Franklin Templeton’s Jenny Johnson gives her outlook for Saudi and active fund management

Jenny Johnson is the first to admit that her company has been far from a beneficiary of recent stock market trends in her home market.

While the S&P 500, which tracks US stocks, recorded its longest rally ever earlier this year, actively managed funds like those her holding company Franklin Resources (more commonly recognised as Franklin Templeton) has become known for have increasingly taken a back seat to their passive counterparts.

“Franklin Templeton is mostly known for active management and its been a bit of a tough time for active managers, but you know the last 10 years has been a hugely momentum market,” she explains on a brief stopover in Dubai for an investor conference.

“There was almost a blind flux of money into the market in passive.”

As a sign of this shift, investment research firm Morningstar said $692bn flowed into passive funds, which typically track a market index or segment, last year and $7bn flowed out of active funds – with Franklin itself among the biggest losers after seeing $28bn of outflows on the active side.

This trend continued in the third quarter with the most withdrawn from active funds during the period since 2011, at $86bn.

Franklin itself saw overall assets under management drop 5 per cent over the last fiscal year from $753.2bn to $717.1bn, with $38bn of net outflows to September 30.

But with the US Federal Reserve raising interest rates for the eighth time since 2015 in September she says there are hopes that this trend will change.

October 2018 presented one of the most volatile periods for stocks in years with the S&P 500 seeing its biggest monthly decline since September 2011.

“We’re already starting to see that in the last six weeks as soon as you start to normalise central bank intervention, you’re going to see a much more normal market where there is more volatility and less correlation.”

Johnson is hoping this trend and other changes in the investment landscape can help draw investors back to the fund house her grandfather Rupert Johnson founded in 1947.

Among the key opportunities she sees for the firm is in the emerging market space, where a sell-off has taken place in recent months linked to financial issues in the likes of Turkey and Argentina. The MSCI Emerging Markets Index, a key metric of EM performance, is down 16-17 per cent in year-to-date terms at the time of writing.

“You look at progress in Latin America on reforms and some of the reforms going on in Saudi Arabia, as well as some markets stepping back and going the other way, and so there is going to be a bifurcation of the opportunities.”

Franklin has developed something of a name for itself in the emerging market space thanks in part to the efforts of the former executive chairman of Templeton Emerging Markets Group, Mark Mobius, who left the firm in January after more than 30 years to set up his own asset management firm.

But even with his departure, Johnson sees the firm’s “investment feet on the ground” across key emerging markets as being an advantage.

This includes Franklin Templeton’s Dubai office, where it claims to have been the first asset manager to establish a presence in Dubai International Financial Centre back in 2000. Following the full acquisition of local firm Algebra Capital at the start of 2011, the office now stands at 44 people with representation in the global technology and sukuk practices as well as emerging markets and private credit.

While there are no plans for further regional acquisitions or new offices for now, the firm sees key growth opportunities in Saudi Arabia, despite recent setbacks linked to the killing of journalist Jamal Khashoggi.

Foreign investors withdrew $1.7bn from Saudi stocks in October as Western leaders criticised the kingdom and pulled out of an investment conference over its alleged involvement in Khashoggi’s disappearance after he entered the Saudi consulate in Istanbul on October 2.

Despite the withdrawals, Johnson says the firm has been encouraged by recent reforms in the kingdom ranging from changes to stock market rules to the lifting of a female driving ban and foreign investment restrictions in some sectors.

“[When] social and economic reforms happen and you have a young population you’re going to end up having growth and that just is an opportunity for our business,” she explains.

Supporting this outlook have been decisions in recent months by market index compilers FTSE Russell, MSCI and S&P Dow Jones to upgrade the Saudi stock market to emerging market status next year, potentially bringing in tens of billions of dollars to the market.

“We think that Saudi is a growing market with growing potential. The fact is with MSCI adding Saudi to the emerging markets index we think that could be a $40bn-$50bn influx of capital there, and so that of course is going to buoy the markets there as well.”

