Irish turnaround is 'probably one of the investments of the decade'
INTERVIEW:It’s a crisp, blue Californian day at Franklin Templeton’s head office in San Mateo, on the US west coast. The asset management firm, located between the city of San Francisco and Silicon Valley, has become an unlikely protagonist in Ireland’s ongoing financial story.
Within 18 months, the company’s fixed income portfolio manager* has gone from being known to just a select group in financial circles to something of a household name – in Ireland anyway.
He doesn’t say so, but one gets the impression that Michael Hasenstab, who has built up an €8.5 billion holding in Irish bonds, is not entirely comfortable with the kind of cosy familiarity and everyman commentary this public profile brings. The 39- year-old fund manager is more used to explaining his investment strategy to the world of high finance.
With $165 billion of assets under his management, Hasenstab is one of the biggest – and most successful – fund managers in the world. His flagship Templeton Global Bond Fund has clocked up annualised returns of 10.66 per cent over the 10 years to the end of October last for investors.
But it is his recent investment in Ireland that has caught the attention of the investor community and the public on this side of the Atlantic.
Hasenstab first popped up on the Irish radar in July 2011 when his fund began buying Irish government bonds aggressively. It was a precarious moment – Ireland had just been downgraded to junk status, yields had soared to 14 per cent, and, as Hasenstab puts it, there was “massive panic” in the market.
Since then Franklin Templeton has increased its purchases in the secondary market and partaken in the NTMA’s bond auctions this year. It now owns an estimated €8.5 billion, or 10 per cent of the Irish bond market, a mix of primary and secondary, though most was accumulated in the secondary market in 2011 and early this year. So, the obvious question is, why Ireland?
“We had been looking at Ireland quite intensely for close to a year before we actually made our investment,” says Hasenstab. “Our initial read was that the market seemed to be lumping a handful of countries together as if they were all the same – Ireland, Greece, Portugal, Italy. Any time the market lumps a bunch of countries together, chances are it’s oversimplifying the situation.
“For us, the two outliers were Greece and Ireland. Our view on Greece was that it was fiscally insolvent.”
But Hasenstab and his team of analysts spied an opportunity in Ireland. “What really attracted us on the economic side, and still attracts us, was the very competitive economic fundamentals.
“Taking aside the chaos of the financial crisis, where clearly there was an over-investment, and a crash, this was evidently a country with an incredible wealth of long-term drivers of growth.”
Chief among these were competitiveness and “labour flexibility”, he says. “Ireland was far more flexible than any country in Europe in terms of its skilled, productive workforce and flexible labour market. A downward adjustment in real wages allowed exports to get competitive.”
Dealing with its problems upfront, including recapitalising its banks, also distinguished Ireland from most of the rest of Europe. “Take the banks for example. What Spain is doing today, Ireland did three years ago.”
Politically, Ireland’s “relative bi-partisan” support across the political parties, coupled with relative social cohesion, helped to instigate change, Hasenstab says. He acknowledges the social cost of these measures, including unemployment.
“[That] will take time to recover. There is no way to go through a financial market collapse of the magnitude of Ireland, the UK, the US without incurring an elevated level of unemployment. The question is to try and get through it as quickly as possible.”
Short-term pain will lead to recovery, is his message. “Look at Japan, where an inflexible labour market means you never get the innovation, you never get the recovery; you just stagnate for decades.”
Franklin Templeton’s investment in Ireland has so far proved prescient since its initial investment in July last year. Irish bond yields are now down to as low as 4 per cent. The sharp increase in the value of Franklin Templeton’s Irish bonds means the fund is sitting on billions of euro of paper gains.
The fund’s exposure to Ireland has caused some in the investment community to question whether Franklin Templeton’s holding is driving the Irish bond market.
“I would take those comments with a grain of salt,” says Hasenstab. “We bought a lot of Irish securities at very distressed prices [which] means someone was selling those bonds.
“I think there’s a fair amount of regret by people who sold those at distressed prices when they are now trading at par or above par. I think there is also some regret from people who missed what I would argue is probably one of the investments of the decade, the Irish turnaround.”
