Michael Hasenstab
Senior Vice President, Co-Director, Portfolio Manager
Franklin Templeton Fixed Income Group's International Bond Department
February 17, 2010

Please note: The Reuters "Dealing Room" is a real-time forum. This transcript has been edited for clarity.

REUTERS MODERATOR: Hi Dealing Room. I want to introduce Michael Hasenstab, Senior Vice President, Co-Director and Portfolio Manager for the international bond department of the Franklin Templeton Fixed Income Group. He oversees approximately US$60 billion in assets under management.

Among his funds, Michael manages the Templeton Asian Bond Fund, which has a 4-star rating from Morningstar¹ and was up 23 percent² last year, as well as the Templeton Global Bond Fund, which has a 5-star rating¹ and was up 19 percent³ in 2009. Welcome to the Dealing Room, Michael.

MICHAEL HASENSTAB: Hello from San Mateo, California.

REUTERS MODERATOR: Probably warmer there than here in Hong Kong!

HASENSTAB: Yes, another tough "California winter"... 65 degrees and sunny.

REUTERS MODERATOR: I'll kick things off for us. It's hard not to worry about European sovereign debt these days. The RBA and BoK have both indicated they are! How concerned are you about your portfolios being affected by heightened sensitivity over sovereign debt risk?

HASENSTAB: There are certainly risks in some sovereign debt markets. Most notably, Greece's debt dynamics are currently non-sustainable and require unprecedented adjustments. This will present a meaningful challenge to the Euro area as a whole. As a result, we hold no Greek bonds and have negative exposure to the Euro.

However, at the same time, we should not forget there are many countries that are running very prudent debt policies and have good fiscal conditions. Take Norway, for example. The government oil fund is approximately four times larger than their entire government bond market, so sovereign debt risk is clearly very small. Australia is another example of very low sovereign risk.

QUESTION: Michael, what do you think of a possible Greece pull out from the EU? I am assuming the market has not priced in this risk...

HASENSTAB: Very low chance that Greece pulls out. If they did, it would send bond yields through the roof and trigger an even more severe recession.

There is also very little risk that Greece is forced out. However, a major fiscal adjustment is necessary to avoid a restructuring.

QUESTION: Hi Michael - so if you don't see Greece leaving the Euro zone, at which point do you reconsider the Euro short position?

HASENSTAB: Greece is one problem for the Euro, but there are others.

Most importantly European growth will very likely lag U.S. growth due to the relative conditions in credit markets. The U.S. took a very aggressive response to the crisis (monetary, bank recapitalization, fiscal) and while there are costs to these measures, they will likely result in a faster exit from the recession.

QUESTION: If a restructuring by Greece is needed, they have 30 days to come up with a proper plan. Do you think the electorate would be able to accept it, or would the Greek government have the stomach for it?

HASENSTAB: Regarding Greece's stomach, it's hard to say. Thus far we have seen very little political consensus to aggressively tackle the fiscal problems and Greece still faces strikes. These are strikes that are due to not getting pay hikes, let alone the pay cuts that are likely necessary to bring fiscal accounts in order.

QUESTION: Hi Michael, you said that you have negative exposure to the Euro. Are you more upbeat on the USD generally? Is the current strength just associated with risk aversion/sovereign concerns? Or is there something in the macro backdrop, with the U.S. seemingly on a stronger footing at least at the moment compared with Europe, UK and Japan?

HASENSTAB: Regarding the USD, it is more than just risk aversion and reversal. Relative conditions are what matter most and, in this respect, Japan looks likely to be the last developed economy to raise rates due to persistent deflation and a very weak domestic economy. Europe took a more gradualist approach to the crisis and, as a result, banks are still laden with significant bad debts, which limit their ability to expand credit.

Additionally, Europe was still adding labor well past the peak of output, whereas the U.S. was already cutting jobs even before the recession hit. While this caused a very painful rise in the unemployment rate, it has meant productivity rates in the U.S. have gone up due to falling unit labor costs, whereas the reverse is true in Europe.

