Templeton Global Bond (Euro) Fund A (Ydis) EUR

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1 Templeton Global Bond (Euro) Fund A (Ydis) EUR Franklin Templeton Investment Funds Fund Manager Report Unconstrained Fixed Income Product Details 1 Fund Assets Fund Inception Date 29/08/2003 Number of Securities 117 Including Cash Bloomberg TGBEFAD LX ISIN LU Base Currency EUR Investment Style Unconstrained Benchmark JP Morgan Global Government Bond (Hedged into EUR) Index Morningstar Category Global Bond - EUR Hedged Asset Allocation 2 % Fixed Income Cash & Cash 8.51 Equivalents Overall Morningstar Rating TM 3 Fund Description The fund aims to maximise total investment return consisting of a combination of interest income, capital appreciation and currency gains by investing principally in a portfolio of fixed or floatingrate debt securities and debt obligations issued by government or government-related issuers worldwide. The name of the fund reflects the base currency of the fund (euros), and does not necessarily imply that any particular portion of the fund s net invested assets is denominated in euros. Key Points The US Federal Reserve continued with its balance sheet unwinding in November. In Europe, yields generally declined but the euro strengthened against the US dollar. Across emerging markets, yields rose in specific areas of Latin America and Asia, with some exceptions. Emerging-market currencies broadly appreciated against a weakened US dollar during the month, with notable appreciations in the Mexican peso and Argentine peso. For the month, currency positions, sovereign credit exposures and interest-rate strategies had largely neutral effects on the fund s absolute performance. The fund s relative underperformance was primarily due to interest-rate strategies. Currency positions and sovereign credit exposures had largely neutral effects on relative results. Performance Data Performance Net of Management Fees as at 30/11/2017 (Dividends Reinvested) (%) 4 1 Mth 3 Mths YTD 1 Yr 3 Yrs 5 Yrs 10 Yrs Since Inception (29/08/2003) A (Ydis) EUR JP Morgan Global Government Bond (Hedged into EUR) Index Calendar Year Returns (%) 20% 10% 0% % A (Ydis) EUR JP Morgan Global Government Bond (Hedged into EUR) Index Past performance is not an indicator or a guarantee of future performance. Portfolio Manager Insight Market Review The US Federal Reserve (Fed) kept rates unchanged at its November meeting, but market expectations for a rate hike in December notably strengthened (federal funds futures on 30 November indicated around a 98% implied probability of a hike). Jerome Powell was nominated by US President Donald Trump to be the next Fed chair, scheduled to replace Janet Yellen in February Markets have appeared to view Powell as a mainstream continuation of the Yellen/Bernanke Fed, though Powell brings more private sector experience and more support for deregulation. Market expectations for additional rate hikes in 2018 strengthened after the Powell nomination, with federal funds futures indicating expectations for another rate hike in March The yield on the 10-year US Treasury (UST) note rose three basis points to finish the month at 2.41%. 1. All holdings are subject to change.

