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.
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