Ashley Redmond: I'm Ashley Redmond for Morningstar and I'm on the line with Franklin Templeton's Ed Perks. Ed manages the Franklin Income Fund for U.S. and Canadian investors.
Ed, thanks so much for joining me.
Ed Perks: It's good to be with you.
Redmond: The Franklin Income Fund is a Bronze-rated fund in the U.S., and in Canada it's not yet rated because it's just over a year old. The fund takes a similar approach in both countries with the goal of maximizing income while maintaining the prospects for long-term capital appreciation. So Ed, where are you seeing opportunities in the U.S. market?
Perks: We're finding opportunities across a pretty broad spectrum of the markets. That said, our portfolio approach today really does have us a little bit more focused on equity securities, and more specifically the opportunity in dividend-paying stocks.
I think it's important— it's not just necessarily the highest yielding stocks that we're focused on—but also on those companies that we think are in a great position in terms of strength of their balance sheet; as well as the path that they've taken over time in growing their dividend. So, dividend growers are a big focus for Franklin Income Fund.
Redmond: Overall for income investors, would you say there's more opportunity right now in stocks or bonds?
Perks: We still feel like the relative value between stocks and bonds still tilts slightly in favour of stocks. So, that is more of our focus today. That said, we have seen some movement in the fixed income markets. Particularly when you step back on a year-over-year basis and even further back into 2013, we have seen longer-term interest rates move up over that time period.
Now clearly year-to-date they're down a little bit, but that backup in long-term interest rates as well as some volatility in credit spreads has created some pockets of opportunity for us in fixed income.
In addition, we've actually seen some increased issuance of convertible securities. So that's an area that also kind of bridges the gap between equity and fixed income, and we've been finding nice opportunities there as well.
Redmond: And within bonds, what's the best bet right now for income investors?
Perks: In the context of really thinking about rising long-term interest rates—part of that in our view is normalization from the extraordinary monetary policy measures that we've had in place for much of the last five years—has started to happen. We remain pretty optimistic about economic growth over the longer term. So in general, our emphasis has been trying to deemphasize rate-sensitive securities in favour of more credit driven [securities].
So we are really focused more on corporate bonds and to some extent still on high-yield corporate bonds. There we want to be very selective and really emphasize our underlying credit fundamentals and research. Really understanding where we think individual credits are going from a standpoint of either being able to grow and deliver on improved credit metrics over time or commitment to deleveraging.
Redmond: Taking a look at the analyst report, it looks like the fund in the U.S. has overweights in basic materials, energy and utilities, for example. So, we will switch back to stocks, within stocks what areas have been providing more opportunity?
Perks: I would say first-of-all in stocks—and this is probably the one thing that's really evolved over the last decade or so— is that we're finding more companies from a broader range of sectors that are focused on dividends. And like I said [earlier] growing those dividends over time. That said, some of the traditional yield sectors like utilities still actually stand out to us as being pockets of opportunity. Now utilities, as we all know, are really highlighted as being possibly one of the more sensitive sectors to rising long-term interest rates. While we certainly do agree with some element of that, we also think that within the utility sector there are different growth dynamics at play.
For example, opportunities to invest in energy infrastructure, whether it be gathering systems or pipelines or storage facilities; the opportunity to invest in renewables, generation, wind and solar; the opportunity to invest in, on a longer-term basis, LNG (liquefied natural gas) export facility; so there are some pockets and there are some nice growth themes within the utility sector in the context of reasonable valuations that we've been focused on.
I would say today it's a nice opportunity set for a yield-oriented investor in the equity market and that's something that we continue to stay focused on.
Redmond: What's your overall take on the credit environment right now?
Perks: We've had a very nice rally in credit over the last several years and I think one of the real important dynamics that we've seen is this opportunity for companies to issue debt. A lot of the focus has been on not just benefiting from lower long-term interest rates and lower financing costs for these companies, but also extending those maturities in creating what we call runway before maturities really start to come due. We think that's a very positive overall credit dynamic and something that in all likelihood with modest economic growth should keep default rates fairly low.
That has a lot to do with why we're still constructive on credit. Now we do want to be very specific in our security selection, but that does give us some opportunity.
Redmond: One thing we've been talking about at Morningstar is an eventual rising rate environment. So, what's your take on how income investors should position themselves today?
Perks: That's certainly one of the bigger issues for income investors, not just going forward, but something that we've seen already in this past year as I referenced on a year-over-year basis. Going back certainly to the beginning of 2013 we have seen that move up in longer-term interest rates.
Now while we don't really expect a major rise in long-term interest rates, we do think it's certainly possible to see a kind of a gradual migration up in rates. We do think diversification and thinking about opportunities for yield in other sectors like equities, like convertible securities, is certainly an important part of minimizing your exposure or the impact that rising rates can have on your portfolio. In more of the fixed income exposures that we have today, we are trying to emphasize those companies where we think fundamentals are improving and that's going to be the primary driver of the securities return potential.
We're also cognizant of where we stand on a maturity bases and the duration of our fixed income portfolio, and in general, we've kept that a bit shorter. So I think it's always most instructive to be able to look and see how a portfolio is done when rates have risen. And in the context of a pretty steep rise in long-term interest rates in 2013, we do think things like the diversification in Franklin Income really benefited our investors.
Redmond: Makes sense. Thanks so much for taking the time to talk to us today, Ed.
Perks: It was good to be with you.
