| Franklin Templeton Investments CIO of global bonds Michael Hasenstab |
If the world doesn’t think Michael Hasenstab, chief investment officer of global bonds at Franklin Templeton Investments, is making a big mistake — at least some of the time — then he’s not doing his job. That’s Hasenstab’s own view of what it means to be a contrarian investor, a mind-set that led him to break out of running a stable of very successful bond funds to launch a hedge fund.
It’s not as if Hasenstab has lacked investing flexibility during his time at Franklin Templeton. He’s one of the pioneers in managing unconstrained bond funds, which allow the active shifting of portfolios among all types of fixed-income asset classes. As a portfolio manager of the Templeton Global Bond Fund, the Templeton Global Total Return Bond Fund and similar institutional strategies at San Mateo, California–based Franklin, Hasenstab has done very well turning left when the world was turning right.
His $71 billion Templeton Global Bond Fund has returned an average 8.24 percent annually over ten years, a feat that made it No. 1 in the world bond category as of January 24 of this year. Hasenstab has made some bold bets over the years. In 2011 the Global Bond Fund became one of the largest private holders of Irish sovereign bonds (the fund now has 9.55 percent of its assets in the bonds), taking advantage of the panic over the euro zone to buy the securities at bargain-basement prices in the secondary market. As the situation stabilized, Hasenstab started investing new money and directly lending to the Irish government, certain the country was only experiencing a short-term liquidity shortage. The bet ultimately paid off as Ireland began to turn itself around, though some investors left the fund in early 2012 after some short-term underperformance convinced them the risks were too high. The fund has done similar trades in Hungary, and Hasenstab now thinks the world is too bearish on South Korea, a country he feels has good growth in front of it.
In October 2010, Hasenstab launched a hedge fund, Global Summits Fund; he is an avid climber who scaled Mount Everest last year, hence the name. The hedge fund now has about $500 million in assets and takes an approach similar to that of the Global Bond Fund, though with a broader mandate that includes the ability to short securities and invest in frontier markets. According to a letter obtained from a fund investor, Global Summits has returned 9.67 percent annually since inception. Hasenstab continues to manage both the hedge and bond funds.
Hasenstab, 40, did not feel drawn to investing growing up in Washington State. As an undergraduate at Carleton College in Minnesota, then as a master’s candidate at the Australian National University, he studied political economy, international relations and the economics of development, hoping to work either at the U.S. State Department or the World Bank. But first he needed experience in the private sector. In 1995 he entered Franklin’s management training program. He put his plans for the World Bank on hold after he joined the high-yield bond group, doing emerging-markets sovereign analysis. “I never looked back,” he says.
But Hasenstab emphasizes that the break with his academic pursuits is more apparent than real. The type of investing he’s interested in involves the intersection of political science, economics and the markets. “It’s similar to public sector economic policy, but it has a more immediate tangible outcome, and that was what really excited me,” he says.
Hasenstab took a leave of absence from Franklin to earn his Ph.D. in economics from Australian National, then returned in 2001 to work on the Global Bond Fund. He believes portfolio managers need the ability to be nimble as investors try to preserve their wealth in a world where central bankers have pushed most rates to zero. “As we look forward over the next, frankly, five years to an environment that will be very different from the past ten, an unconstrained, truly global approach is absolutely critical,” he says. “You need to really minimize interest rate risks and exploit opportunities in currencies and emerging markets.” Hasenstab adds: “Ten years ago a lot of people looked at us as if we had two heads. Now everybody is trying to roll out unconstrained funds.”
Alpha Contributing Writer Julie Segal recently talked with Hasenstab, discussing his strategy, why he wanted to run a hedge fund and the future of fixed income.
Alpha: You’ve been running the Templeton Global Bond Fundsince 2001. Why launch a hedge fund?
Hasenstab: We wanted to zero in on a couple of opportunity sets that were not available to us because of the size and regulatory restrictions of either a mutual fund or an institutional account based off that approach. I also wanted to get more flexibility by decreasing the size of the fund. At the same time, I wanted to make certain types of investments that you can do in a hedge fund vehicle that just are not appropriate for the risk-return profile of the Global Bond Fund.
What new types of investments intrigued you?
First was to move into some new niche frontier markets that are exciting but too small and not really appropriate for a large fund such as the Global Bond Fund. Many of the opportunities we were seeing in some of these frontier markets through our travels looked really interesting, but there wasn’t a home for them. So we wanted something that could navigate that: a speedboat that could move in and among those markets.
