 4% yields on the 10-year Treasury; we generally had a very strong period in corporate credit, meaning credit spreads in the corporate universe had tightened significantly, and we were somewhat idea-constrained. Actually, if you look at June 30, 2005, we had about 8% cash, which is a pretty high cash balance for us. Fast forward to today, we’re down, generally, in the 1.5% range on cash, we’ve had much better opportunities with the back-up in [interest rates for] Treasurys, and a little bit of volatility in corporate credit spreads. We think fixed income has become, overall, much more attractive. To the extent that you have dynamics like that playing out in the Treasury market, we can take advantage.

So you’ve had more opportunity to pick and choose?

A year ago (June 30, 2005), we were very equity-tilted, and when I talk about equity or stocks in the portfolio I’m really talking about common stocks, convertible preferred stocks, and any straight preferreds that we may own–we were up at close to 53% of the portfolio. The flip side of that–the bond side–we were very idea-constrained, and having a difficult time justifying the exposure, certainly our view was somewhat negative on interest rates particularly when we were down below 4% on the 10-year. We’d gotten down below 40%, [to] 39.2% in total fixed income, and within that virtually all of our exposure was geared toward corporate debt; we had about 4% in mortgage-backeds, so we were very credit-oriented. Fast-forward a year to June 30, 2006, we’re actually much more balanced; in fact, we’ve actually flipped to the point where bonds actually exceed our stocks. Our [allocation to] stocks [has] declined about five percentage points down to just below 47%, bonds are just below 52%, and the cash is at 1.7%, so [it was] quite a swing.

Can you talk about some of your largest holdings?

Chesapeake Energy (CHK) is one of our larger positions that we’ve added recently–meaning in the last year.