Franklin Templeton Investment Funds GUIDE TO BOND FUNDS. Dealer Use Only. Not for Distribution to the Public.

Transcription

1 Franklin Templeton Investment Funds GUIDE TO BOND FUNDS

2 What is a BOND? ISSUERS OF BONDS A bond is a loan, also considered a negotiable IOU, or debt security, issued by a corporation, government or government agency. Investors who buy bonds lend a certain sum of money (principal) to the bond issuer for a specified time period (term). The issuer promises to repay the principal and to make regular interest payments to the bondholder during the term at a rate set when the bond is issued. This stream of payment is considered income or yield. This rate does not change, which is why bonds are called fixed-income investments. Government Bonds A government bond is a bond issued by a national government denominated in the country s own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Municipal Bonds It is common for states, cities, counties, and towns to issue bonds to pay for public projects (roads, etc.) and finance other activities. A major appeal of municipal bonds for investors is the tax efficiency and safety of principal they typically offer. Corporate Bonds Companies issue bonds to finance projects such as modernizing or building new facilities. Corporate bonds come in various maturities usually from one to 40 years. Issues represent a variety of credit qualities also deemed as one measurement of risk. A regular income stream is the main appeal of most bonds. A bondholder usually expects to receive regular interest payments until the bond matures, at which point principal is returned. A bond investor receives the bond s face value at maturity. Before then, however, its market value, like stocks, may rise or fall depending on conditions prevailing in the market. Bonds typically become more valuable when interest rates fall and less valuable when interest rates rise. So an investor could have a capital gain or loss when selling a bond before it matures. Mortgage-Backed Securities A mortgage-backed security (MBS) is similar to a bond, but its cash flow is backed by mortgage payments. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE

3 Bond Prices and INTEREST RATES TWO SIDES OF A SEESAW Like stocks, bond prices can fluctuate in response to a number of factors. Although changes in credit quality and market availability play roles, shifts in prevailing interest rates exercise the most influence over bond prices. Interest rates and bond prices behave like two sides of a seesaw. When interest rates drop, existing bond values usually rise. When rates climb, values usually fall. But depending on the issuer, there may be many other factors that influence a bond s price. Generally, the longer a bond s maturity, the higher the interest-rate risk. In other terms, its price is more sensitive to interest-rate changes. Chart 1: BOND PRICE FLUCTUATION Interest Rates Maturity in years Bond Prices Chart Source: shows Franklin seesaw Templeton of interest Investments. rates versus Chart bond shows prices seesaw over 10, of interest 20, 30 rates years. versus bond prices over 10, 20, 30 years.

4 Bond Mutual FUNDS A bond fund is a professionally managed pool of money that invests primarily in those bonds appropriate to its investment goal. Composing a cost-effective, diversified portfolio of individual fixed-income securities may require greater resources than the average investor has available, so bond funds offer an affordable and convenient alternative. Bond funds are distinguished by the type, credit quality, and length of maturity of the bonds in which they invest. Those emphasizing shorter-term securities and higher credit quality tend to be more conservative than ones offering longer maturities and lower credit quality. More conservative funds generally hold out the prospect of reasonable returns and low risk exposure, while aggressive funds offer higher returns in return for accepting higher risk exposure. For example, high-yield bond funds invest in relatively low-rated bonds issued by companies. In return for accepting to invest in a bond with a low rating, a high-yield bond fund (and those who invest in it) expect a higher income stream than they could obtain from more highly-rated instruments. When an entity wishes to raise funds by issuing a bond, rating services such as Moody s and Standard & Poor s may investigate the bond issuer s financial condition to assess its ability to make interest and principal payments and thereafter assign a credit rating to the bond issue in question. In general, issuers of lower-rated bonds need to offer higher interest rates to attract investors and compensate them for the additional credit risk they assume. Investment-grade bond funds invest in higher quality bonds than the kind of bonds in which high-yield bond funds invest. Investment-grade bonds come with lower risk premiums. As such, they tend to have lower yields. ADVANTAGES OF INVESTING IN BOND FUNDS* While bond funds are as varied as the individual bonds in which they invest, most offer investors the following benefits: Regular Monthly Income A typical bond fund distributes virtually all of its interest income on a monthly basis. Professional Management Professional money managers determine which bonds to buy and sell based on individual security research. They also offer the added value of institutional trade execution and portfolio and risk management. Diversification By owning dozens and even hundreds of individual bonds, a bond fund allows investors to spread principal across a larger number of bonds and currencies than investors probably could achieve on their own. Access to Global Financial Markets Most individual investors do not have the ability to purchase individual bonds in markets outside their own. Easy Access to Liquidity Investors may sell some or all of their shares in a fund at any time and receive their current value (which may be more or less than their original cost). Conclusion Bond funds enable investors to access a diverse pool of bonds at a fraction of the cost of buying those bonds individually. A fund s average maturity can actively be readjusted to deliver the best possible returns to the end investor. *Front-end and, in some cases, back-end sales loads, redemption fees, management fees, Rule 12b-1 fees and other expenses are associated with Franklin Templeton mutual fund investments. Investors' returns are reduced by these fees and expenses. Funds are offered through prospectuses, which contain detailed information about a fund's goals, charges, expenses and risks. They should be read carefully before investing.