2 The Fed continued with its balance sheet unwinding in November, targeting around US$6 billion in USTs and US$4 billion in mortgage-backed securities (MBS) to roll off each month as they mature. That volume is scheduled to increase every three months, beginning in January 2018, as the monthly pace of UST unwinding increases to US$12 billion and the MBS pace increases to US$8 billion. Markets appear to be underappreciating the potential impacts of Fed unwinding, in our view, which we expect to put upward pressure on yields as price-sensitive buyers incrementally replace the Fed s proportional ownership of USTs. Overall, we expect UST yields to continue rising as the Fed unwinds its balance sheet and tightens policy, while inflation pressures build on exceptional strength in the US labour market. In Europe, yields generally declined but the euro strengthened against the US dollar. We expect widening rate differentials between rising yields in the US and the low to negative yields in the eurozone to depreciate the euro against the US dollar. Although the European Central Bank (ECB) is scheduled to reduce the pace of its bond-buying programme in January 2018 to 30 billion per month, down from the current pace of 60 billion per month, the overall monetary effect is still highly accommodative. ECB President Mario Draghi has continued to indicate that rates are not likely to be hiked until quantitative easing (QE) ends, implying that rates would likely remain unchanged in Overall, we expect monetary accommodation to continue in Europe in the upcoming year, with the potential for exceptionally low rates to continue through the end of Draghi s term in November Outside of the ECB, we continue to see ongoing risks to political cohesion across Europe as populist movements continue to influence the political discourse. In Germany, Angela Merkel s efforts to form a coalition government in November were unsuccessful, increasing the political uncertainty for Europe. The euro remains vulnerable to unresolved structural and political risks across Europe, in our view. In Japan, Prime Minister Shinzo Abe s political mandate remains strong after his political coalition maintained its supermajority in October elections. We expect Abenomics programmes to continue as planned with Abe s ongoing political strength. Japan s economy continues to need weakness in the yen. The Bank of Japan (BOJ) continued with its QE programme in November as short-term yields in Japan remained negative. Rising UST yields should produce a more effective environment for the BOJ to actively deploy additional monetary accommodation that weakens the yen, as it continues to target a 0.0% yield on the 10-year Japanese government bond. Overall, we expect the yen to weaken on widening rate differentials with the US. Across emerging markets, yields rose in specific areas of Latin America and Asia, with some exceptions. Emerging-market currencies broadly appreciated against a weakened US dollar in November, with notable appreciations in the Mexican peso and Argentine peso. A number of countries continued to see positive yield carry, benefitting from elevated yields. In Argentina, President Mauricio Macri s political coalition has strengthened in both houses of Congress after election victories in October, improving the likelihood of passing tax and labour reforms. We continue to have positive medium-term outlooks for both Argentina and Brazil as their governments trend away from prior failed policies and move towards important structural reforms. Risk-adjusted yields in Brazil and Argentina remain attractive, in our view. Additionally, we continue to see a number of local-currency markets that we believe are undervalued, particularly in India, Indonesia, Mexico and Colombia. The potential impact of Fed policy tightening on emerging markets should vary from country to country, in our view. Several emerging markets have significantly higher yields than the US Brazil has around a 10.0% yield on its 10-year bonds, Mexico around 7.0% and Indonesia around 6.5%. Countries with this type of yield advantage over USTs should fare better as the Fed unwinds its balance sheet; however, emerging markets with lower yields would likely be more vulnerable, particularly if the interest-rate differential flips. We see additional scope for currency appreciation in specific emerging markets over the medium term, particularly in countries with economic resilience and relatively higher, maintainable rate differentials. Performance Review In November, currency positions, sovereign credit exposures and interest-rate strategies had largely neutral effects on the fund s absolute performance. The fund maintained a defensive approach regarding interest rates in developed markets, while holding duration exposures in select emerging markets. Select duration exposures in Latin America (Brazil) detracted from absolute results, while select duration exposures in Asia ex Japan (Indonesia) contributed. The fund s relative underperformance was primarily due to interest-rate strategies. Currency positions