Dan Hallett

From our Canadian Bureau: Templeton Growth Gets New Manager - Again Changing of the Guard A Non-Event

It was just this past summer when Templeton Growth saw its lead management duties handed over from Mark Holowesko to Sean Farrington - just its second manager change in the fund's 46-year history. This week, just a few short months later, it was announced that yet another change at the helm was on the horizon. Given the fund's below average compound return numbers and recent manager changes, some may think it's time to exit this old fund. We'll look at why this fund remains a keeper.

Details of the change

After just a few months in charge of Canada's largest mutual fund, Sean Farrington has accepted a role elsewhere within the Franklin Templeton organization, leaving George Morgan as the main guy behind this $10 billion Growth Fund starting in January. Farrington will be working with Mark Holowesko on a hedge fund for the firm's high net worth clients.

It's a natural reaction for some to look at some of the underperforming Canadian portfolios for which Mr. Morgan was lead manager and draw conclusions about his ability to run the Growth Fund. However, such a judgement would be short sighted without truly knowing the man or the organization. Morgan has been assisting Don Reed on Templeton's International Stock fund since 1995 and has been successful as a lead manager on global portfolios for Franklin Templeton's institutional clients. More importantly, in this case, is the firm's investment process.

The organization is larger than the individual

Whenever a mutual fund announces a change in lead managers, there is one key question that investors must ask: was this fund's past performance attributable to the management firm or to the individual manager? My September 29 article for myto.com about manager turnover outlined the qualities that investors should look for in a management company so that they choose investments that are immune to effects of manager changes.

In that article, I highlighted Franklin Templeton for their highly disciplined investment process and organizational structure. In a firm like this, nobody is bigger than the organization. In other words, the heart of the investment process is their proprietary stock database and strong team of analysts that do the legwork to compile the "bargain list" of approved stocks. Once that list is put together, lead managers need only pick from that approved list to structure their portfolios. In a conference call this past week, Morgan confirmed that lead managers simply don't have the discretion to pick stocks that aren't on Franklin Templeton's "bargain list." The role of the lead manager should not be minimized, but it needs to be placed in proper perspective, in the context of the larger process.

To demonstrate, let's look at the Templeton Canadian Stock fund for a moment. Of the past six calendar years, just once (in 1997) did it beat the TSE 300 or the average in its category (Source: Paltrak98). However, Franklin Templeton has tried everything with that fund, from relaxing their value criteria to changing lead managers and nothing seems to work. The fund continues to underperform. Why? I'm not exactly sure what it is, but I'm pretty sure of what it's not. It's not the lead manager. On the flip side, Mark Holowesko took over the Growth Fund from the legendary Sir John Templeton (talk about a tough act to follow), but the organization made that a smooth transition.

The myth of underperformance

Investors often look at historical compound returns when comparing funds. In carrying out this exercise with this fund one might come to the conclusion that Templeton Growth has been below average for the last ten years. In fact, the poor showing over that time is due mainly to one awful year - 1998 - when the fund turned in a paltry 0.7% return. In fact, looking back at the last ten calendar years, this fund has beaten most of its peers and the Morgan Stanley World Index in eight and six of those years, respectively (Source: Paltrak98). In addition, on a year-to-date basis, the fund is ahead of both its peers and the index. That's a far cry from ten years of underperformance.

Outlook

Templeton's process remains soundly unchanged, their team of analysts are numerous and talented, and the portfolio is full of quality names that are trading at substantially lower valuations than the Morgan Stanley Capital International (MSCI) World Index, with higher yields. To illustrate, consider the fact that Templeton Growth has the following valuation ratios as of November 30, 2000:

• a weighted average price-to-book ratio of 1.7 times (vs. 3.5 times for the MSCI index)
• a price-to-earnings ratio of 11.6 times (vs. 26.4 times for the index)
• a price-to-cash-flow of just 6.4 times (vs. 14.2 times for the index)
• a dividend yield that is double the index's 1.5% yield (before fees)

Portfolios with similar characteristics have, over time, tended to produce higher returns with relatively less risk than an index.

Manager changes often give rise to a reorganization of the portfolio by the incoming manager, often resulting in big taxable distributions. However, given the consistency of this firm's approach, Morgan expects to make no significant changes to the portfolio - good news for unitholders.

Recommendation

If Franklin Templeton had been having trouble retaining skilled managers and/or analysts, I'd be worried. However, that's not what has happened. Instead, Holowesko and Farrington have simply accepted new opportunities within the firm.

To recap, Templeton Growth is a fund that has outperformed its peers in 8 of the last 10 calendar years, has an investment style that is consistent among all of its individual team members, and holds stocks that are cheap and fundamentally attractive. Finally, Franklin Templeton has orchestrated very smooth and successful manager changes in the past.

In my opinion, this is ample evidence that Templeton Growth continues to be a superb core holding for many portfolios. In other words, it's a "buy."

Dan Hallett, B.Comm., CFP is Senior Investment Analyst with Sterling Mutuals Inc. Sterling Mutuals Inc. is registered in Canada as a mutual fund dealer in the provinces of Ontario, British Columbia and Manitoba. Published mutual fund return data was provided by Paltrak 98.