5 Benefits of Diversifying YOUR PORTFOLIO LOWER VOLATILITY Chart 3 shows that for the period December 31, 1987 through December 31, 2007, the worst bond market performance in any calendar year was -6.53% in the year ending December 31, 2005, while the worst stock market performance was % in the year ending December 31, Simply put, while the long-term gains of bonds have not been as substantial as those of stocks, they have tended to be more consistent and thus less volatile. LOW CORRELATION Bonds have had low correlations with almost all major asset classes, including stocks, over the past 25 years. Low correlation means bond and stock returns under similar conditions are often moving in opposite directions. Although it does not ensure a profit or guarantee against loss, low correlation between stocks and bonds may help reduce a portfolio s volatility. Chart 2: CORRELATION MATRIX CHART 3: RANGE OF BEST AND WORST ANNUAL RETURNS BONDS STOCKS Stocks 34.63% Bonds BONDS STOCKS % Chart as of December 31, Source: MSCI World Index, Bonds: Lehman Global Aggregate Index. The starting point for return measurement is March 31, Correlation measures how strong the relationship is between two assets. A correlation of 1.0 means that the two move in perfect tandem with each other. A correlation of zero means that the relationship between them is totally random. A negative correlation between two assets means that they move in opposite directions under similar market conditions % -6.53% Worst Source: MSCI AC World Index and the JP Morgan Global Government Bond Index. The starting point for return measurement is December 31, 1987 ending December 31, Returns include reinvestment of interest and dividends. Indexes are unmanaged, and one cannot invest directly in an index. The chart is for illustrative purposes only and does not represent the performance of any Franklin, Templeton or Mutual Series fund. Past performance does not guarantee future results. Best

6 Chart 4: BONDS CAN HELP BALANCE A PORTFOLIO Average Annual Total Return 9.38% 13.81% 8.53% 8.11% 7.16% 6.14% Stocks 50% Stocks/50% Bonds Bonds Source: Lipper Hindsight & Franklin Templeton Investments. January 29, 1988 December 31, MSCI AC World Index and the JP Morgan Global Government Bond Index. Returns include reinvestment of interest and dividends. Indexes are unmanaged, and one cannot invest directly in an index. The chart is for illustrative purposes only and does not represent the performance of any Franklin, Templeton or Mutual Series fund. Past performance does not guarantee future results. Chart 5: IMPROVING A RISK RETURN PROFILE Annualized Return % MSCI AC World 100% JP Morgan Global Gov t Bond Annualized Risk Source: Lipper. Annualized Efficient Frontier to December 31, Equities (MSCI AC World) and Fixed Income (JP Morgan Global Government Bond). Rolling 3-Year Period. U.S. Dollar, equal 10% weightings. Income Reinvested. No Rebalancing Lipper Limited (a Reuters company). The chart is for illustrative purposes only and does not represent the performance of any Franklin, Templeton or Mutual Series fund. Past performance does not guarantee future results. Risk BONDS MAY HELP BALANCE A STOCK PORTFOLIO In the 19 years from January 29, 1988 to December 31, 2007, the MSCI World Index had an average annual total return of 9.38% (in U.S. dollars), with a standard deviation (a measure of volatility and risk) of 13.81%. (A higher standard deviation equals a higher level of volatility). Over the same time period, the JP Morgan Global Government Bond Index had a 7.16% average annual total return, with a standard deviation of 6.14%. In other words, the JP Morgan Global Government Bond Index delivered lower annualized returns over the past 19 years, but was also much less volatile. However, a 50/50 combination of the two indices would have produced an average annual total return of 8.53% in return, with a standard deviation of 8.11%. This suggests that investors whose portfolios were equally balanced between bonds and stocks would have achieved higher returns than investors exclusively invested in bonds, but would have exposed themselves to lower volatility than those invested exclusively in stocks. Chart 6: BONDS HAVE HAD POSITIVE RETURNS IN DOWN MARKETS Stocks Bonds 19.37% 11.75% 4.55% 2.34% % -4.23% % % Chart 4 shows that, as expected, equity returns have readjusted in recent years; a balanced, relatively lower risk, portfolio would have been more appealing. IMPROVED RISK-ADJUSTED RETURNS Chart 5 shows that employed correctly, a blend of bonds and equities can help improve an investor s overall risk-return profile. Source: MSCI AC World Index and the JP Morgan Global Government Bond Index. December 31, 1987 December 31, Returns include reinvestment of interest and dividends. Indexes are unmanaged, and one cannot invest directly in an index. The chart is for illustrative purposes only and does not represent the performance of any Franklin, Templeton or Mutual Series fund. Past performance does not guarantee future results.

