There is no doubt that Europe is experiencing some political and economic upheaval as a region. Political instability has dominated Europe for a number of years now and shows no sign of abating, with the recent Brexit decision, the upcoming Italian referendum and a busy election schedule in 2017 next year across a number of countries. In addition, fixed income investors in the region have seen historically low sovereign yields in parts of the region, driven down by central bank action and investors looking for safe-havens to invest their money.
With that in mind, investing in European fixed income may not have an obviously strong appeal to some, but there is risk that these investors would be ignoring a highly diverse region where opportunities remain. Indeed, while causing some challenges, the political and economic uncertainty has at times caused a degree of volatility and dislocations that has actually presented investors with significant opportunities in both sovereign and corporate debt. From a global perspective, a number of European bond markets can still offer an attractive pick up over negative yields offered in countries such as Japan. Additionally, unlike the US, Europe is a region where we expect to see low interest rates for some time to come, and in such an environment we would expect to see European fixed income outperform a number of its developed market peers.
In order to take advantage of the best opportunities in the region, whilst also navigating its challenges, , a flexible, benchmark unconstrained, multi-sector, pan-European (not purely EU) strategy is most appropriate, and in the Franklin European Total Return Fund, this is the approach we take.
The Fund’s positioning will always reflect the investment team’s research intensive outlook and will use all of the appropriate sub-asset classes available to it, from investment grade to high yield across both corporate and sovereign debt in an effort to achieve its principal objective of maximising total investment return consisting of a combination of interest income, capital appreciation and currency gains.
Looking at the current status quo, markets appear to have stabilised after the volatility caused by the UK referendum result, which although requiring much time and expenditure to sort out may ultimately lead to less long-term change than originally feared by some investors. Nevertheless, there remains a significant risk that political impasse and lack of direction may undermine confidence across Europe and particularly within the eurozone, providing another reason for the ECB to keep monetary policy extremely accommodative for some time.
We remain underweight on low-to-negatively yielding government bond markets of Germany and France, and have no appetite for adding exposures to those markets now, given that yields have fallen further into negative territory. We prefer to take corresponding overweight allocations to smaller countries like Ireland and the United Kingdom where yields are more attractive. The fund also has overweight positions in economies such as Latvia and Romania which in our view have superior economic growth prospects and better debt-to-GDP ratios.
The fund’s overweight corporate credit exposure is reflective, to an extent, of the ECB’s corporate bond purchase programme which has provided a broadly favourable backdrop for these markets. However it is still important to assess the underlying credit risk, and therefore we would stress the importance of fundamental, bottom-up analysis in determining issuer strengths and weaknesses and developing a comprehensive understanding of activity within specific sectors.
Managed by David Zahn, CFA, Franklin Templeton’s Head of European Fixed Income, the fund has successfully outperformed most of its peers in the past 3 and 5 year time periods. The fund offers investors a strategy that invests in sovereign, investment grade corporate and high yield debt from issuers across the region and can also take currency positions in non-Euro markets such as Poland, Scandinavia and the United Kingdom. This flexible approach enables the fund to take advantage of the best opportunities within the region and the dislocation that occurs at times.