While he accepts that some investors were precluded from holding the bonds because of the ratings downgrade, he believes this only accounts for some of the dumping of assets onto the market at the time. “It was a mix. Some had to; some panicked.”
The fact that Franklin Templeton partook in this year’s NTMA bond auctions also dispels this idea that the holding is in some way a driver of the market, he says. “You don’t drive secondary prices if you take part in primary issuance.”
Neither is his position on Ireland predicated on a deal on Irish bank debt, he says. The decision at the June summit to de-couple sovereign from banking debt, contributed to a fall in Irish bond yields this year.
“Our investment is not dependent on that, but I think Ireland absolutely deserves it. Ireland is benefiting from the fact that they took the tough medicine upfront but the terms that they got from official support probably could be revisited . . . I think there is growing awareness that Ireland really is the model for growth and austerity and any credit they can get from that is well deserved.”
He also dismisses fears about the possible impact of any sudden offloading of the holding. “We’re not looking at short-term trade, we’re looking for a country that we can make an investment in for years. That applies to our investment strategy across the board.
“Our typical investment is three to five years. We’re really looking to invest in a country where we think over the course of the next one to 10 years, it will be in a lot better position in the future than it is today.”
Does this mean he plans to hold the bonds until maturity? “We certainly keep them a long time. Whether it’s all the way to maturity varies.
“It’s really a function of how things play out, but certainly when we went into Ireland, like in any country, we’re taking a view that five years from now, the Irish economy is going to be in a much better place.”
Hasenstab also points out that the funds’ holding of Irish government bonds is relatively moderate. “While Ireland is an important investment in the portfolio, relative to the total assets I manage, it’s moderate . . . The size of the fund gives us the staying power to ride through any short-term changes.
“We don’t worry about month-to- month or quarter-to-quarter volatility. Our investment performance as judged by our shareholders is based on long-term investment performance, so that may mean that maybe Ireland underperforms for a month, or a quarter, but what we really care about is whether it is on the right long-term track.”
Taking a contrarian view has been a hallmark of Hasenstab’s investment strategy. His two most significant managed funds – Templeton Global Bond Fund, and Templeton Global Total Return Fund, which are open to international, including Irish, investors – have accumulated a diverse portfolio of perceived riskier bond assets which have delivered double-digit growth.
Ireland keeps company with countries such as Poland, Hungary, Mexico and Korea in the funds. Essentially, the policy is to buy in when others are selling.
For Hasenstab, the fund’s strategy on Ireland is simply replicating other successful positions in the fund. He cites the example of Korea, the fund’s largest holding, which underwent a period of over-leveraging but has now seen its debt-to-GDP ratio fall, and its manufacturing industry move up the value chain.
Indonesia, which underwent a liquidity crunch at the end of 2008 and early 2009 is another example, which has delivered gains for the fund.
Choosing to invest in perceived riskier assets is no mean feat in light of the colossal sums of money at stake – Hasenstab manages $165 billion on behalf of investors.
But the firm’s investment philosophy is underpinned by a much more fundamental belief that the investment landscape is changing. Risk taking is becoming an inevitable – even essential – part of all investment strategies, he says. To preserve value, in other words, you have to take risks.
“In the past, you could put money overnight on deposit at the bank, or buy a 10-year US Treasury or German bund which was considered your risk-free asset. The reality today, given where those short-dated yields are and given where inflation is, is that is no longer risk-free . . . Putting money overnight on deposit is actually a guaranteed way to lose money, inflation will eat away at that.
“Long-term treasury yields in the US or Germany are at very, very expensive levels and, on a real basis, negative, so that’s not a safe haven. So even just to preserve one’s financial assets, one has to take a degree of risk . . . So what our task is is to look for where we’re getting adequately compensated to take risk.
“You’re going to have to take risk but the key is to make sure you’re getting compensated for that risk, so what we’re doing is trying to scour the world for areas where we think, five years from now, those investments will have equal and better value than they do today, where we’re earning a decent real yield, generating some income in that process.”
Central to this strategy is a strong emphasis on research. Some 50 senior executives report into Hasenstab from Franklin Templeton’s offices in San Mateo, London and Singapore as well as the Bric countries, reinforced by research personnel based in local markets.