and sovereign credit exposures had largely neutral effects on relative results. Select overweighted duration exposures in Latin America (Brazil) detracted from relative performance, while select overweighted duration exposures in Asia ex Japan (Indonesia) contributed. Portfolio Positioning During the month, we remained positioned in a number of emerging markets, with notable local-currency duration exposures in Brazil, Argentina, Colombia, Indonesia and India, and notable currency exposure to the Argentine peso. We have adjusted specific positions in recent quarters, including eliminating our local-currency exposures in Malaysia in February. In credit markets, we continued to see areas of value in some specific sovereign credits. We also remained positioned for rising yields by maintaining low overall portfolio duration and holding negative duration exposure to USTs through interest-rate swaps. Outlook & Strategy We expect UST yields to rise and the US dollar to strengthen as the Fed moves towards tightening policy while US inflation pressures pick up. We also expect the Fed s balance sheet unwinding to put upward pressure on yields. Several major buyers of USTs have pulled back from the UST market in recent years, including foreign governments and central banks in Asia, notably the People s Bank of China. Major oil producing countries have also pulled back, becoming net borrowers instead of net lenders as they were when oil prices were above US$100 per barrel. The Fed will now be added to that list of diminishing demand, as it unwinds its UST and MBS positions. Although the Fed s credibility came into question when it backtracked on projected rate hikes in 2016, we expect it to remain on course with balance sheet unwinding and rate moves for the remainder of 2017 and into Recent comments from Fed Chair Janet Yellen have emphasised the need to normalise policy while indicating that subdued inflation is not as much of a concern. The Fed has indicated intentions to hike rates in December, hike rates three times in 2018 and move towards a policy rate of 2.75% in Markets have appeared to focus on the speed and extent of rate hikes from the Fed, but not placed enough attention on what will happen to fixed income markets as the Fed unwinds its balance sheet. The Fed will be the first central bank to unwind QE, likely followed by the ECB at a later stage. This level of balance sheet unwinding is unprecedented it could theoretically go smoothly with few disruptions, but in practicality we think that is unlikely. Uncertainties in the markets would likely put further pressure on bond valuations, in our view. Investors who are holding longer duration exposures are taking on a lot of asymmetric risk, in our opinion, particularly in an environment of economic resilience and growing inflation pressures. On the whole, we continue to expect inflation pressures to rise with resilience in the US economy and exceptionally strong US labour markets. We have seen wage pressures pick up in specific pockets of the economy, and we expect those pressures to accelerate. Policy constraints on immigration have also been pressuring wages in various labour sectors. Additionally, financial sector deregulation has the potential to accelerate franklintempleton.lu 2

3 credit activity, stimulate investment and accelerate the velocity of money, which would further drive inflation. Fiscal expansion could similarly add to inflation dynamics. Overall, our expectations for rising inflation are not dependent on any specific policy adjustments (nor are they dependent on commodity prices); rather they reflect all of the already-existing factors combined with the potential for supplemental policy factors. We see preconditions for rising inflation over the next couple years, which should pressure yields higher. In the major developed economies, we anticipate continued monetary accommodation and low rates in Japan and the eurozone while rates rise in the US those increasing rate differentials should depreciate the yen and euro against the US dollar, in our opinion. Japan now has its monetary policies in a good place to essentially allow the Fed to do the work of depreciating the yen for them. During much of 2016, no matter what the BOJ did, the Fed s actions (or lack of action) determined the rate differentials and the currency valuations. When the Fed lowered expectations for rate hikes in March 2016, that move essentially washed out the effectiveness of any easing policies from the BOJ. The same can now be true in the reverse the BOJ does not have to change anything in its current policy stance to get the depreciation it seeks if the Fed now resumes raising rates at a more meaningful pace. Additionally, the BOJ is nowhere close to a stage where it can taper its QE programme, as the country continues to battle deflation. Thus ongoing QE is expected for quite some time. Despite the eurozone being in a cyclical upswing, we continue to have a negative view on the euro not only because of ongoing monetary accommodation, but also because of populist risks. ECB