With political impasse hanging over deficit reduction efforts in the U.S. and Europe’s sovereign debt crisis continuing to cast its long shadow over markets at home and abroad, it would seem that “debt” has joined the ranks of four-letter words not used in polite company. Given that repute, investors might be surprised to hear Franklin Strategic Income Fund Portfolio Manager Eric Takaha cast debt in a positive light:
“First of all, I’d say debt, used prudently, can actually be a positive, whether it’s for an economy or a corporation. It allows them to invest in their businesses and grow over time. When our investment team thinks about debt, whether it’s for a sovereign country or an individual corporation, we think about how that entity approaches use of debt, if they are doing so in a prudent fashion, or if they are getting overly aggressive.”
In volatile times when entire asset classes can be painted by the same broad brush, it’s especially crucial to be rational and disciplined in selecting investments. Identifying a good investment opportunity entails more than just an analysis of the basics, such as cash flow and margin. As Takaha points out, the strategic direction of a company’s overall industry and how a company positions itself for growth bear careful and thorough scrutiny:
“When we look at an individual opportunity, whether it’s a high yield or investment grade company, we look very closely at its mission. Are they looking to expand gradually or grow very rapidly? Are they looking to do things that might favor shareholders over bondholders? Then we spend a lot of time examining the industry and its strategic direction over time. We have a very large group of analysts, both on the sovereign side and the corporate side, who really dig into these situations and keep us well positioned to potentially uncover those opportunities that, over time, should be moving in the right direction.”
Peeling back the layers of data can be as daunting as it is fascinating, though. Where do you start? If you’re Mr. Takaha, you begin with Franklin Templeton’s Fixed Income Policy Committee, which meets every week to determine which sectors they deem to be offering the best values. From there, individual teams examine current positioning and overall exposure to various market sectors:
“We’re able to leverage the expertise of all the different senior folks from each of the sector teams when determining allocations. Once we have a decision for a given sector, we go back to the research teams and say, hey, what are some of your best ideas for individual securities to populate the portfolio?”
But what about those of us without hallway access to teams of analysts? Facing wave upon wave of media-reported alarms, what’s a holiday-harried investor to think? Takaha’s take:
“Unfortunately, I think the headline noise is going to continue. The good news is that even with all this noise and even with the fairly weak economy that we had in the first half of this year, a lot of the investments that we’re looking at, particularly on the credit side, have chugged along in terms of their fundamentals. What we’re trying to do is separate out some of the market noise from the fundamentals and see how it all plays out over the coming months. We think that by continuing our focus on the fundamentals of individual securities, as long as they continue to be fairly supportive, we’ll continue to find good, long-term investment opportunities.”
Until next time, here’s a side dish of Sir John Templeton wisdom to chew on:
“The most costly errors in selecting stocks are made by people whose thinking is dominated by the question of the temporary short-term trend of earnings.”
WHAT ARE THE RISKS?
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. High yields reflect the higher credit risks associated with certain lower-rated securities held in the portfolio. Floating-rate loans and high-yield corporate bonds are rated below investment grade and are subject to greater risk of default, which could result in loss of principal—a risk that may be heightened in a slowing economy. The risks of foreign securities include currency fluctuations and political uncertainty. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Investing in derivative securities and the use of foreign currency techniques involve special risks as such may not achieve the anticipated benefits and/or may result in losses to the fund. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. The fund is actively managed but there is no guarantee that the manager’s investment decisions will produce the desired results. These and other risk considerations are discussed in the fund’s prospectus.