Second, we wanted the flexibility of the short side. Obviously, any currency investment by definition is a long-short pair. We had used a lot of swaps, basically short exposures, in the Global Bond Fund for hedging purposes, but they were limited to that. We wanted a strategy that could go beyond that and look to directionally make money more specifically on a rising interest rate environment — not just hedge interest rate risk but actually position the fund to make money on rising rates.
The third area I was interested in was moving into different parts of the capital structure — not just government bonds but quasisovereigns or corporates in markets that may not have a developed government market. This is a very different risk-return profile.
The hedge fund has attracted both high-net-worth and institutional investors, particularly endowments. What kind of feedback are institutions giving you abouta hedge fund with such a flexible mandate?
It’s funny. It reminds me a lot of when we first started talking about the Global Bond Fund institutionally. People didn’t know what box to put it in. It’s the same thing now with this strategy. Some people will put it in global macro; some will say, “No, it’s absolute return.” Others will say it’s emerging markets because the fund does have a big stake in emerging and frontier markets. It just doesn’t fit in that really nice, neat box. But if you’re concerned about the box, then maybe the fund isn’t the right fit.
Walk us through a trade you’ve done in the funds.
Japan has faced the issue of deflation for decades, and the solution of inflation targeting — printing money to help lower real interest rates by changing inflation expectations — was well understood. However, it was never implemented because of opposition from the powerful Ministry of Finance and some factions within the Bank of Japan. But suddenly, there was interest to pursue quantitative easing, and I started searching to find the reason why after all these years Japan would make such an about-face and start printing. Then, on one country visit, it clicked: The country was running out of money. The aging population was starting to deplete their savings, trade surpluses were turning to deficits, and massive debt levels combined with low nominal yields made the government debt unattractive to foreign investors. As a result, Japan would have to find a new source to finance its massive stock of debt and fiscal deficits. QE was the answer, partly desirable to help stimulate growth but more importantly to finance government budget deficits. It became clear that if QE had consensus among major constituent groups within Japan’s policymaking structure, the outcome would be large Japanese yen depreciation.
What trade did you implement as a result?
A short yen position versus the U.S. dollar would be the way to profit from the change in policy direction. Furthermore, this position was consistent with our view that U.S. yields would go higher and a larger interest rate differential between the U.S. and Japan would drive the yen weaker. The short yen trade thus also allowed us to hedge against the risks of rising U.S. yields.
How do you navigate running both a hedge fund and a long-only strategy?
A lot of our global macro thinking will frame our view on the world, and then it’s really just a question of the implications: for example, our view on Chinese demand for commodities or QE or the effect of money printing on global inflation. All those things will have a direct investment implication for some of the countries in Global Bond that we’re invested in, such as Malaysia, which is a huge palm oil exporter to China. The answers to those questions will also have investment implications for the hedge fund, as some of our frontier markets that may be in Africa are going to be recipients of investment coming from China and have resources that China needs. The difference between the two strategies is the application of a thesis. The magnitude of the execution will be different, and the instruments we use may be slightly different between the two strategies, but the thesis would be the same.
Is your time frame longer in the hedge fund?
I would say it does lean toward being longer. But frankly, it’s long in both. One of our core beliefs and one of the factors of our success is that we have always taken a longer-term horizon than most. It may be that in some of these frontier markets you might extend it out a little bit further, but we’ve also done that in the Global Bond Fund. We’ve often had a three- or five-year investment horizon.
Everyone knows good investors need to be contrarian.But that’s easier said than done. How do you do it?
Yes, no one goes out and says, “We follow the herd.” I think one of the ways or one of the prerequisites to do it is being in a corporate culture that values and believes in the long term. If we were judged month-to-month, quarter-to-quarter, we wouldn’t have the luxury of being long-term. Without that you can’t be contrarian because you can’t pick the exact timing of when your trades will work out.
Do you ever question your decisions?
Yes! If it feels easy, then you’re not being contrarian. It has to almost feel uncomfortable, where you second-guess yourself three or four times and think to yourself, “Everyone believes I’m wrong.” That’s not an easy process to go through. You can only go through that if you’re in a corporate culture that values that.
What else leads to investment success?