President Mario Draghi has indicated a desire to eventually normalise rates but has also said that the eurozone continues to need monetary accommodation. Optimism for the eurozone appeared to be at a peak during the summer that belied the unresolved structural and political risks within the union, in our view. However, the euro notably weakened after the German elections in September, as Angela Merkel s win came with new uncertainties around forming a coalition. Additionally, the far-right movement polled at its highest level in several generations. Merkel s efforts to form a coalition in November were unsuccessful, increasing the political uncertainty for Europe. Overall, we continue to see ongoing risks to the political cohesion across Europe as populist movements continue to influence the political discourse. We have recently focused on countries that are less externally vulnerable and more domestically driven, and that have demonstrated their resilience to potential increases in trade costs. Select emerging markets that have higher rate environments and domestically oriented economies are likely to fare better in a rising-rate environment than countries with low yields and more externally driven economies, in our view. In Asia, we currently prefer countries with strong domestic drivers that are less leveraged to China, such as India and Indonesia, while we have moved away from economies that are more externally dependent, such as Malaysia. In Latin America, we are focused on countries that have turned away from previous failed experiments with populism, such as Brazil and Argentina, and are now moving towards more orthodox policies with credible monetary policy, proactive business environments and outward-looking trade. We also see attractive valuations in countries like Mexico and Colombia that have maintained sound policy discipline while broadening their economies beyond commodities. China s economy remains in a soft landing, but ongoing rebalancing is needed for the long term. The near-term picture looks fairly stable, in our assessment, but we have concerns for two or three years down the road as China s pace of growth now depends on almost five times as much credit to generate one unit of GDP as it took in the surge of post-global financial crisis growth, starting in The Chinese authorities appear aware of this, but it remains to be seen if they can effectively manage a slowdown in credit. We have seen a number of policies wind down, but we do not expect a hard landing at this point. However, if China has not reduced its credit dependence in a couple years and we get an exogenous shock, such as a recession in the US, then China s ability to intervene to stimulate its economy will be substantially less effective than it was during the last US recession. These risks warrant ongoing monitoring, but the near-term picture appears to support a continued moderation in growth and not a hard landing. Our philosophy is grounded in a focus on long-term fundamentals and patience. We believe that while markets can deviate from fundamentals in the shorter term, they tend to reflect them over the medium to long term. Thus we seek to identify and exploit the imbalances we see in the market and position for the directional trends we see going forward, ahead of inflection points. Our oftentimes contrarian viewpoint also allows us to find potential investment opportunities particularly during periods of volatility and panic, where we can exploit market mispricing. Portfolio Characteristics 5 JP Morgan Global Government Bond Portfolio (Hedged into EUR) Index Yield to Maturity 1.83% 1.20% Yield to Worst 1.83% 1.20% Average Duration Yrs 7.85 Yrs Average Credit Quality 6 BBB AA Average Weighted Maturity 4.66 Yrs 9.79 Yrs 6. The average credit quality (ACQ) rating may change over time. The portfolio itself has not been rated by an independent rating agency. The letter rating, which may be based on bond ratings from different agencies, is provided to indicate the average credit rating of the portfolio s underlying bonds and generally ranges from AAA (highest) to D (lowest). The ACQ is determined by assigning a sequential integer to all credit ratings AAA to D, taking a simple, asset-weighted average of debt holdings by market value and rounding to the nearest rating. The risk of default increases as a bond s rating decreases, so the ACQ provided is not a statistical measurement of the portfolio s default risk because a simple, weighted average does not measure the increasing level of risk from lower rated bonds. The ACQ is provided for informational purposes only. Derivatives are excluded from this breakdown. franklintempleton.lu 3

