By Matt Wirz and Tom McGinty 

When oil prices collapsed late last year, the $83 billion Franklin Income Fund suffered mightily, losing more than $2 billion on its energy-company investments.

Ed Perks responded as portfolio managers at Franklin Templeton often do: He doubled down, purchasing $2 billion more of energy-sector junk bonds.

So far, the trade is a bust. Stock and bond prices declined further this summer as oil dropped. In August, fund investors pulled out about $1.47 billion, the biggest departure in the fund's 67-year history save for October 2008.

The bond market has transformed immensely since the financial crisis.

Investors have piled into bond mutual funds in record numbers, while low interest rates compelled the funds to buy riskier securities to deliver income. Meanwhile, banks have retreated from trading, reducing their stockpile of bonds by more than two-thirds from the precrisis high.

That makes it harder for mutual funds to buy and sell bonds, which they now own in record amount. Mutual funds owned 17% of the $7.8 trillion corporate-bond market in 2014, up from 8% of the $5.4 trillion market in 2008, according to data from the Securities Industry and Financial Markets Association and the Investment Company Institute.

Across the industry, there are 10 bond mutual funds managing more than $40 billion today, up from two in 2010, according to data from Morningstar. Franklin Resources managed $867 billion at June 30, up from $507 billion in 2008.

When central bankers start lifting interest rates, bond prices will fall and bond funds will take losses, says Markus Brunnermeier, an economist at Princeton University who specializes in financial crises. The biggest danger for mutual fund managers will be "run risk" of mass shareholder redemptions, and funds with high concentrations of illiquid securities will be the most susceptible, he says.

The question for Mr. Perks and other large fund managers is this: Can they avoid painful losses from liquidations when those outflows hit?

Deep roots

The Franklin Income Fund is one of the oldest and most storied funds in America. It has been among the strongest performers in its mutual-fund category, returning an average of 6.8% a year since 2000 by investing in a shifting mix of stocks, bonds and other assets. It has paid a dividend every month since 1948.

But the fund lost 10.2% over the past 12 months because Mr. Perks concentrated about 20% of its portfolio in energy stocks and bonds. After adding $20 billion into the fund from 2009 to 2014, investors have pulled out about $3.8 billion during 2015, according to data from Morningstar Inc. Analysts peppered Franklin executives about losses from the fund on a June conference call and the stock of parent company Franklin Resources Inc. has declined 30.5% this year.

Mr. Perks says the fund will manage the redemption wave as it has others throughout its history.

In July, investors withdrew $776 million from the fund and the 45-year-old fund manager sold short-term junk bonds at high prices, boosting the cash portion of the portfolio to 6.72% from 1.98%. When stock-market turmoil--and outflows--increased in August, he spent cash on redemptions and on buying hundreds of millions of dollars of stocks he considered cheap. Investors in the fund lost 4% in August, compared with a 2.7% loss for investors in comparable funds, according to Morningstar.

"How we manage these periods coming out of volatility has a lot to do with our historical success," Mr. Perks said. "We don't stick our heads in the sand and hope everything turns out OK.

Big in 'junk'

Franklin Income Fund owns about $25 billion of high-yield, or "junk" securities, more than any other mutual fund. Mr. Perks says he had no problem selling junk debt in August and that his portfolio also holds large quantities of easy-to-trade stocks.

About 21% of the bonds the Franklin Income Fund owned as of March 31 might not have been sellable within seven days--based on the average daily trading volume of the bonds over the first six months of the year, an analysis by The Wall Street Journal of MarketAxess data shows. The data aren't a comprehensive measure of liquidity but they give some indication of what assets might be tough to sell in a market panic.

Franklin disagrees with the Journal's analysis: "Fund liquidity is measured, pursuant to SEC guidelines," a firm spokeswoman said in an email. "On that basis, as of Aug. 31, 2015, 0.14% of the Franklin Income Fund's portfolio constituted illiquid securities."

