FYI: Cope & Paste 6/7/14: Reshma Kcpadia
Regards,
Ted
It has been a confusing year for bond investors. The one thing everyone agreed on—that bond prices would fall as investors moved into stocks—turned out to be not, in fact, what happened. Concerns about China's economic slowdown, and the strength of the U.S. recovery, along with geopolitical tension between Russia and Ukraine, have caused investors to flock to the security of U.S. government bonds.
But Michael Hasenstab, who oversees $185 billion as chief investment officer for Franklin Templeton's global bond team, isn't much for knee-jerk security. In the funds he helps run—including the $71 billion Templeton Global Bond (ticker: TPINX), focused on sovereign debt; the $8.6 billion Templeton Global Total Return (TGTRX), which can invest in all kinds of bonds; and the $1 billion closed-end Templeton Global Income Common (GIM)—he has eschewed U.S. government debt for five years.
Hasenstab, 40, has been part of Templeton's bond team since 1995 (except for a short break to finish his doctorate and dissertation on China's financial markets at Australian National University), and took the helm at Global Bond in 2001. He's a true contrarian, buying bonds that most investors are fleeing. Case in point: Hasenstab has become one of the largest holders of Ukraine's debt, though it makes up less than 5% of Templeton's global bond funds' assets.
"Slivers of [China's] banking system are toxic...but it's unlikely we'll see a systemic collapse." -- Michael Hasenstab Photo: Jordan Hollender for Barron's
Over the past decade, Global Bond has returned an average of 9% a year, topping Morningstar's world bond category. But this year has been trickier, and the fund is at the bottom of its category. Hasenstab expects bond-market volatility to rise as central-bank policies around the world part ways after years of being largely in sync. Just this week, the European Central Bank moved into new territory, pushing interest rates below zero to ward off ultralow inflation and protect its fragile economy. That runs counter to the Federal Reserve, which has been winding down its bond-buying, and is expected to raise rates next year. The emerging markets, too, face widely disparate growth prospects—and policies.
Despite all this, Hasenstab warns against being too cautious, saying that bond investors need to invest globally, especially as rates rise over the long term. But he picks his spots carefully—in terms of geography and type of investment. Barron's caught up with Hasenstab by phone at his San Mateo, Calif., office, in between overseas trips.
Barron's: What is the outlook for the bond market?
Hasenstab: We are not expecting a blowup, but yields will rise as the Fed stops buying bonds. Higher yields are also more consistent with economic growth of 3% and inflation of 2% over the medium term. That means core U.S. bond yields will produce negative returns. That's why it's necessary to go global, and be unconstrained by a benchmark.
Where are the biggest opportunities?
Asia outside Japan looks reasonably strong, including Malaysia and Korea. In Europe, Poland and Hungary are benefiting from improving German exports [for which they provide services]. Credit has remained favorable, given their low levels of debt and stronger growth rates, and many have higher short-term rates and undervalued currencies.
What does the European Central Bank's interest-rate cut last week mean for the bond market?
It's in line with our view that global liquidity will remain abundant as the ECB and Bank of Japan continue to print money, even as the Fed tapers. As a result, periodic panic in markets surrounding Fed policy is overstated.
Global Total Return invests in more than sovereign debt. What else do you own in that fund?
With default rates low, companies refinancing, and U.S. growth improving, high-yield U.S. corporate debt is in the sweet spot. It's not as cheap as a couple years ago, but you can get a higher yield, and fundamentals are still good.
Where is the biggest disconnect between your view on the ground and what the market expects?
China. There is an investment slowdown, but it's part of an intentional reform agenda by the government. What's not being talked about is the good investment China is making as it moves tens of millions [of people] from rural areas to cities, requiring large investments in subways, schools, and sewage systems. Investment will be half of what it was in the past, but better quality. That, plus increased consumption, paint a reasonable picture for China's economy. But the market is looking at economic indicators like industrial-production data that have been falling.
China's banking system also worries some investors, especially its "shadow banks," which provide financing outside the regular system, with limited oversight.
Slivers of the banking system are toxic. We'll see some headlines that aren't great, but it's unlikely we'll see a systemic collapse of the Chinese banking system. Some of the wealth-management products that are speculative and unregulated were ill-conceived and should probably go bust. Bigger banks should absorb some third-tier banks.
That all sounds pretty bad.
Shadow banking is small, compared with the whole system. For example, the Bank for International Settlements [a clearinghouse for central banks] estimated shadow banking to be 5% of gross domestic product, compared with 150% in the European Union. China has $4 trillion in reserves and is growing at 7%. They can absorb nonperforming loans. It's when your economy is not growing that you run into problems.
How sustainable is that 7% growth?
It's attainable in the next one to two years because of the Chinese consumer—they are earning more and spending more. Wage costs have been on a double-digit growth path. Bike, car, and TV sales have gone up, and that spending anchors economic growth. Of that 7% economic growth, five percentage points could come from consumption.
Comments
What does the European Central Bank's interest-rate cut last week mean for the bond market?
It's in line with our view that global liquidity will remain abundant as the ECB and Bank of Japan continue to print money, even as the Fed tapers. As a result, periodic panic in markets surrounding Fed policy is overstated.
Global Total Return invests in more than sovereign debt. What else do you own in that fund?
With default rates low, companies refinancing, and U.S. growth improving, high-yield U.S. corporate debt is in the sweet spot. It's not as cheap as a couple years ago, but you can get a higher yield, and fundamentals are still good."