If you’re really focused just on research, then a lot of these things become easier. You’re not focused on what the day-to-day moves are. You’re focused on “Is this fundamentally a good story or a bad story?” That was us with Ireland, for example. We sat down and we knew the market was messy and there was a lot of noise, but at the end of the day our fundamental research said this is going to be money good and we just need to step in.
Another example is Turkey. For years we were wrong because the market just kept rallying and rallying, and we said, “We just don’t feel good about the policy mix.” And then, sure enough, it kind of unravels. So if you can focus your attention and the debate and the internal discussions really on research, I think that helps.
What are opportunities for credit hedge funds and even the Global Bond Fund now that the financial system is regulated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and similar rules around the globe?
For us I don’t think the Dodd-Frank regulations really changed anything. What probably has changed in terms of the landscape is the less plentiful leverage in the system and the higher cost of that leverage. Now, we’re not using that. We have implied leverage in the hedge fund in some of our positions, but we’re not going out and borrowing money.
Some of the regulatory changes and capital adequacy requirement changes have affected some of the markets’ short-term volumes and the amount of liquidity that some broker-dealers can provide. And I think some in the hedge fund community relied very heavily on high-volume trading. That’s not us. We’re making a strategic investment in a country for three years, so really we’re looking for very different sources of liquidity. In many cases the liquidity that we’re getting comes domestically from a country as their pension funds and banking systems develop. It doesn’t come from the New York or London broker-dealer communities. The landscape is changing, and I think it does have winners and losers. We’ve been fortunate that it really isn’t hitting us.
So liquidity is actually increasing in some of the securitiesyou’re invested in?
Yes, because of domestic financial development, including the introduction of pension schemes and pension funds in some countries. The growth of local mutual funds, banks and financial systems also is part of that path. Because of all that, liquidity has actually been growing in places. Whereas liquidity has been shrinking in New York.
Are there also opportunities now that the banks’ proprietarytrading desks are not competing for some of these deals? Or is that also a different game?
I think to some extent, yes, there are cases where deals would have gone on the balance sheets of banks that are now being passed on to the market because the banks don’t have the balance-sheet capacity to take them. That is true.
You’ve been running an unconstrained global bond fund for years, but now many fixed-income managers feel they need to move among different sectors and regions. What are the challenges?
Well, let’s take the global part of unconstrained. It’s not as simple as hiring a bunch of people in different parts of the world. It’s the learning curve. We’ve been doing this as part of a global bond strategy for decades, as a firm for over 50 years and operating with a 24-hour trading day all over the world. It takes a lot of time, going through some mistakes. We’ve gone through all the major financial crises in the emerging markets and survived. You learn a lot through those experiences.
What about the more pedestrian aspects of that, like operating and doing business in remote and undeveloped countries?
We were one of the first funds to invest in Korea. And let me tell you, that was a headache just settling trades and dealing with regulatory issues. Now when we go into a new frontier market — say, in Africa — we have the infrastructure in place. We already know how to settle trades locally. We don’t have to go through total return swaps in New York. We can go right to the source. And that’s something we learned after decades. A lot of investors, when they do want to go global, don’t have that legal or operational infrastructure to actually deal locally, so they’re forced to go to a New York bank for a total return swap that is expensive and not liquid. We were fortunate to be able to leverage what Templeton had pioneered on the emerging-markets equity side as well.
What about the ability to manage a portfolio withoutthinking about tracking error, which many say will be a necessary skill going forward?
I think a tracking error manager and a non–tracking error manager just have a different way of looking at the world. And so when one tries to do the other or the other tries to do the reverse, it’s a philosophical change.
What’s the big theme for the hedge fund?
To hedge against global inflation for which the seeds are being sown because of all this loose liquidity. So we look for countries rich with commodities, an asset that can actually hold value over time. And then it’s a question of how we access those real assets. We like the real assets in many of these countries. And then it’s a question of how do we access it. In many cases we’re investing in corporates that have access to those resources and in countries we think are getting the governance structure right. In some cases we’re directly buying local debt with the expectation that over time the risk premium in the country will come down, which will lead to exchange rate appreciation and lower yields.
I think looking for structural transformation in frontier markets is a really exciting — difficult but really exciting — prospect. And I think the catch-22 and why it’s been so hard for hedge funds to do frontier markets is it takes an incredible amount of research to do it right, but you can only invest a limited amount of money.
What will it take to succeed as a fixed-income investor?
You’ve got to be truly global; you’ve got to be unconstrained; you’ve got to manage for really active alpha sources. If you’re providing just beta, you will lose.