QUESTION: Morning (or evening) Michael. So you like AUD and AUD bonds? Anywhere else in Asia you particularly like the Bond + CCY risk, and any thoughts on China's recent sales of U.S. Treasurys that has received a lot of attention?

HASENSTAB: Non-Japan Asia broadly should benefit from higher relative growth and rising relative rates. These factors should drive further capital inflows that will in turn support growth and currencies. Additionally, many Asian currencies are starting from an undervalued point.

While we shouldn't read too much into one month's data on China's treasury holdings, it does represent a major issue. The U.S. is increasingly reliant on foreign lenders and, given our massive debt levels, we should expect upward pressure on rates over the medium to longer term. Hence our zero weight in U.S. Treasurys.

QUESTION: Michael - a question passed on from a client: Do you like Indonesian bonds? Everyone seems to say Indonesia has great fundamentals but foreigners seem more interested in short term (BI) bills rather than government bonds.

HASENSTAB: Indonesia has made significant progress over the last 5 years. Inflation expectations are now better anchored. Fiscal policy is very prudent. Debt to GDP ratios have been falling (vs. the reverse in many developed economies). President SBY's focus on anti-corruption measures has been an important catalyst to bring in more FDI. Finally, the senior policy makers at the Bank of Indonesia and the ministry of finance proved very adept at managing the economy during the crisis, and this adds to the credibility of macro economic policy in Indonesia. So in general, we are positive on the outlook. Clearly, as with any emerging market there are risks and we need to monitor developments closely, but any country that came through 2009 with positive growth deserves a degree of credit.

REUTERS MODERATOR: Thanks Michael. I noticed you have quite a bit of exposure to Korea. How do BoK Governor Lee's latest remarks about rates having to rise in the "not too distant future" affect your investment strategy? Do you think Lee wants to hike rates before he steps down in March?

HASENSTAB: Clearly economic conditions in Korea have been improving for some time, and it would seem natural that interest rates normalize over 2010 and 2011; however, a good amount of this is already priced in to the market. Although it is hard to speculate on the exact timing.

QUESTION: Hi Michael, good to speak to you again. Borrowing concerns have started emerging from India to Philippines. Do you think that will stay policymakers' hands in too sharp a policy tightening and how does that affect your allocation decisions?

HASENSTAB: Both India and the Philippines have expanded their fiscal expenditures during the crisis. However, the Philippines in particular had made very good progress on fiscal consolidation prior to the crisis. Thus we really need to see what the next administration does. If they return to the fiscal path pre-crisis, then the Philippines should be in okay shape.

QUESTION: Michael, if relative growth and relative rates is seen playing in favour of Asia even in the midst of sovereign risk in the EU, what do you think if certain economies that have large fiscal deficits? Don't you think that fund managers are going to be a lot cautious and may demand a slight increase in premium?

HASENSTAB: I do think we will see increasing differentiation among sovereign risk going forward. Broadly, Asia entered the crisis in a good position. Leverage rates were low, bank bailout costs were minimal, and debt to GDP ratios were low before the crisis – so recent countercyclical spending will not put debt to GDP ratios on an explosive path. This is very different from conditions in several European economies or conditions facing Japan, the UK or the U.S. The fiscal risks in the latter are clearly greater.

REUTERS MODERATOR: Michael has to rush off to a meeting, but I want to thank him for being generous with his time. That was a lively session. Hope you enjoyed being "back" in Asia, Michael.

HASENSTAB: My pleasure! Great to chat and look forward to staying in contact. Cheers, Michael.

Source: Reuters

Footnotes:

1. Overall Morningstar Rating as of 31 December 2009. © 2010 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. London. A Division of the McGraw-Hill Companies, Inc. All rights reserved.
2. As of 31 December 2009, calculated using NAV-NAV pricing based on reinvested dividends, in USD terms. The annualized return net of 5% sales charge is 17.1%. The performance relates to the A(mdis)USD share class of the fund.
3. As of 31 December 2009, calculated using NAV-NAV pricing based on reinvested dividends, in USD terms. The annualized return net of 5% sales charge is 12.9%. The performance relates to the A(mdis)USD share class of the fund.