What’s Scarier?
November 7, 2011

Dr. Jekyll and Mr. Hyde had nothing, it seems, on current market volatility. We’ve all witnessed the substantial gains of one day followed by the vertigo-inducing drops of the next. Say what you will about the importance of maintaining an unemotional, disciplined, long-term perspective, but skittish investors aren’t eager to put money into a sideways market.

That said, with yields plunging to historical lows, investors may not be able to afford to ride out bumpy markets solely in bonds. Some stock exposure seems warranted, though some investors, understandably, want something to take the edge off the volatility.

Enter hybrids. 

Senior Vice President and Director of Core, Hybrid Portfolio Management and Franklin Income Fund Portfolio Manager Ed Perks describes the strategy: 

Ed Perks

Ed Perks

“In our hybrid strategy, we pursue our investment objectives with a very open policy in terms of the asset class mix. So rather than just focusing on income opportunities in fixed income or yield-oriented opportunities in equities, we’re really looking across the entire landscape of equity and fixed income for specific securities that we think are going to best help us meet the investment objective in any market environment.” 

Recent heightened levels of volatility in both the equity and fixed income markets have actually created income opportunities forFranklin’s hybrid strategy. Mr. Perks states:

“Even in this shifting environment, we’re seeing opportunities, including strong performance from some corporate bonds and high-yield bonds, in particular. We’ve also seen tremendous debt-refinancing activity from several companies that we hold—so when money comes back to the portfolio as a result, we look at the broader opportunity set for deployment—that’s largely been dividend-paying common stocks. It has been a somewhat unique time in that we are seeing high-quality companies offer dividend yields actually in excess of long-term interest rates, and that’s quite interesting. We’ve also seen some opportunities in convertible securities.”

The core hybrid team also applies its multi-asset hybrid management model to the Franklin Balanced Fund and Franklin Equity Income Fund. While these funds each feature unique investment objectives, their overall hybrid strategies are similar to the approach applied to Franklin Income Fund. Mr. Perks explains: 

“The Franklin Balanced Fund strategy has more of a balanced approach to total return, so a combination of both income and capital appreciation. It is also aiming to provide a little broader exposure to the fixed-income asset class. One of the real differentiations is a limitation on non-investment grade corporate bonds of no more than 10% of the Franklin Balanced Fund, whereas Franklin Income Fund can have a significant weighting in non-investment grade. The Franklin Equity Income Fund, as the name would imply, is going to be the most equity-oriented of the hybrid funds.” 

Overall, the hybrid portfolio mix is never static and it changes over time. Currently, there is a slight tilt toward fixed income in the Franklin Income Fund, while equities comprise the majority of the other hybrid funds—Franklin Balanced Fund and Franklin Equity Income Fund. Concludes Mr. Perks:

“We’re fully invested and comfortable in today’s marketplace, volatility and all. In general, we’ve seen a decline in our fixed income exposures over the past couple of years, though it is difficult to project where that mix is going to go. We manage on a daily basis. In many instances, when we look at a specific company, we evaluate common stocks, outstanding convertible securities and corporate debt. We look for the broader opportunity, including the possibility of owning a combination of securities in the same company.” 

Until next time, Beyond Bulls & Bears leaves you with this quote from Sir John Templeton:

 “An investor who has all the answers doesn’t even understand the questions.” 



 

What Are the Risks?

Franklin Income Fund

The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. The fund’s portfolio includes a substantial portion of higher yielding, lower-rated corporate bonds because of the relatively higher yields they offer. Floating-rate loans are lower-rated, higher-yielding instruments, which are subject to increased risk of default and can potentially result in loss of principal. These securities carry a greater degree of credit risk relative to investment grade securities. While stocks have historically outperformed other asset classes over the long term, they tend to fluctuate more dramatically over the shorter term. These and other risk considerations are discussed in the fund’s prospectus.

Franklin Balanced Fund

The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. As the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. While stocks have historically outperformed other asset classes over the long term, they tend to fluctuate more dramatically over the shorter term. These and other risk considerations are described more fully in the fund’s prospectus.

Franklin Equity Income Fund

While stocks have historically outperformed other asset classes over the long term, they tend to fluctuate more dramatically over the shorter term. The fund’s investment in foreign securities also involves special risks, including currency fluctuations and economic as well as political uncertainty. These and other risks are described more fully in the fund’s prospectus.

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