4 Portfolio Diversification Geographic Allocation 2 NON-US Mexico Brazil Colombia Argentina 4.44 USA South Korea Indonesia India EUROPE Serbia Ukraine Bosnia and Herzegovina MIDDLE-EAST/AFRICA Ghana South Africa SUPRANATIONAL ST CASH & CASH EQUIVALENTS 7.61 OTHER % 10% 20% 30% 40% 50% 60% Currency Allocation 2 EUROPE NON US-DOLLAR Argentine Peso Mexican Peso Colombian Peso Brazilian Real US-DOLLAR MIDEAST/AFRICA Ghanaian Cedi-New South African Rand Indian Rupee Indonesian Rupiah South Korean Won % 0% 20% 40% 60% 80% 100% 120% Geographic Weightings vs. JP Morgan Global Government Bond (Hedged into EUR) Index NON-US Mexico Brazil Colombia Argentina 4.44 USA EX-JAPAN South Korea Indonesia India EUROPE NON-EMU EUROPE Serbia Ukraine Bosnia and Herzegovina MIDDLE-EAST/AFRICA Ghana South Africa SUPRANATIONAL ST CASH & CASH EQUIVALENTS OTHER % -25% 0% 25% 50% 75% Currency Weightings vs. JP Morgan Global Government Bond (Hedged into EUR) Index 2 EUROPE NON US-DOLLAR Argentine Peso Mexican Peso Colombian Peso Brazilian Real US-DOLLAR MIDEAST/AFRICA Ghanaian Cedi-New South African Rand Indian Rupee Indonesian Rupiah South Korean Won % 0% 25% franklintempleton.lu 4

5 Sector Weightings vs. JP Morgan Global Government Bond (Hedged into EUR) Index 2 Credit Quality Ratings 7 Local Currency Government/Agency Bonds - Investment Grade AAA 1.69 Local Currency Government/Agency Bonds - Non-Investment Grade AA Non-Local Currency Sovereign Bonds - Non-Investment Grade 7.80 A Derivatives 0.38 BBB US Treasuries/Agencies BB Supranational 1.68 B 7.95 Cash & Cash Equivalents 0% 10% 20% 30% 40% 50% 60% 70% 8.51 Templeton Global Bond (Euro) Fund JP Morgan Global Government Bond (Hedged into EUR) Index Cash & Cash Equivalents % 5% 10% 15% 20% 25% 30% Investment Grade Non-Investment Grade Cash & Cash Equivalents Supplemental Performance Statistics Supplemental Risk Statistics 8 3 Yrs 5 Yrs 10 Yrs Since Inception Standard Deviation (%) Templeton Global Bond (Euro) Fund JP Morgan Global Government Bond (Hedged into EUR) Index Tracking Error (%) Information Ratio Sharpe Ratio Templeton Global Bond (Euro) Fund JP Morgan Global Government Bond (Hedged into EUR) Index Investment Team Portfolio Manager Years with Firm Years Experience Michael Hasenstab, Ph. D., Executive VP & Chief Investment Officer Sonal Desai, Ph. D., Senior VP, Portfolio Manager, Director of Research Information Ratio and Tracking Error information are displayed for the product versus the JP Morgan Global Government Bond (Hedged into EUR) Index. franklintempleton.lu 5

6 Important Legal Information This document does not constitute legal or tax advice nor is it investment advice or an offer for shares of Franklin Templeton Investment Funds (the Fund ). Subscriptions to shares of the Fund can only be made on the basis of the current prospectus and, where available, the relevant Key Investor Information Document, accompanied by the latest available audited annual report and the latest semi-annual report accessible on our website or which can be obtained, free of charge, from Franklin Templeton International Services, S.à r.l. - 8A, rue Albert Borschette, L-1246 Luxembourg. Past performance is not an indicator or a guarantee of future performance. The value of shares in the Fund and income received from it can go down as well as up, and investors may not get back the full amount invested. Investment in the Fund entails risks which are described in the Fund s prospectus and, where available, in the relevant Key Investor Information Document. Special risks may be associated with a Fund s investment in certain types of securities, asset classes, sectors, markets, currencies or countries and in the Fund s possible use of derivatives. References to particular industries, sectors or companies are for general information and are not necessarily indicative of a fund s holdings at any one time. Currency fluctuations may affect the value of overseas investments. When investing in a fund denominated in a foreign currency, your performance may also be affected by currency fluctuations. Where a Fund invests in emerging markets, this investment can be more risky than an investment in developed markets. No shares of the Fund may be directly or indirectly offered or sold to residents of the United States of America. Shares of the Fund are not available for distribution in all jurisdictions and prospective investors should confirm availability with their local Franklin Templeton Investments representative before making any plans to invest. The information provided is not a complete analysis of every material fact regarding any country, market, industry, security or fund. Because market and economic conditions are subject to change, comments, opinions and analyses are rendered as of the date of this material and may change without notice. A portfolio manager s assessment of a particular security, investment or strategy is not intended as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy; it is intended only to provide insight into the fund s portfolio selection process. Holdings are subject to change. Securities mentioned in this report are not a solicitation to purchase those securities, and are examples of some securities which performed well. Not all securities in the portfolio performed well. These securities do not represent all the securities purchased, sold or recommended for advisory clients, and the reader should not assume that investment in the security listed was or will