Franklin Mutual Global Discovery Fund

Franklin Mutual Global Discovery Fund's stock selection process is disciplined and consistent. "Deep value" is the core philosophy of the fund's investment process – the fund ....

YT Kum, CFA 11.12.2008
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Investment Strategy
Franklin Mutual Global Discovery Fund's stock selection process is disciplined and consistent. "Deep value" is the core philosophy of the fund's investment process – the fund always looks for companies with significant discount (more than 30 percent) to their intrinsic values. The fund's investment process is completely bottom-up and research driven, with no regard to any benchmark. The fund also explores opportunities in distressed securities and merger arbitrage, but the investment portion is not significant due to its risk budget.

As a "deep value" investor, the fund always aims at buying quality names at cheap prices. The fund defines "quality names" as companies with goo

d managements and leading positions in the industries. Ideally, companies in industries with less competition are preferred (such as tobacco). The fund also keeps its eyes closed to some catalysts, such as spin-offs and share buybacks, which may help to unlock shareholder values.

The Fund mainly invests in mid-cap and large-cap companies with a market capitalization greater than USD 5 billion. It may invest up to 100 percent of it net assets in non-U.S. issuers. All non USD currency exposures are hedged back to USD.

Management Profile
Anne Gudefin, with around 20 years experience in the industry, has managed Franklin Mutual Global Discovery Fund since its inception in October 2005. Charles Lahr, with around 11 years experience in the industry thus far, joined Anne early last year to co-manage the fund.

Anne and Charles, same as other portfolio managers of the Mutual series, are backed by the entire investment team of the Mutual series, which consists of other six portfolio managers, three assistant portfolio managers, and eight research analysts. All portfolio managers and research analysts have their own research responsibilities and they all contribute investment ideas for all funds in the Mutual series. Most of the investment team members are based in New Jersey. The Mutual series does not share research resources with other Franklin funds or Templeton funds.

The team is mainly organized along industry lines, with three specialists covering distressed, bankruptcy and reorganizations. Each team member covers a minimum of 12 – 15 stocks and the research process is coordinated by Peter Langerman, CEO of the Mutual series, and Michael Embler, CIO of the Mutual series.

We see that the fund truly applies team approach – everyone in the team contributes to the portfolio construction with no dominant position, hence it is expected that the fund can still maintain its "deep value" investment approach over the long haul, even with members' departure. In sum, given the team's rich experience (averagely 15 years experience in the industry) and a clear team structure, we have high regard for the investment team.

Performance Analysis
The fund's relative performance has been strong since its inception – the fund resides in the top decile of the Morningstar Global Large-cap Blend category over the three-year as of November-end. As for the absolute performance, dampen by the darkening economic outlook, the fund posted a slight loss of 0.89 percent per annum over the past three years.

Thanks to its "deep value" investment philosophy and the successful tactical cash positioning, the fund outruns its peers during the tough time this year – it dipped 28.64 percent as of 5th December, largely outperforming the average funds in the category, which posted a deep loss of 47.29 percent on average.

On the risk front, the fund has a respectably low volatility (three-year) of 11.13 percent, which is well below its peers' average of 18.78 percent. The fund never aims to be a winner in short-term, but their short- and long-term performances are both outstanding.

Mutual series has amassed a tremendous long-term track record, which may serve as indirect evidence to the fund's success in the "deep value" investment philosophy.

Portfolio Analysis
The fund's extremely low volatility is a feat that no peer has come close to matching. The secrets behind the feat are 1.) defensive stock selection; 2.) diversification, and; 3.) tactical cash positioning.

The fund's large-cap portfolio is generally in line with its "deep value" strategy. Although we have no idea to how significant are the fund's holdings' discounts to their intrinsic values, we can still derive comfort from its stock selection – the fund's portfolio biases to some industries with less competition, such as tobacco and food beverage. Over the long term, history proves that these industries are relatively defensive, though many of them also suffer heavily in the current tsunami.

The fund's portfolio is developed-country-centric (the fund only had very little exposure to an Indian company and a Mexican company at September-end), which helps the fund to stave off the volatility from emerging market equities. At September-end, the funds stashed 16 percent and 9 percent of assets to US equities and French equities respectively.

The fund's defensive stock selection style often helps to maintain its low risk characteristic. However, the fund's investments in distressed securities and merger arbitrage, though they are not significant, may add risk to the portfolio. If performance is the best proof of everything, investors should not worry too much about these investments.

Moreover, the fund's forays into index put options in 3Q08 (the fund has no exposure to option now) also give us some worries, though they are well-timed thus far, as the investment team is structured along industry lines and has no specialist in option trading strategy. Besides, option trading is a short-term trading strategy but not a long-term investment approach; hence it would be somewhat in conflict with the fund's value-oriented philosophy. At September-end, the fund had a combined exposure of 1.41 percent to put options on Euro Stoxx and S&P 500.

As for diversification, the fund's portfolio consists of 158 stock holdings, and top ten holdings only soak up 17.79 percent of total assets at September-end. Taking its high cash level into consideration, the fund is very diversified in normal sense.

The fund is not obliged to be fully invested in equities – if no company fits the fund's stock selection criteria, it will hold more cash. At September-end, the fund held 40.89 percent of cash, compared with 20.48 percent at December-end last year, which is the largest contributor to its outstanding performance this year. However, high cash level is a double-edged sword – it can help a portfolio to weather any storm, but it will hinder portfolio's performance during good times. Given that the fund's cash level is much higher than its peers all the time (around 25 percent on average since inception); investors should keep their eyes closed to how the fund manages its cash holding, especially in good times.

The fund's TER is 1.87 percent as of July-end, which is slightly higher than its peer's average of 1.74 percent.

More on Mutual Series
There are totally three offerings in Mutual series available for sale in Hong Kong, including Franklin Mutual Beacon Fund, Franklin Mutual European Fund and Franklin Mutual Global Discovery Fund. Although they focus on different regions, all three funds share the same investment team and all research resources, thus it is no surprise that holdings of these three funds are similar. British American Tobacco and Imperial Tobacco Group, for instance, can be found in the top ten holdings of all three funds' portfolio. In other words, investing in all three funds can offer investors little help in diversification.

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About Author

YT Kum, CFA  YT Kum is a consultant for Morningstar, contributing to manager selection and asset allocation activities in Asia, and is responsible for providing investment thought leadership on topics relevent to investors in Asia.  

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