7 Chart 7: VOLATILITY AND RETURNS OF DIFFERENT ASSET CLASSES DIVERSIFICATION A balanced mix of bonds and equities in your overall portfolio may help lower risk as bond and stock markets often behave very differently. Over the last 20 years, there have been four down years for stocks, in each of which bonds (as represented by the JP Morgan Global Government Bond Index) had positive returns as shown on chart 6. Therefore, investors that held both stocks and bonds in their portfolios saw their negative stock returns in those four years partially or completely offset by positive bond performance. Chart 7 further emphasizes the risk-reward trade-off of including bonds within a diversified portfolio. BENEFITS OF GLOBAL BOND DIVERSIFICATION Now more than ever, investors focused just on their domestic markets are missing out on increasing opportunities around the world. Economic cycles vary from one country to another. Typically, most countries are not simultaneously at the same point in the economic cycle. Spreading investments across several different countries or regions may help investors reduce the negative impact on their portfolios when one country or region experiences difficulties. FTIF Templeton Global Bond Fund (a subfund of Franklin Templeton Investment Funds, a Luxembourg-registered SICAV) is a good example of a globally diversified fund. Charts 8 and 9 show the fund s investment approach, which involves investing in multiple international bond markets and currencies in an effort to mitigate risk and enhance overall return potential. Average Annual Total Return 20% 15% 10% 5% Bond Large Value Stocks Foreign Stocks Risk/Volatility Small Value Stocks Large Growth Stocks Small Growth Stocks 0% 0% 5% 10% 15% 20% 25% Source: Lipper. 20 yrs to December 31, Large-cap growth stocks are represented by the S&P 500 Index/Barra Growth Index; large-cap value stocks are represented by the S&P 500 Index/Barra Value Index; small-cap growth stocks are represented by the Russell 2000 Growth Index; small-cap value stocks are represented by the Russell 2000 Value Index; foreign stocks are represented by the MSCI EAFE Index; and bonds are represented by the Lehman Brothers U.S. Aggregate Index. Risk is measured by the annualized standard deviation of monthly total returns. Chart 8: PORTFOLIO COMPOSITION December 31, 2007 FTIF TEMPLETON GLOBAL BOND FUND CURRENCY BREAKDOWN % OF TOTAL TOP 10 CURRENCIES Source: Franklin Templeton Investments as of December 31, Chart 9: PORTFOLIO COMPOSITION December 31, 2007 FTIF TEMPLETON GLOBAL BOND FUND GEOGRAPHICAL BREAKDOWN % OF FIXED INCOME TOP 10 COUNTRIES Source: Franklin Templeton Investments as of December 31, Japanese Yen % Swedish Krona % Swiss Franc % Malaysian Ringgit % Norwegian Krone % Poland Zloty % Brazilian Real % Indo Rupiah % S Korean Won % Egyptian Pound % Sweden % South Korea % Malaysia % Poland % Brazil % Indonesia % Supranational % Canada % Mexico % Norway %

