Global Investment Committee Allocation Views

Transcription

1 January 11, 2013 Investment Team Update 5 July 2017 Global Investment Committee Allocation Views PERSPECTIVE FROM FRANKLIN TEMPLETON SOLUTIONS This investment team update describes the views of the Franklin Templeton Solutions (FT Solutions) Global Investment Committee (GIC) an experienced team of investment professionals who specialize in equities, fixed income, cross asset and absolute return investments. The committee meets regularly to share multiple viewpoints, debate implications and assess risks. This process generates key investment themes, which can be expressed in a variety of portfolios that FT Solutions offers to clients. The text below describes the views of the FT Solutions GIC as at the date of this publication. These views are for general information only, are subject to change, apply solely to FT Solutions strategies and are not representative of the views or strategies of other Franklin Templeton investment groups. Executive Summary as at 5 July 2017 On a main asset class level, we held a favorable view of global equities and commodities. We have a negative view of government bonds. Our preference is for assets we believe should benefit from investors shifting their focus from regional geopolitical concerns to improving economic conditions, such as those for European and Japanese equities. The persistent momentum for global equity markets and the business cycles in countries such as Japan, Australia and the United Kingdom have suggested to us caution with regard to bond performance potential, and we prefer short duration in global bond markets. Our analysis indicated that we are in the later stages of the credit cycle. In this environment, we prefer emerging-market (EM) bonds relative to high-yield bonds, given historical and relative valuations, the yield advantage of EM debt, more flexible EM central bank policy and less headwinds from potential US policy. Asset Class Preference* Major Themes That Frame Our Tactical Asset Allocation 1. Continued Global Growth: Many macro indicators have suggested a positive growth outlook. Expectations for fiscal stimulus in developed markets (DMs) have raised global growth forecasts for 2017 across these markets. 2. Inflationary Pressures: We see the overwhelming deflationary pressures in DMs during the past few years subsiding. DM central banks are departing from unconventional operational tools and, in some cases, have reduced support. However, financial conditions remain easy across DM central banks, in our view. *Based on our analysis of market factors. 3. Business Cycle Remains Positive: The output gap, the US Treasury yield curve, negative real short-term interest rates and low recession risk (especially in the United States) suggest to us that the business cycle should remain positive in the medium term. All information presented herein represents solely the general views of the FT Solutions GIC as at the date of this publication and is for illustrative purposes only. Any statements about strategy positioning are as at 5 July 2017 and are subject to change without notice. The positioning of a specific portfolio may differ from the information presented herein due to various factors, including, but not limited to, allocations from the core portfolio and specific investment objectives, guidelines, strategy and restrictions of a portfolio. Not intended as investment advice or an investment recommendation. There is no assurance any forecast, projection or estimate will be realized.

2 Current Convictions from the FT Solutions GIC MAIN ASSET CLASSES EQUITY REGIONS FIXED INCOME SECTORS Asset Class Equities Corporate Bonds Government Bonds Commodities Hedge Funds Cash Developed (DM) United States Europe Japan Canada Emerging (EM) US Treasuries Ex-US Govt. Bonds High Yield Investment Grade (IG) EM Debt (-) N (+) Represents month-over-month change Our Viewpoint Macro indicators have remained supportive of risk assets, based on our analysis. We have observed a number of indicators that, despite some deceleration, suggest to us continued global growth, stronger corporate fundamentals and encouraging investor sentiment. First-quarter earnings were strong. Valuations relative to history present risks to our favorable view. High-yield bonds are extremely overvalued, in our view. Current interest-rate coverage ratios and low recession risk are supportive of investment grade (IG), but corporate fundamentals are weak and spreads rich relative to history. We favor EM debt relative to high yield, given stronger relative valuations, and bank loans due to their highest yield with least amount of duration. Given low term premiums for Treasuries and other DM government bonds, inflation pressures in the United States, potential for less demand for Treasuries, and improved growth and inflation data in Europe, we have an unfavorable view of DM government bonds broadly, especially those outside the United States, and most notably German Bunds. Expected increases in capital expenditures, an uptick in global manufacturing and an increase in world trade growth depict advantageous conditions for commodities. However, technical indicators weakened in June. We also consider a negative roll return. 