One fund company in particular has bet big on Ukraine in 2013: Franklin Templeton. In light of the recent events, Morningstar’s Fund Research team has therefore examined the potential impact on Templeton’s bond funds covered by the Morningstar Analyst Rating.
In the course of 2013, the US asset manager has increased its total exposure towards Ukraine up to about $5 billion. The company would thus be one of the largest creditors of the central government; some analysts have calculated that Franklin Templeton holds about one third of the total USD denominated public debt of Ukraine.
Is There Room for Worry?
According to Morningstar’s analysts, although they are important figures , they lose significance when compared to Franklin Templeton’s total AUM; in particular, their Global Bond team alone is responsible for approximately $200 billion in assets.
Two of Templeton’s funds are indeed very popular across Europe: the Templeton Global Total Return Fund and the Templeton Global Bond Fund, which have respectively €27 billion and €30 billion under management as of January 2014. In other words, in terms of size these are the largest bond funds currently available for sale in Europe. Moreover, both funds, managed by Michael Hasenstab and Sonal Desai, are among some of the most subscribed across Europe.
It is worth noting that both Templeton Global Total Return Fund and Templeton Global Bond Fund currently have a positive assessment by Morningstar Fund Analysts team – their Analyst Rating is respectively Bronze and Silver.
But How Much are They Exposed, And What are the Risks?
According to the figures published by the firm, the exposure as of end 2013 would be considerable in absolute terms. The total market value of the Ukrainian securities held in the portfolios is more than $1 billion.
However, Morningstar analysts have reassessed this data in context – comparing it to the assets under management. In actuality, the exposure toward the country is close to 2% for both funds bearing in mind that the Templeton Global Total Return Fund had 430 bond holdings in its portfolio at the end of November 2013.
A weight of this kind is generally not very significant for the purposes of the overall performance of a fund. However, there are other considerations to be made. In general, the main risks of the operation can be summarized into two kinds: liquidity risk and credit default risk.
Liquidity risk refers to the situation in which it is difficult to liquidate a position because the number of buyers is reduced during periods of great uncertainty. But this risk is almost cancelled by the long-term strategy of the manager, who is willing to hold the securities until maturity, if necessary. As a matter of fact, a previous Hasenstab’s bet on Indonesian debt eventually required an eight-year investment horizon.
Moreover, our analysts point out that it is not unusual for the managers to hold a significant portion of a country’s debt. In fact, on other occasions the managers have taken a contrarian approach to investing. In 2011, for example, they were among the very few investors to bet on Ireland, putting into practice their macroeconomic assessments with considerable conviction. Their approach is based on macroeconomic views and fundamental valuations, and so far it has been successfully implemented with remarkable discipline.
Hence, the main source of risk is the risk of default, i.e. the actual ability of the issuer to repay the debt at maturity. To give you an idea, over the past days the price of five-year credit default swaps on Ukraine sovereign debt has traded around 1000 basis points (the price of a CDS represents the price paid to ensure a principal against a possible default by the issuer, and is therefore a measure of credit risk; for comparison, the price of a five-year CDS on U.S. government bonds is about 38 basis points).
The message is that this risk is currently concrete. But, even in a worst case scenario, that of a default by Ukraine on its sovereign debt, any loss incurred by the subscribers would be limited, thanks to portfolio diversification. And even so, one should note that the country’s solvency seems to be a priority for both its main trading partners, namely the EU and Russia.
One fund of the same firm that is considerably more exposed is the Templeton Emerging Markets Bond Fund – Silver Rated by Morningstar analysts and co-managed by Michael Hasenstab and Laura Burakreis), whose geographic allocation on Ukraine at the end of January 2014 stood at 9.65%. However, the size of this fund is much lower than its Global Bond peers.
In conclusion, our confidence in the ability of the managers remains unchanged and we do not believe that the recent events are sufficient or decisive reason to change the opinion about the quality of the investment. The position on Ukraine is a relatively small bet for both the Global Bond funds. On one hand this is a risky stance, but on the other hand these securities are carrying a higher yield to maturity than other emerging market securities.
In addition, the risk profile of the funds is in other respects lower than their peers: for example, exposure to interest rate risk is significantly lower than the category average. The managers of the funds have been right on other occasions, showing skills in anticipating market movements, as evidenced by the excellent risk -adjusted performance over the years. In any case, our analyst fund report identifies for both funds a supporting role in a diversified portfolio, suitable for investors who are aware of their inherent risks.