Franklin monitors concentration and liquidity risk with a team of 100 risk-management professionals, says Wylie Tollette, who built the department and now runs risk management for the California Public Employees' Retirement System. The team calculates fund performance, dissects how much in losses and gains come from active investment decisions versus from broader market moves, then analyzes the risk in each fund.

"It took about 10 years and a lot of resources to develop that, but the firm was very committed to it," Mr. Tollette says.

Much of Franklin's success comes from an unusual willingness to hold on to losing trades and turn them into winners. Mr. Perks, a former football place kicker nicknamed "Steady Eddie" by teammates at Yale University, credits Charles B. "Charlie" Johnson, the man who led Franklin for 56 years, for much of his sangfroid.

Family legacy

Although publicly listed, Franklin remains controlled by its founding family, the Johnsons of Hillsborough, Calif. Charlie Johnson took Franklin over from his father in 1957, when it managed $2.5 million, and ran it until 2012, when he handed over the reins to his son Greg Johnson.

Charlie Johnson stressed frugality, civility, hard work and innovation at the firm and launched it into the investment big leagues. He grew so wealthy he is now the principal owner of the San Francisco Giants. Mr. Johnson, also a former Yale football player, donated $250 million to the school in 2013, its largest gift ever.

"He's the opposite of a meddler," says Larry Baer, president of the Giants, about Mr. Johnson. In sports, he said, "you have your George Steinbrenners who want to be into everything--that's not Charlie."

Staying calm

Mr. Perks fit into the down-to-earth culture. Despite buying stocks and bonds in hundred-million-dollar chunks on Wall Street, he rarely wines and dines, preferring to leave his office in San Mateo, Calif., by 4 p.m. to coach his childrens' baseball and soccer teams.

The son of a Brooklyn firefighter, Mr. Perks grew up in Levittown, Long Island, and joined Franklin's management training program in 1992 right out of Yale.

He arrives at work at 5:30 a.m. to prepare for the open of markets in New York, and executives from the companies he invests in often drop by. Last week the CEO of Royal Dutch Shell--Franklin is the third largest shareholder, according to Capital IQ--paid him a visit.

"I taught him to be opportunistic, to not necessarily go with the crowd, " Charlie Johnson says of Mr. Perks.

While Mr. Perks sold some bonds in the recent oil downturn, he purchased more than $1 billion face amount of debt between Energy XXI Gulf Coast Inc., Halcon Resources Corp. and Linn Energy LLC, often at deep discounts.

In some cases he exacted a price for his support.

In July, Linn Energy LLC announced that it would suspend stock distributions to build cash that could service debt payments, sending its stock tumbling by 48%. It is an approach Mr. Perks encouraged. "We've been engaged with management on that," says Mr. Perks.

Some of the bonds trade at half of what he paid, but Mr. Perks says he is fine waiting for higher commodity prices.

Ten years ago, higher natural-gas prices helped sink the value of bonds he held in electricity producer Calpine Corp. Distressed-debt investors called hoping he would sell them the bonds but instead he bought still more, and later profited when gas prices fell again.

Now hedge funds are calling anew, trying to buy his energy bonds. His response is the same. "When we have investments that become distressed, many market participants automatically assume we're going to sell but that's not how we do things."

Write to Matt Wirz at matthieu.wirz@wsj.com and Tom McGinty at tom.mcginty@wsj.com

 

Subscribe to WSJ: http://online.wsj.com?mod=djnwires

(END) Dow Jones Newswires

September 21, 2015 11:34 ET (15:34 GMT)

Copyright (c) 2015 Dow Jones & Company, Inc.
Franklin Resources (NYSE:BEN)
Historical Stock Chart
From Feb 2024 to Mar 2024 Click Here for more Franklin Resources Charts.
Franklin Resources (NYSE:BEN)
Historical Stock Chart
From Mar 2023 to Mar 2024 Click Here for more Franklin Resources Charts.