1 Sector-level dispersion among US equities has continued to widen. For example, the performance spread between the best and worst S&P 500 sectors increased in 2016 after remaining relatively narrow for the previous several years. Historically, hedge funds have demonstrated generally healthy performance when the spread has widened. Macro indicators increasingly supportive of risk assets such as equities, commodities and emerging-market debt. Recovery in earnings, profit margins, productivity and manufacturing all strengthened, leading us to favor risk assets over cash. Elevated DM government bond valuations outside the US with low yields; cash more attractive defensive asset class. Economic indicators attractive relative to history, driven by corporate earnings surprises, improved gross domestic product (GDP) forecasts and strong retail sales. Monetary policy supportive. Corporate fundamentals strong relative to history due to revenue data, earnings data, profit margins. But return on equity (ROE) is weak. Valuations are elevated, with most metrics over one standard deviation rich relative to 10-year history. Revenue, profit margins, earnings momentum strong, but poor ROE presents risk. Economic indicators are attractive relative to history, with some attractive OECD leading indicators. Valuations elevated, with most metrics over one standard deviation rich relative to 10-year history. Economic indicators are favorable relative to history due to strong corporate earnings surprises, retail sales, industrial production and GDP forecasts. European Central Bank (ECB) policy is supportive. Corporate fundamentals attractive relative to history due to revenue growth, earnings growth, earnings revisions and earnings momentum. ROE extremely weak but improving. Valuations increasingly expensive but still less so compared to DM peers. Geopolitical risks. Economic indicators are attractive relative to history, driven by OECD leading indicators, industrial production. Central bank policy supportive, and money growth improving and attractive relative to history. Corporate fundamentals are strong relative to history, including revenue growth, earnings revisions, attractive ROE. Profit margins are strongest relative to DM peers. Relative valuations are attractive compared to DM peers. Positive economic surprises, leading indicators, industrial production supportive. Money growth improved, monetary policy supportive. Revenue growth, earnings growth, earnings revisions and earnings momentum strong. ROE and profit margins weak but improving. Valuations stretched but improving across trailing and forward price-to-earnings (P/E) ratios. Economic fundamentals are mediocre due to weak retail sales, industrial production and GDP forecasts, which are unattractive relative to history. However, corporate earnings surprises have been attractive and improved noticeably. Poor money growth is a large headwind. ROE, profit margins extremely unattractive. But earnings and revenue data attractive. Valuations are high, but more attractive than DMs. Equities are overbought, in our view. Higher relative yields, risk-off sentiment, stalled wage growth, geopolitics are upside risks to our unfavorable view. Path of 2017 rate increases, tightening labor market, low term premium may cause yields to rise. Less certainty now on fiscal easing through potential tax cuts, infrastructure spending to increase growth and inflation. These policies also add to fiscal deficits and national debt. Valuations and wage growth support Treasury Inflation-Protected Securities. High valuations, low term premiums, improved economic data led to unfavorable view. Small rise in yields could quickly wipe out any carry. Improved inflation and inflation expectations in Europe. Fiscal policy either expansionary or less contractionary in Europe. Global headwinds, fears of secular stagnation, geopolitics, ECB/Bank of Japan quantitative easing all technical supports. Our fair value model indicates high-yield valuations rich, fundamentals weak. Bank loans preferred due to highest yield for least amount of duration. Potential for deregulation, favorable tax reform, increased fiscal spending supportive of sector due to high expectations for corporate earnings to improve. Corporate fundamentals are weak and have deteriorated for several years. Rising rates are bearish for IG duration and total return potential. Current interest-rate coverage ratios and low recession risk supportive, in addition to ECB buying of European IG. Spreads are rich relative to history. Positive carry supports excess return potential. Yields are