Templeton Emerging Markets Bond Fund and Templeton Global Bond Fund are managed by Franklin Templeton Investments and represented in Malta by MeDirect Bank (Malta) plc.
Bonds issued by a select group of the world’s strongest emerging markets offer an attractive way to benefit from their growing success.
Today we think of Japan as one of the world’s most advanced economies. But its rise to riches is surprisingly recent: in 1960, Japan’s entire economic output was worth just over $44bn in today’s money, according to World Bank figures, while the US economy was hugely larger at $543bn1.
Fast-forward less than two generations, to 1993: Japan’s output had soared to more than $4.4 trillion – 100 times its size in 1960 – while the US economy was a little less than 13 times bigger, at $6.9 trillion1.
There are few more striking examples of a country moving from emerging to developed status than Japan’s extraordinary rise after the second world war – and it is that potential for countries to accelerate their growth and transform their fortunes that makes today’s emerging markets such a focus of interest for investors.
Japan’s story is striking, for sure, but emerging markets (EMs) are all very different: they move at different speeds, they can go backwards as well as forwards, and “economic miracles” like Japan’s are exceptional.
Faster growth and less debt
However, looking around the world today it is clear that many EMs – countries at different stages of the journey to developed-world status, such as China, Brazil and Argentina – are growing considerably faster than regions such as Western Europe, North America or indeed Japan, now firmly in the developed camp. In 1980, EMs accounted for 37% of world economic output. By 2017 that had soared to 59%.2
As well as enjoying faster economic expansion, the strongest of them have better economic underpinnings, with smaller levels of debt for example, and yet they offer investors significantly higher interest rates than much of the developed world has had since the financial crisis a decade ago.
This means that investors who put a portion of their money into well-managed emerging economies have an opportunity to earn a higher yield than they can in developed markets. In addition, they may also benefit from the improving economic outlooks and higher growth rates that emerging markets countries can potentially offer over the long-term.
Focus on EM government bonds
Calvin Ho, Portfolio Manager and Director of Research for Templeton Global Macro argues that one of the best ways to approach the opportunities in emerging markets is to invest in government bonds issued by a select set of economically strong or improving countries.
“We’re looking for countries with stable institutions, resilient economies and good domestic demand,” he explains. “At the moment we see specific countries that are in the midst of important economic transformations, notably Brazil and Argentina. The valuations in those countries appear underappreciated by investors – the risk-adjusted yields are quite compelling.”
“Brazil, for example, has come to the end of a decade of heavy state control of the economy and is turning around. We can see a political will there not to repeat the policy mistakes of the past.”
The rise of local-currency bond markets
Two of Franklin Templeton’s bond funds – Templeton Emerging Markets Bond Fund and Templeton Global Bond Fund – concentrate on so-called sovereign bonds (those issued by governments). Twenty years ago, emerging market governments predominantly borrowed in “hard currencies,” mainly the US dollar, because local capital markets were less developed, and access to international capital was more readily available to EMs through the hard-currency markets.
However, over the past two decades, the picture has changed radically. Today, many emerging markets have reformed and strengthened their economies, while substantially expanding their local-currency financial markets. As a result, international investors are no longer limited to hard-currency bonds. In fact, the local-currency EM debt market is now eight times the size of the hard-currency market3.
Local markets also tend to be more liquid than the hard-currency markets, because there is more domestic buying support to step in and buy bonds when foreign investors may be broadly exiting. The ability to issue local-currency government bonds also tends to correlate with a higher credit quality for a country. Countries with stronger financial conditions tend to be less dependent on the hard-currency markets to raise capital. This is an important advantage for countries trying to avoid taking on external (hard-currency) debt that would get more expensive to repay if their own currency should fall in value against the US dollar, for example.
Why specialist expertise is critical
International investors must still factor currency risk into their calculations, however. This is where the expertise of a well-resourced fund manager with long experience in the field becomes indispensable. Managing the risks of currency fluctuations – and positioning the fund to benefit from favourable changes – is a key concern for Franklin Templeton’s bond fund managers.
Some investors are tempted to buy an index fund to gain exposure to EM bonds, but this approach often sees investments split between countries improving their performance and others that are going backwards. In EM bonds, it is often better to avoid tracking an index and to instead invest very selectively in a group of countries that are going through a positive transformation.
Templeton Global Macro’s analysts travel extensively to countries to see for themselves the steps that policymakers are taking to accelerate and strengthen their countries’ development. The team says it is looking for orthodox economic policy and sound management by an independent central bank. “Right now,” says Mr. Ho, “we see a select subset of countries that are doing the right things from a policy perspective and have positive patterns emerging, but it remains important to be highly selective and active within the asset class.”
What are the risks of investing in Templeton Emerging Markets Bond Fund?
The value of shares in the Fund and income received from it can go down as well as up and investors may not get back the full amount invested. Performance may also be affected by currency fluctuations. Currency fluctuations may affect the value of overseas investments. There is no guarantee that the Fund will meet its investment objective.
- The Fund invests mainly in debt securities of any quality issued by entities located in developing and emerging markets. Such securities have historically been subject to price movements, generally due to interest rates, market factors or movements in the bond market. As a result, the performance of the Fund can fluctuate over time.
- The Fund may distribute income gross of expenses. Whilst this might allow more income to be distributed, it may also have the effect of reducing capital.
- Other significant risks include credit risk, derivatives risk, emerging markets risk, liquidity risk.
For full details of all the risks applicable to this Fund, please refer to the “Risk Considerations” section of the Fund in the current prospectus of Franklin Templeton Investment Funds.
1. World Bank national accounts data, and OECD National Accounts data files. Data in US dollars. 2. IMF, World Economic Outlook, October 2018. 3. Bank for International Settlements, Institute of International Finance.
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An investment in the Fund entails risks which are described in the Fund's prospectus and the relevant KIID. The value of shares in the Fund and any income received from them can go down as well as up, and investors may not get back the full amount invested. Past performance is not an indicator, nor a guarantee of future performance. When investing in a fund denominated in a foreign currency, performance may also be affected by currency fluctuations. Where a fund invests in emerging markets, the risks can be greater than in developed markets. Where a fund invests in derivative instruments, this entails specific risks that may increase the risk profile of the fund and are more fully described in the Fund’s prospectus and in the relevant KIID.
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