Johnson believes these upgrades could help the kingdom and wider Gulf region, which has been “punching under its weight”, lose its perception of being solely linked to oil.

“Over time, being included in the index will bring more institutional investors to start paying more attention to the market,” she adds, while suggesting experience of other emerging markets showed the current controversy was unlikely to be a long-term factor.

“That’s the thing with emerging markets, you have these spikes in political activities and that can certainly slow down the flow of capital. As it works through it can pick back up – it’s rarely a permanent impairment of capital.”

As a sign of this positive outlook, in June the firm announced several of its funds had been made qualified institutional investors in Saudi Arabia ahead of the MSCI decision. Just before the Khashoggi controversy hit it also launched a Saudi-focussed exchange traded fund.

The ETF, which came alongside others focusing on South Africa and Latin America, is part of a surprising change in direction for the firm, which has traditionally focussed on actively managed products.

The latest launches bring Franklin’s total to around 40 US-listed ETFs currently trading with fees ranging from 0.09 per cent to 0.39 per cent between developed and select emerging markets, although they still only represent a relatively small percentage of assets under management.

Johnson says the firm believes passive and active funds both belong in people’s portfolios but indicates the firm will continue to favour active products, which still represent 85 per cent of the money held in open-ended mutual funds despite recent declines, in the future.

“Most people over the long run have twists and turns in their portfolio and that’s why if you only pick one we like the choice to be active. If you have the ability to have a portfolio big enough to give you both then both can be appropriate.”

Other moves at the company this year have been linked to acquisitions. In January, Johnson announced an agreement to acquire Edinburgh Partners Limited, an independent fund manager with an AUM of $10bn.

It followed the deal with another in October to acquire alternative credit manager Benefit Street Partners, which has around $26bn in AUM.

“We have one of the largest cash positions of anybody in the asset management business and we do that precisely because as opportunities exist we want to have the cash to be able to acquire them,” she explains.

Johnson says in any acquisition the firm looks for a cultural fit, which in the case of the Edinburgh deal came in the form of CEO Dr Sandy Nairn, who previously worked for late investor Sir John Templeton at Franklin for more than a decade.

More broadly, the firm is eyeing capabilities that will help it weather changes in the investment landscape.

Johnson says she has heard plenty of warnings of the death of the broker since joining in 1988 but she believes human fund managers will continue to remain part of its makeup even if technology plays a larger role.

“The biggest issue with underperformance on the retail client is when there is market disruption they pull money out at the wrong time and are too slow to get back in. We are big believers in that human intervention to keep them in the market is essential to having the good returns,” she says.

“What we think is the technology will enable that financial advisor to be efficient.”

The future then for Franklin Templeton appears to be one where big data and analytics allow fund managers to make more informed decisions.

Johnson says a March deal to acquire data science investment firm Random Forest Capital is an example of the capabilities the firm wants to bring in, namely the use of data scientists to support decisions on which loan portfolios to buy.

“We think it’s just one indication of how data science is going to be important for any kind of active manager to find unique sources of insight leveraging the massive amount of data that’s been created.”

A similar approach is planned outside of the fixed income market with Franklin now establishing financial technology centres where data scientists will find and analyse data using artificial intelligence to support the decisions of investment teams. One such example includes a new office in Vizag, India, in which it will invest up to $62m and support 2,500 jobs.

Johnson says these insights, along with a diversity policy that has seen more than a quarter of leadership roles at the company occupied by women, will place Franklin Templeton in good stead for the future.

“We’re a firm that really has focussed on diversity of thought, getting the best talented people. The danger in the industry has always been your unconscious bias.”

And, amid expectations that the bull market in the US will continue, it will be time for her firm to prove that active management can return to form.

“We tend to think there is still some opportunity in the US market because of the tax reform and the stimulus that gave. You’re obviously long in the cycle here of the bull market but we still think it has some more to go.”