noticeably attractive relative to high yield. Challenges include pro-growth policies, which could lead to higher US rates and USD, and realignment of global geopolitics. However, US implementation of trade restriction policies is uncertain, which supports EMs. Individual economies' fortunes are likely to differ widely. EM USD aggregate inline with history. Recently falling 10-year US Treasury yield, lower implied volatility of Treasury options, and less EM FX risk support EM debt. No arrow = No change from the previous month The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. All viewpoints reflect solely the views and opinions of the GIC. Equity regions and fixed income sector totals roll up to the main asset classes. Global Investment Committee Allocation Views 2

3 Cross Asset Many of the core themes supporting risk assets such as global equities in the first half of 2017 have persisted as we entered July. The pace of global growth has remained on track for marked improvement for the calendar year. Global purchasing managers indexes (PMIs) remained in expansion territory in recent months, despite a recent decline in US manufacturing PMI. The trend for a positive and rising (PORI) regime for composite, manufacturing and services PMIs suggests favorable global equity performance potential in the near term, following healthy performance in the first half of In addition, inflation pressures appeared to have peaked based on our analysis. Stronger income statement corporate fundamentals, robust global liquidity and potential inflows into global equities also represented tailwinds. Corporate performance also supported risk assets, in our assessment. Measures of corporate profit margins (see Chart 2) and earnings momentum (see Chart 3) have trended upward recently. A significant improvement in the breadth of earnings revisions over the past six months represented to us a notable tailwind for risk assets such as equities. Historically, when earnings revisions have trended up, global equity performance generally has been robust. However, the precipitous climb is a risk to our view and has led us to temper expectations going forward, as we believe this measure may be approaching an extended level. The US Federal Reserve (Fed) has expressed continued confidence in the improving US economy, and global financial conditions remained accommodative following the Fed s interest-rate hike in June, which also suggests enhanced performance potential. Consistent with these trends, the breadth of earnings across the MSCI All Country World Index remained strong as at mid-june. A measure of sentiment, the IFO Economic Climate Survey, found in the past few months that optimism among national and global organizations improved considerably from earlier in Although the potential for robust US fiscal policy remains somewhat obscured, the implementation of these policies would support risk assets. Furthermore, risk assets such as global equities have priced in less optimistic expectations for these supportive policies, based on our analysis, which may allow for greater potential for surprises to benefit global stocks. We also see the possibility for gains in US productivity, should proposed tax changes take effect. Although most indicators were supportive of risk assets, some geopolitical risks still remain, as has uncertainty regarding proposed fiscal policy. Investors have tempered optimism surrounding proposed US tax reductions as the timing and certainty regarding these cuts remained in question. GIC Asset Class Views Equities Corporate Bonds Government Bonds Commodities Hedge Funds Cash N + The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. Represents month-over-month change No arrow = No change from the previous month Additionally, tensions remained elevated between the United States, along with its allies, and North Korea, Syria and Russia, among others. Sentiment and certain valuations also appeared less favorable to us. The global equity risk premium was below its rolling fiveyear average and falling as at mid-june. Given the continued uncertainty surrounding political and legislative events, the risk premium did not sufficiently compensate investors for these risks, in our opinion. A pullback in corporate earnings surprises also suggested a potential headwind. Another cautious indicator for global equities was an environment of high P/E ratios and low volatility. Historically, this regime has been associated with muted performance for the forward three-month period. The combination of high P/E ratios and low volatility suggests to us a level of investor complacency. However, we see more supportive factors than possible hurdles for global equities. With the Fed s June interest-rate increase and the Bank of England s unexpectedly close decision on the next day to keep interest rates unchanged, we see the potential for more hawkish central bank policy during the remainder of 2017 