Global Bond Funds Hit a Strong-Dollar Headwind

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Global bond funds have been a popular, and largely successful, vehicle for investors large and small in recent years. With the U.S. Federal Reserve maintaining a near-zero interest rate policy, these funds offer a pick-up in yield compared to domestic bonds. And given better fiscal, trade and economic conditions in many foreign countries, they’ve also offered a currency “kicker” — the potential for additional returns through foreign currency appreciation.

However, the recently renewed strength in the U.S. dollar, driven primarily by safe haven demand, has thrown a wrench in the works.

Franklin Resources’ $61 billion Templeton Global Bond Fund A (MUTF:TPINX), for instance, has been this year’s best-selling mutual fund, but investors cashed in and withdrew $487 million in November, its first month of redemptions since November 2008, Bloomberg News reported recently.

Weakness in emerging market currencies has been hurting the fund’s performance recently. In a September article on Franklin Templeton’s website, fund manager Michael Hasenstab explained that the Templeton Global Bond A’s recent underperformance against its peers was the result of “temporary panic and contagion as opposed to fundamental market problems.”

A wide variety of global bond mutual funds — actively managed and passively managed, as well as index and actively managed ETFs — offer investors a slew of risk-return characteristics in form of interest income and capital appreciation. And “global”‘ should mean just that: having the ability to invest in domestic U.S. dollar bonds, as well as home- and foreign currency-denominated bonds of developed and emerging market countries.

Exchange Rate Risk

Investing in foreign currency-denominated bonds entails assuming currency exposure, or foreign exchange rate risk. Global bonds vary as to whether and to what degree they either actively manage these risks, try to hedge them completely or leave them unhedged. A weakening U.S. dollar can boost the total return of a global bond fund substantially. Conversely, a strengthening dollar can significantly reduce returns.

For Templeton Global Bond Fund A investors, it’s been the latter of late. The fund is down nearly 0.9% in the past month, down 4% over the past three months, and down 2.77% year-to-date. Over the past three years, however, it has produced a total annualized return of 10.31%. Morningstar has some good tools for bond investors, so let’s take a look at how Templeton Global Bond Fund A’s performance stacks up.

As a baseline comparison, here’s a Morningstar chart showing how $10,000 invested in TPINX (blue line) at the start of 2002 would have grown compared to the same investment matching Morningstar’s World Bond Category Index (orange line) and the Barclay’s Capital Aggregate US Treasury Bond Index (green line).

Courtesy of Morningstar

Here’s a table comparing 5-year annualized returns for five high performing global bond mutual funds. Hasenstab and Sonal Desai are the fund managers for all three Templeton Global Bond funds.

 

Global Bond Funds’ Annualized 1-, 3- and 5-Year Trailing Returns
Fund 1-year 3-year 5-year
Templeton Global Bond A (TPINX) -1.54% +10.31% +9.01%
Templeton Global Bond C (TEGBX) -2% +9.88% +8.57%
Templeton Global Bond R (FGBRX) -1.78% +12.53% +10.19%
Dreyfus International Bond A (DIBAX) +4.17% +9.04% +9.49%
Dreyfus International Bond I (DIBRX) +4.42% +9.31% +9.75%
Source: Google Finance

The following table drills in and shows TPINX’s monthly per-share returns for 2011 compared to those for Barclay’s Capital’s US Treasury bond index and Morningstar’s International Bond category.

2011 TPINX Barclay’s capital u.s.
Treasury bond index
U.S. Agg Bond
TR USD Cat (IB)
November -3.62 -0.09 -1.85
October +4.89 +0.11 +1.79
September -7.96 +0.73 -3.09
August -1.07 +1.46 +0.18
July +1.30 +1.59 +1.84
June -0.28 -0.29 -0.18
May -0.14 +1.31 -0.30
April +2.85 +1.27 +2.89
March +1.41 +0.06 +0.42
February +1.34 +0.25 +0.79
January -0.59 +0.12 +0.11

Hasenstab has positioned Templeton Global Bond A defensively of late. The fund is holding a large percentage (nearly 44%) of its capital in cash, compared to Morngingstar’s World Bond category average of 13.96%. More than 47% of its holdings are in government bonds, versus a category average of 39.77%. Of the total bond holdings, 58.63% are bonds in the shortest (1 to 3 years) maturity range. That compares to a category average 17.29%.

Staying the Course

Templeton’s Hasenstab believes investors are being too skittish, and that they’re overestimating the risks posed by the EU debt crisis and the economic slowdown in China. He’s holding fast to the research-driven, fundamental strategic view that has held up very well for the fund’s investors over the longer term despite its recent underperformance. Hasenstab maintains that bond markets outside the U.S., EU and Japan offer investors the most attractive investment opportunities.

“On a long-term basis, we continue to find value in a lot of currencies outside of the U.S., outside of Europe, and outside of Japan. So places such as Sweden, Australia, Korea, and Norway, a lot of countries where conditions are better, we think their currencies will benefit,” Hasenstab wrote in Franklin Templeton’s Oct. 31 Global Market Outlook.

“We are finding a lot of opportunities in emerging markets, which are experiencing stronger growth. They don’t have [many of] the leverage problems that we have in the developed world. And we’re also remaining very defensive on interest rates.”

Hasenstab and team’s analysis and portofolio management have proved very successful over the long term. Past performance is no guarantee of future returns, of course — as all investment prospectuses and recommendations note. Hasenstab has taken a contrarian view, making the call that current risks are overblown and that an all-out credit crisis and global recession along the lines of 2008-2009’s meltdown won’t reoccur. Others are not so sanguine.


Article printed from InvestorPlace Media, https://investorplace.com/2011/12/global-bond-funds-hit-a-strong-dollar-headwind/.

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