be profitable. Holdings are subject to change, holdings of the same issuer have been combined. The information provided is not a recommendation to purchase, sell or hold any particular security. The security identified does not represent the Fund s entire holdings and in the aggregate, may represent a small percentage of such holdings. There is no assurance that security purchased will remain in the Fund, or that security sold will not be repurchased. In addition, it should not be assumed that any securities mentioned were or will prove to be profitable. For the most current information on the fund, please contact your Franklin Templeton marketing representative. Performance figures are not based on audited financial statements and assume reinvestment of interest and dividends. When comparing the performance of Franklin Templeton Investment Funds (the Fund ) with a benchmark index, it is important to note that the securities in which Franklin Templeton Investment Funds invests may be substantially different than those represented by the benchmark index. Furthermore, an investment in Franklin Templeton Investment Funds represents an investment in a managed investment company in which certain charges and expenses, including management fees, are applicable. These charges and expenses are not applicable to indices. Lastly, please note that indices are unmanaged and are not available for direct investment. Certain data and other information shown have been supplied by outside sources. While we consider that information to be reliable, we give no assurance that such data and information is accurate or complete. References to indexes are made for comparative purposes only and are provided to represent the investment environment existing during the time periods shown. The indices include a greater number of securities than those held in the Fund. An index is unmanaged and one cannot invest directly in an index. The performance of the index does not include the deduction of expenses and does not represent the performance of any Franklin Templeton fund. Past performance is not an indicator or a guarantee of future performance. CFA and Chartered Financial Analyst are trademarks owned by CFA Institute. Important data provider notices and terms available at 2. Figures reflect certain derivatives held in the portfolio (or their underlying reference assets) and may not total 100% or may be negative due to rounding, use of derivatives, unsettled trades or other factors. Information is historical and may not reflect current or future portfolio characteristics. All holdings are subject to change Morningstar, Inc. All rights reserved. The information contained herein is proprietary to Morningstar and/or its content providers; may not be copied or distributed; and 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. 4. Source for all information is Franklin Templeton Investments. Benchmark related data provided by FactSet. Past performance is not an indicator or a guarantee of future performance. Periods greater than one year are shown as average annual total returns. Fund performance data include reinvested dividends, and is net of management fees. Sales charges, other commissions, taxes and other relevant costs to be paid by the investor are not included. The fund offers other share classes subject to different fees and expenses, which will affect their performance. Please see the prospectus for details. 5. Yield to Maturity, Yield to Worst, Average Duration and Average Weighted Maturity reflect certain derivatives held in Portfolio (or their underlying reference assets). 7. Ratings shown are assigned by one or more Nationally Recognized Statistical Rating Organizations ( NRSRO ), such as Standard & Poor s, Moody s and Fitch. The ratings are an indication of an issuer s creditworthiness and typically range from AAA or Aaa (highest) to D (lowest). When ratings from all three agencies are available, the middle rating is used; when two are available, the lowest rating is used; and when only one is available, that rating is used. Foreign government bonds without a specific rating are assigned the country rating provided by an NRSRO, if available. If listed, the NR category consists of rateable securities that have not been rated by an NRSRO. The N/A category consists of nonrateable securities (e.g., equities). Cash includes equivalents, which may be rated. Derivatives are excluded from this breakdown. Information is historical and may not reflect current or future portfolio characteristics. All holdings are subject to change. 9. Information Ratio is a way to evaluate a manager s ability to outperform a benchmark in relation to the risk that manager is assuming, with risk defined as deviation from the benchmark. This measure is calculated by dividing the portfolio s excess return (portfolio return less the benchmark return) by the tracking error (derived by taking the standard deviation of the monthly differences between the portfolio return and the benchmark return over time). 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