as DM economies continue to expand. With broad expectations for higher interest rates moving forward, investor cash flows have started to tilt more toward equities as opposed to bonds. This trend may signal a pivotal investor shift away from government bonds following a 30-year period of inflows. Although ECB President Mario Draghi and fellow ECB members have kept a dovish tone on monetary policy, positive economic reports and low unemployment in Europe may lead to an eventual taper. In an environment where corporate earnings results and earnings surprises to the upside have raised consensus expectations for global equities, low volatility remained intact and supportive of equity multiples, and robust quantitative easing programs from major central banks have continued, we maintain a favorable view of global equities. Global Investment Committee Allocation Views 3

4 Financial Conditions Have Remained Accommodative Chart 1: Global Financial Conditions Index June 2012 May Corporate Profit Margins Remained Positive Chart 2: Net Profit Margins, MSCI World Index June 2012 June Financial conditions above zero = supportive /12 3/13 1/14 11/14 9/15 7/16 Global Threshold 5/ /12 6/13 6/14 6/15 6/16 6/17 3MMA 6MMA Global Equity Statistics PORI POFA NERI NEFA Regime Agnostic Average 3M Fwd. Return 2.7% 2.9% -0.8% 0.9% 1.5% Median 3M Fwd. Return 3.5% 3.5% 1.7% 1.0% 3.2% Std. Dev. of Return 4.4% 5.2% 9.8% 9.3% 7.6% Level of Confidence 91% 87% 88% 30% N/A % of Time in Regime 31% 21% 26% 22% 100% Source: Bloomberg. Data as at 31/5/17. Data reflects two-month lag. PORI = positive and rising. POFA = positive and falling. NERI = negative and rising. NEFA = negative and falling. Past performance does not guarantee future results. Global Equity Statistics 3M > 6M 6M > 3M Regime Agnostic Average 3M Fwd. Return 2.4% 0.0% 1.4% Median 3M Fwd. Return 2.7% 0.7% 2.2% Std. Dev. of Return 5.9% 10.4% 8.2% Level of Confidence 100% 99% N/A Count % of Time in Regime 59% 41% 100% Source: Thomson Reuters Datastream. Data as at 16/6/17. Time period for statistics grid is October 1995 June Statistics calculated using weekly data (MSCI World). In comparison to global equities, we held an unfavorable view of global bonds. Our analysis of relative valuations between the two asset classes found equities more attractive. We also evaluated global bond markets employing a model that considers factors such as the business cycle, the slope of the yield curve across markets, momentum for 10-year government bonds and price momentum in equity markets (which we view as a contrarian indicator for bonds). We evaluate these indicators to assess the performance potential for global bonds over the next one to two months. While bond price momentum appeared supportive to us in most major markets, other areas suggested caution with regard to duration. For example, we regarded the carry or yield curve between bond markets as largely unfavorable in Japan and the United States. Similarly, the business cycle appeared as a headwind in countries such as Japan, Australia and the United Kingdom, based on our analysis. The combination of low term premiums for global government bonds and the persistent momentum for global equity markets also suggested to us caution with regard to bond performance potential. Furthermore, our base case scenarios for monetary policy from major central banks were generally supportive for global equities, and neutral or slightly bearish for global government bonds. The potential for expansionary fiscal policy in the United States and Europe, which could bolster interest rates, represents another headwind. After evaluating these factors and weighing related considerations, we maintained a preference for short duration in global bond markets. Elsewhere, commodity prices generally continued to weaken in June, most notably in energy. However, we still observed several areas of support for commodities. Investor sentiment for the asset class has continued to decline over the past few years, which we find as a contrarian, bullish sign. Global capital expenditure spending has risen in recent months from low levels. Furthermore, several fundamental indicators remained supportive of commodities. Relative and long-term valuations, worldwide trade levels, and China composite leading indicators all appeared to be tailwinds for commodities, according to our analysis. With regard to oil, the supply/demand outlook reflects more normalized conditions, in our opinion. Although technical indicators remained generally weak for commodities in June, fundamentals were more supportive of the asset class, including long-term and relative valuations. Global Investment Committee Allocation Views 4

