Franklin Boosted Ukraine Bet to $6 Billion as Selloff Began

Franklin Resources Inc.’s biggest funds ramped up their bet on Ukraine by more than $1.4 billion in the third quarter, adding to the asset manager’s status as the country’s largest international bondholder weeks before street protests deepened the worst rout in developing markets.

The U.S. and European versions of the Templeton Global Bond Fund and the Templeton Global Total Return Fund increased holdings of Ukrainian international dollar debt by $1.4 billion in face value to more than $6 billion, or about 40 percent of the country’s outstanding overseas securities, quarterly filings from the end of August and September show.

The bond selloff that began in September has intensified as protests turned violent after President Viktor Yanukovych halted trade pact talks with the European Union in favor of a possible deal with Russia. Yields on Ukraine’s notes due in June have soared to more than 19 percent a year after they were issued at 7.95 percent, making them the worst-performing emerging-market sovereign dollar bonds this year, as the country’s foreign reserves tumbled to a seven-year low.

“We are not very optimistic,” Steffen Reichold, an economist at Stone Harbor Investment Partners LP, which manages $63 billion in assets and is underweight on Ukrainian debt, said in a telephone interview from New York. Trading is drying up as default concerns grow, he said. “Right now, it doesn’t seem that there’s much bid out there. It’s very difficult to sell a significant amount.”

High Yield

The yield on Ukraine’s dollar notes due in June 2014 slipped 18 basis points, or 0.18 percentage point, to 19.43 percent at 5:15 p.m. in New York and was up 303 basis points this week, according to data compiled by Bloomberg.

Franklin Templeton, whose $190 billion global bond group is overseen by Michael Hasenstab, looks to buy “out of favor” assets that it anticipates will rebound, spokeswoman Stacey Johnston Coleman said.

She cited the group’s investment in Irish debt in 2011, which she said stirred up “a lot of noise about the size and associated risk” at the time, as an example of a contrarian investment that paid off for the fund. As the European debt crisis faded, Ireland’s bonds gained 56 percent over the past two years, according to an index compiled by Bloomberg.

The $70 billion Templeton Global Bond Fund, based in San Mateo, California, has returned 9 percent annually over the past decade, ranking in the top 1 percentile among its peers, according to data compiled by Morningstar Inc. Hasenstab was named the Top Global Bond Fund Manager in 2010 by Bloomberg Markets magazine.

‘Contrarian Approach’

“Franklin Templeton’s global bond group often takes a contrarian approach to investing,” Johnston Coleman said in an e-mailed response to questions. “It has the research capabilities, size and long-term perspective to buy and hold investments that are out of favor. The group has the size to take what may seem like large stakes in a single country, and hold those positions for as long as needed.”

Ukraine’s crisis is deepening as the country, mired in its third recession since 2008, burns through reserves in a bid to prop up the currency and meet foreign debt payments. Reserves have plunged 16 percent this year to $20.6 billion.

The eastern European nation has about $59.5 billion in local and foreign currency bonds and loans outstanding, including more than $35 billion maturing by the end of 2017, according to data compiled by Bloomberg.

“The repayment requirement is very large,” Stone Harbor’s Reichold said. “It’s more likely to default than many people think.”

Dollar Bonds

Ukrainian dollar bonds have lost 9.4 percent this year, heading for their biggest annual slump since the 2008 global financial crisis, according to data compiled by JPMorgan Chase & Co. The 11.78 percent average yield on the country’s dollar debt is the second-highest among major developing nations after Venezuela, according to JPMorgan.

Five-year credit default swaps protecting holders of the nation’s debt against non-payment have surged 110 basis points this week to 1,097 basis points. The contracts traded at 627 basis points at the end of last year.

Russia and the EU are jostling for influence over the nation of 45 million people, which serves as an essential transit route for Russia’s gas shipments to Europe. Ukraine’s opposition is pushing for a cabinet free of influence from Russia, which supplies 60 percent of the country’s gas, and for expanded trade to pull the nation out of recession.

Cabinet Changes

Demonstrations escalated yesterday, the 13th day of protests against Yanukovych’s rejection of the EU trade pact, as tens of thousands of people marched to the presidential palace in central Kiev to demand the government be fired after the opposition lost a no-confidence vote in parliament. Calls by protesters for the administration’s dismissal intensified even as Prime Minister Mykola Azarov pledged cabinet changes.

The government is stepping up its hunt for financial support to stem the crisis. Yanukovych is lobbying in China for investments and loans while delegations will travel to Russia and Belgium, according to Azarov.

“There needs to be a fundamental catalyst to really lead to stability in bond prices,” Alexander Moseley, a senior portfolio manager at Schroders Plc, which oversees $87 billion in fixed-income assets globally, said in a telephone interview from New York. There needs to be “some clarity over whether there will be early presidential elections and clarity over what the opposition and the protesters will do next, and ultimately clarity about an additional source of foreign exchange over the course of 2014.”

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