This co-mingling of the macro and the local, politics and economics, is one of the unique offerings of Franklin Templeton’s bond portfolio, according to Hasenstab, and one that can perhaps be traced to his own undergraduate degree in international relations and political economy. (Hasenstab later completed a PhD in economics, specialising in China.)
He cites a former professor, Roy Grow, a specialist in international relations as a key mentor, who “conceptually helped to look at the world through that political-economic lens”.
Hasenstab himself spends about a third of his time on the road. He and his team have visited Ireland “several” times, and have met “all the main characters”, he says. While he remains tight-lipped on individuals, he is believed to have met Department of Finance head John Moran and NTMA chief executive John Corrigan.
Overall, Hasenstab is optimistic about the prospects for Ireland and Europe. “Ireland is about three to four years ahead of other countries in Europe,” he says, though he believes that the European response to the crisis has improved.
“The crisis management has improved dramatically . . . Now the challenge will be getting the long-term sustainability back on track, so we need ongoing commitment to appropriate fiscal measures, ongoing steps towards labour market flexibility.”
In a nutshell, he believes long-term economic recovery and sustainability can be put down to that good old reliable – the debt/GDP ratio.
“Take the debt to GDP ratio. The thing Ireland has going for it is that it’s lowering the debt and increasing the GDP. For many other countries, they’re trying to lower the debt, but they don’t have any GDP growth . . .
“I don’t think that Europe, in a broad sense, will have the pro-growth competitiveness of Ireland, but if they got half of it, or even a quarter of it, that’s probably enough.”
CV Michael Hasenstab
Name: Michael Hasenstab
Job: Senior vice president of Franklin Templeton fixed income group and co-director of international bond department
Family: Married, one child
Lives: San Francisco
Education: BA in International Relations and Political Economy at Carleton College, a small private liberal arts college in Northfield, Minnesota; Masters and PhD from Australian National University, where his PhD thesis focused on the development of China’s debt and equity markets .
Career: Joined Franklin Templeton in 1995. After taking a leave of absence to complete his PhD, he rejoined the company in 2001. Has managed its flagship fixed income funds, such as the Templeton Global Bond Fund for just over 10 years .
Hobbies: Mountain-climbing. Despite several visits to Ireland, he doesnt play golf.
Something you might expect: Hes being compared to other heavyweight bond investors such as Bill Gross of Pimco.
Something that might surprise:In a departure from the investment banker alpha-male stereotype, in person he is a quietly confident, well-spoken all-round nice guy.
View from abroad: Hasenstab on . . .
Ireland:“Ireland is now the second fastest if not the fastest growing economy in Europe, along with Germany. The PMI numbers in Ireland are in fact better than in Germany.”
Ireland as a destination for FDI: “Ireland maintains very business-friendly income taxes and corporate taxes, so it remains a destination for foreign companies who want to operate in Europe. This is not an accident. Its because of the business, regulatory and tax environment.”.
His 10 per cent holding of Irish bonds:“It’s an important investment [but] relative to the total assets I manage, it’s moderate.”
The liquidity of the Irish secondary bond market:“Right now there are more buyers than there are sellers . . . Some of the buyers that sold off in the middle of last year are coming back in.”
Europe:“Europe needs co-ordination beyond crisis management. It now needs to focus on more long-term sustainability, which includes a more unified banking union and fiscal arrangement. Those don’t need to happen tomorrow but what we do need to happen tomorrow is that we see signs that we are going in that direction. We need to see progress. We will be watching closely over the next couple of years.”
Monetary policy:“The policy of printing money is unprecedented. Never in the history of central banks have we printed this amount of money. The only example we have is Japan in the 1990s. [The policy is] artifically suppressing yields in the US and Germany, boosting asset prices elsewhere. Ultimately, it will probably transmit inflation into emerging economies.”
European bond-buying:“The ECB is an important stop-gap in the future if a country needs liquidity assitance, provided they are doing the right things fundamentally.”
Rating agencies:“Should Ireland be upgraded? Absolutely. Ireland is regaining access to the credit markets, meeting all of their targets, surprising a little on the upside on some of its targets. As soon as it’s upgraded to investment status, buyers will come back in.”
*This article was edited at 12.02pm on December 14th, 2012