5 Commodities still face some headwinds. July marked the beginning of a seasonable period that has historically seen constrained performance for commodities. High and rising inventory levels for oil and gasoline have continued to weigh on energy commodities. At the same time, we have observed several trends that may reverse this hurdle. First, the crude oil rig count has been slowing over the past 12 months. Second, in June oil production showed signs of slowing across several regions and potentially beginning a downward trend. Even shale production, which has been prolific, was facing rising production costs. Combining these attractive macro growth fundamentals against the recent downturn for certain indicators led us to lower our favorable view of commodities. We balance the favorable factors with a negative roll return. 1 Earnings-Per-Share (EPS) Momentum Has Remained Positive Chart 3: EPS Momentum, MSCI World Index June 2012 June /12 6/13 6/14 6/15 6/16 6/17 Weighted Average 12M EPS 3MMA EPS Momentum Statistics Above 3M Moving Avg. Below 3M Moving Avg. Regime Agnostic Average 3M Fwd. Return 2.5% 1.5% 2.1% Median 3M Fwd. Return 3.6% 2.4% 3.0% Std. Dev. of Return 6.8% 9.5% 8.0% Level of Confidence 42% 45% N/A Count % of Time in Regime 62% 38% 100% Source: Thomson Reuters Datastream. Data as at 27/6/17. Time period for statistics grid is March 1998 June Statistics calculated using monthly data (MSCI World) Bullish Equities Bearish Equities 6/12 6/13 6/14 6/15 6/16 6/17 Difference between Current Fwd. EPS and 3MMA Equities Following an extended period of political uncertainty weighing on European stocks, investor concerns surrounding populist politics in the region have largely faded. Following French presidential run-off election results in May and parliamentary election results in June, along with encouraging economic data, European equities began and sustained a healthy rally. Though some uncertainty surfaced in early June following an election setback for UK Prime Minister Theresa May s party, which could affect Brexit negotiations and timing, continued reversal of the significant investor outflows from European equities in 2016 could further support performance potential for European stocks. We believe the receding political headwinds have allowed an increasing number of investors to focus more on the eurozone s economic growth and emergent inflation as the economic backdrop continues to improve. Higher GDP forecasts for countries in the European Economic and Monetary Union GIC Views of Equity Regions N + Developed United States Europe Japan Canada Emerging The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. Represents month-over-month change No arrow = No change from the previous month (EMU) reflect improving macro conditions, and IFO Survey data signaled optimism among businesses. Consumer confidence also recently climbed in several countries. In core European markets such as Germany, France, the Netherlands and Spain, Global Investment Committee Allocation Views 5

6 earnings growth, momentum and revisions have shown improvement in recent months, although some leading indicators in France and Spain lagged those of peer nations. We are also encouraged by significant potential for the profit margins of European firms to converge with those of their US peers (see Chart 4). Historically, a positive and rising trend for profit margins in Europe has been followed by positive stock performance. We remain fully cognizant of potential headwinds for European stocks. Greece s fight to avoid default could be tested, or lead to new conditions for a bailout. However, in the near term, the country reached an agreement with the European Union in June that unlocked loans of more than 8 billion, allowing the country to meet large debt payments due in July. From an economic standpoint, while we see European demand as the primary driver of the region s economy, deceleration in EM economies, particularly China, could weigh on eurozone growth. Finally, while inflation has started to firm in Europe, it appeared somewhat tenuous as at June-end. Ultimately, however, we hold high conviction that the improving business cycle will trump politics, which led us to maintain a favorable view of European stocks. In Japan, corporate EPS revisions, along with ROE and profit margin momentum, have all been robust in recent months. Japanese profit margins reached an all-time high for the fiscal year ended 31 March 2017, which supported the convergence European Margin Convergence Potentially Bullish for European Equities Chart 4: Profit Margins (Last-12-Month Net Income/Sales) June 2007 June % 10% 9% 8% 7% 6% EMU has a lot of potential for selfimprovement and convergence with the United States. 5% 6/07 6/08 6/09 6/10 6/11 6/12 6/13 6/14 6/15 6/16 6/17 EMU United States European Equity Statistics Agnostic POFA PORI NERI NEFA Signal Bearish Bullish Bullish Bearish Average 0.66% -0.54% 1.65% 1.58% -1.03% % of Time in Regime 45% 53% 35% 65% % in Positive 54% 65% 66% 51% Significant Yes Yes Yes Yes Source: MSCI and IBES. Data as at 27/6/17. PORI = positive and rising. POFA = positive and falling. NERI = negative and rising. NEFA = negative and falling. Past performance does not guarantee future results. of the country s ROE with that of other DMs. ROE momentum was higher than in most DMs. Additionally, a tight labor market has been supporting wage growth and lowered deflation concerns. Significant central bank support in Japan, a large rebound in global trade and a broadly weaker Japanese yen have also served as notable tailwinds. Industrial production in Japan has demonstrated significant expansion over the past two years (see Chart 5). Money growth was robust in Japan, providing what we see as further support for Japanese equity performance potential. Despite the strengths, our analysis indicated to us that analyst expectations and guidance from Japanese corporations have continued to underestimate EPS growth. Valuations also seemed to us to underestimate improved corporate profitability in Japan. Japanese equities offered lower valuations compared to other DM equities across most measures as at mid-june, including P/E, despite less political risk in Japan. Although we find the supportive factors for Japanese equities far outweigh the risks, we have been monitoring leading indicators for the country, including manufacturing activity, which slowed in May. Regional geopolitical risks concerning North Korea also remain. The combination of corporate earnings and profits demonstrating continued strength, tailwinds from labor and currency markets and central bank support, and broadly attractive valuation metrics relative to DM market peers led us to hold a favorable view of Japanese equities. Industrial Production in Japan Strong and Expanding Chart 5: Industrial Production, Year-over-Year June 2012 May % 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% 6/12 4/13 2/14 12/14 9/15 7/16 5/17 Japan United States Japanese Equity Statistics Agnostic POFA PORI NERI NEFA Signal Bearish Bullish Bullish Bearish Average 0.52% -1.01% 1.43% 0.79% 0.02% % of Time in Regime 37% 61% 37% 62% % in Positive 51% 63% 57% 60% Significant Yes Yes No No Source: Thomson Reuters Datastream. Data as at 31/5/17. PORI = positive and rising. POFA = positive and falling. NERI = negative and rising. NEFA = negative and falling. Past performance does not guarantee future results. Global Investment Committee Allocation Views 6

7 Fixed Income Another area of concentrated focus for us is evaluating what stage credit markets have entered. In the US credit market, we found spreads tight across bond sectors, particularly optionadjusted spreads for intermediate-term US Treasuries and investment-grade bonds. Our analysis of consumption expenditures and demand levels led us to conclude US credit markets were somewhat extended, as leverage has risen for many years. This was somewhat atypical and a concern for us, as corporations have historically deleveraged when interest rates were rising. However, a survey of US loan officers indicated lending standards were strengthening, leading to tighter lending conditions. Investor concerns rose late in June surrounding the potential end of accommodative monetary policies from major central banks, which weighed on global bonds. In the United States, the Fed was widely expected to continue with measured increases in interest rates amid a strong labor market and firming inflation. Though some possibility remains that proposed fiscal policies in the United States could extend the credit cycle, our analysis concluded US credit markets lie in the later stage of the credit cycle. In the global corporate bond universe, valuations for high-yield bonds were extremely overvalued at June-end, according to our proprietary high-yield fair value model. We favor bank loans within the corporate bond sector, since they currently offer the highest yield in this sector for the least amount of duration, or sensitivity to interest rates, and we viewed their relative valuations as more attractive relative to high-yield bonds. Despite higher expectations for growth and future interest-rate increases, the US Treasury market appears to us to be excessively pricing in sluggish growth and a conservative path of interest-rate hikes, particularly past Strong US economic data across the labor market, as well as business and consumer sectors, suggest the case for rate tightening has strengthened. Employment in the United States has remained strong (as reflected in the May unemployment rate at a 16-year low), with the rise in nonfarm payrolls and the US economy adding a healthy amount of jobs. These improving US employment indicators should continue to bode well for wage gains, in our opinion. The tighter labor market in the United States supports our view of strengthening inflationary forces, and core inflation has trended higher over the past 12 months. In addition, the gap between the unemployment rate and the nonaccelerating inflation rate of unemployment appears to us to have closed. The Fed may also announce a change to its policy of reinvestment of payments of principal for US Treasuries and agency bonds. This potential action could add to upward pressure on US Treasury yields and spreads for mortgagebacked securities. Given the difference between strengthening GIC Views of Fixed Income Sectors US Treasuries Ex-US Govt. Bonds High Yield Investment Grade EM Debt N + The graphic reflects the views of the GIC regarding each asset class relative to a neutral portfolio allocation. Represents month-over-month change No arrow = No change from the previous month inflationary factors and market pricing, we viewed term premiums in the US Treasury market as low and unattractive. Outside of the United States, overall economic data in Europe have improved recently, and fiscal policy has been turning expansionary or at least less contractionary. The transmission mechanism of monetary policy is showing gradual improvement. Consequently, we view German Bunds as overvalued, resulting in asymmetrical risk and reward. For example, the term premium is currently quite negative for German Bunds, and a small rise in yields could wipe out years of carry. Given our assessment of low term premiums for Treasuries and other DM government bonds, inflation pressures in the United States, improved growth in Europe, and the increased potential for major central banks to curtail stimulus, we have an unfavorable view of DM government bonds broadly, especially those outside the United States, and most notably German Bunds. Increasing uncertainty over President Trump s proposed trade restriction policies and more flexible EM central bank policy have resulted in less of a headwind for EM debt in recent months, in our opinion. Inflation in emerging markets has been falling, which gives EM central banks greater flexibility in monetary policy. These developments have contributed to substantial investor inflows into the asset class in Another reason for inflows into EM debt is the bond sector s yield, which we regarded as attractive relative to US investment-grade and high-yield bonds. This healthy yield has also supported investor inflows into EM debt year-to-date. Our analysis also weighed considerations such as the absolute valuations and spreads for EM debt, which were around their historical average (see Chart 6). We also regarded yields for the EM bond sector as attractive both relative to history and on an absolute basis (see Chart 7). These yields and valuations appeared even more compelling to us when compared to highyield bonds, considering loose commercial and industrial lending conditions, along with a slight rise in default rates for Global Investment Committee Allocation Views 7

8 high-yield bonds. The recently falling 10-year US Treasury yield, lower implied volatility of Treasury options, and less EM Option-Adjusted Spread for EM Debt Was in Line with the Asset Class s Historical Average Chart 6: Actual Minus Estimated Emerging-Market Debt Spread over Time March 2003 June /03 7/05 12/07 4/10 9/12 1/15 6/17 Residual (Deviations from the Model) 1 Sigma Limit Source: Calculations by FT Solutions using data sourced from Bloomberg. The full index name is the JP Morgan Emerging Market Bond Index. Indexes are unmanaged and one cannot invest directly in an index. They do not reflect any fees, expenses or sales charges. Data as at 14/6/17. currency risk also support EM debt. We held a favorable view of EM debt relative to US high-yield debt. In the Short Term, High-Yield Credit Appears Expensive to Us on an Absolute Basis Chart 7: High-Yield Bond Option-Adjusted Spread and Fair Value Model Time Series May 2000 May /00 3/03 12/05 10/08 9/11 7/14 5/17 High-Yield Option-Adjusted Spread Fair Value Model Source: Calculations by FT Solutions using data sourced from Bloomberg. Indexes are unmanaged and one cannot invest directly in an index. They do not reflect any fees, expenses or sales charges. Data as at 14/6/17. WHAT ARE THE RISKS? All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Value securities may not increase in price as anticipated or may decline further in value. Smaller companies can be particularly sensitive to changes in economic conditions and have less certain growth prospects than larger, more established companies and can be volatile, especially over the short term. Investments in smaller-company securities that may have limited liquidity involves additional risks, such as relatively small revenues, limited product lines and small market share. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio s initial investment. A strategy may not achieve the anticipated benefits, and may realize losses, when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time and can reduce returns. Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector. Investments in REITs involve additional risks; since REITs typically are invested in a limited number of projects or in a particular market segment, they are more susceptible to adverse developments affecting a single project or market segment than more broadly diversified investments. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector prices of such securities can be volatile, particularly over the short term. Investments in hedge funds are speculative investments, entail significant risk and are suitable only for persons who can afford to lose the entire amount of their investment. Global Investment Committee Allocation Views 8

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Australia: Issued by Franklin Templeton Investments Australia Limited (ABN ) (Australian Financial Services License Holder No ), Level 19, 101 Collins Street, Melbourne, Victoria, Austria/Germany: Issued by Franklin Templeton Investment Services GmbH, Mainzer Landstraße 16, D Frankfurt am Main, Germany. Authorized in Germany by IHK Frankfurt M., Reg. no. D-F-125-TMX1-08. Canada: Issued by Franklin Templeton Investments Corp., 5000 Yonge Street, Suite 900 Toronto, ON, M2N 0A7, Fax: (416) , (800) , In Canada, FT Solutions is part of Fiduciary Trust Company of Canada, a wholly owned subsidiary of Franklin Templeton Investments Corp. Dubai: Issued by Franklin Templeton Investments (ME) Limited, authorized and regulated by the Dubai Financial Services Authority. Dubai office: Franklin Templeton Investments, The Gate, East Wing, Level 2, Dubai International Financial Centre, P.O. Box , Dubai, U.A.E., Tel.: Fax: France: Issued by Franklin Templeton France S.A., 20 rue de la Paix, Paris, France. Hong Kong: Issued by Franklin Templeton Investments (Asia) Limited, 17/F, Chater House, 8 Connaught Road Central, Hong Kong. Italy: Issued by Franklin Templeton International Services S.à.r.l. Italian Branch, Corso Italia, 1 Milan, 20122, Italy. Japan: Issued by Franklin Templeton Investments Japan Limited. Korea: Issued by Franklin Templeton Investment Trust Management Co., Ltd., 3rd fl., CCMM Building, 12 Youido-Dong, Youngdungpo-Gu, Seoul, Korea Luxembourg/Benelux: Issued by Franklin Templeton International Services S.à r.l. Supervised by the Commission de Surveillance du Secteur Financier - 8A, rue Albert Borschette, L-1246 Luxembourg - Tel: Fax: Malaysia: Issued by Franklin Templeton Asset Management (Malaysia) Sdn. Bhd. & Franklin Templeton GSC Asset Management Sdn. Bhd. Poland: Issued by Templeton Asset Management (Poland) TFI S.A., Rondo ONZ 1; Warsaw. Romania: Issued by the Bucharest branch of Franklin Templeton Investment Management Limited, Buzesti Street, Premium Point, 7th-8th Floor, Bucharest 1, Romania. Registered with Romania Financial Supervisory Authority under no. PJM01SFIM/400005/ , authorized and regulated in the UK by the Financial Conduct Authority. Singapore: Issued by Templeton Asset Management Ltd. Registration No. (UEN) E. 7 Temasek Boulevard, #38-03 Suntec Tower One, , Singapore. Spain: Issued by the branch of Franklin Templeton Investment Management, Professional of the Financial Sector under the Supervision of CNMV, José Ortega y Gasset 29, Madrid. South Africa: Issued by Franklin Templeton Investments SA (PTY) Ltd which is an authorised Financial Services Provider. Tel: +27 (21) Fax: +27 (21) Switzerland: Issued by Franklin Templeton Switzerland Ltd, Stockerstrasse 38, CH-8002 Zurich. UK: Issued by Franklin Templeton Investment Management Limited (FTIML), registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. Authorized and regulated in the United Kingdom by the Financial Conduct Authority. Nordic regions: Issued by Franklin Templeton Investment Management Limited (FTIML), Swedish Branch, Blasieholmsgatan 5, SE Stockholm, Sweden. Phone: +46 (0) , Fax: +46 (0) FTIML is authorised and regulated in the United Kingdom by the Financial Conduct Authority and is authorized to conduct certain investment services in Denmark, in Sweden, in Norway and in Finland. Offshore Americas: In the U.S., this publication is made available only to financial intermediaries by Templeton/Franklin Investment Services, 100 Fountain Parkway, St. Petersburg, Florida Tel: (800) (USA Toll- Free), (877) (Canada Toll-Free), and Fax: (727) Investments are not FDIC insured; may lose value; and are not bank guaranteed. Distribution outside the U.S. may be made by Templeton Global Advisors Limited or other sub-distributors, intermediaries, dealers or professional investors that have been engaged by Templeton Global Advisors Limited to distribute shares of Franklin Templeton funds in certain jurisdictions. This is not an offer to sell or a solicitation of an offer to purchase securities in any jurisdiction where it would be illegal to do so. 1. Roll return refers to the resulting return from rolling a short-term contract into a longer-term contract in a futures market. A negative roll return indicates an investor will lose money when rolling a contract. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. 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