8 Why choose Franklin Templeton Investments as your Fixed Income FUND MANAGER? Since 1949, Franklin Templeton Investments has become a globally recognized bond fund manager, responsible for more than US$146 billion in fixed assets (at end-december 2007). Based in San Mateo (California), New York and London our closely-knit fixed-income group remains in constant contact to monitor and update its perspective on the global economy and markets. Research expertise Our team includes more than 100 investment professionals spread across the globe. As well as California, New York and London, we have analysts based in India, South Korea, China and Brazil. The weekly Franklin Templeton Fixed Income Policy committee meeting provides a forum for team members around the globe to share research aimed at uncovering relative value across the fixed-income spectrum. Relatively low expenses Franklin Templeton s ability to buy bonds in large blocks helps reduce fund transaction costs and expenses. Flexibility As investor s investment objectives change, shares can generally be shifted between Franklin Templeton funds within the same fund family without fees or charges*. Our aim as a leading fixed-income money manager is simply to give our shareholders what they re looking for a high level of current income, consistent with prudent investment management. Christopher Molumphy Chief Investment Officer Franklin Templeton Fixed Income Group Extensive resources Franklin Templeton s bond fund managers have at their disposal a vast array of tools and information. Managers have access to sophisticated models for analyzing portfolio risk and performing risk attribution. A dedicated risk management team also partners with portfolio managers to interpret and apply data from these models. * Certain funds offer multiple share classes, subject to different fees and expenses. Certain exceptions and restrictions apply to the exchange program, as stated in the prospectus, and it may be modified or discontinued by the fund(s). Transfers between funds within a family, while incurring no additional transaction fees, may nevertheless result in a taxable event.

9 Investment PROCESS Franklin Templeton Investments meshes the viewpoints of its in-house portfolio strategists, sector specialists, quantitative analysts, and traders to come up with the best investment ideas as illustrated in chart 10. It actively manages bond funds through a tried and tested process that seeks attractive risk/return ratios with the aim of providing investors with consistent streams of income. Franklin Templeton does this by diversifying investments across a large number of uncorrelated active positions, minimizing risk in the process. Chart 10: FRANKLIN TEMPLETON FIXED INCOME GROUP TOP-DOWN Multi-Sector Teams and Global Investment Forum Position portfolios to capitalize on global economic trends Diversified Portfolio of Low-Correlation Positions BOTTOM-UP Sector Specialist Teams Dedicated sector teams add value through security and sector-specific insights QUANTITATIVE Quantitative Research Dedicated team builds proprietary risk models and identifies alpha opportunities

10 FRANKLIN TEMPLETON FIXED INCOME LINEUP WITHIN FTIF UNIVERSE 8 LONGER DURATION FTIF Templeton Global 6 FTIF Templeton Euroland Bond Fund Franklin U.S. Total Return Fund Bond (Euro) Fund FTIF Templeton European Total Return Fund FTIF Templeton Emerging Markets Bond Fund FTIF Templeton Global High Yield Fund FTIF Franklin High Yield Fund EFFECTIVE DURATION 4 2 FTIF Franklin U.S. Government Fund FTIF Franklin Ultra Short Bond Fund FTIF Templeton Global Total Return Fund FTIF Franklin Strategic Income Fund FTIF Templeton Global FTIF Templeton Global Bond Fund Balanced Fund FTIF Templeton Asian Bond Fund FTIF Templeton Euro FTIF Templeton Global Absolute Liquid Reserve Fund Return (USD) Fund FTIF Franklin High Yield (Euro) Fund SHORTER DURATION 0 FTIF Templeton U.S. Dollar Liquid Reserve Fund FTIF Templeton Global Absolute Return (Euro) Fund -2 AAA Average B INVESTMENT GRADE CREDIT QUALITY BELOW INVESTMENT GRADE Source: Franklin Templeton Investments, December 31, 2007.

11 Different Investments Provide DIFFERENT SOLUTIONS We have highlighted seven common investor needs along with corresponding fixed-income strategies. You can help your clients choose the fixed-income funds discussed on these pages. INVESTOR NEED FIXED-INCOME FUND SOLUTION FRANKLIN TEMPLETON INVESTMENT FUND CHOICES One Diversified Income Investment Multi-sector funds have the flexibility to invest across various sectors of the fixed-income market, such as government, corporate and global bonds FTIF Franklin U.S. Total Return Fund Consistent Income and High Credit Quality GNMA funds invest in Government National Mortgage Association (GNMA) securities, which are pools of home mortgages guaranteed by the full faith and credit of the U.S. government as to timely payment of principal and interest. FTIF Franklin U.S. Government Fund High Income High-yield funds invest in high-yielding corporate bonds (generally with non-investment grade ratings). These securities typically provide higher yields than most other fixed-income instruments because they have a greater risk of default or loss of principal. FTIF Franklin High Yield (Euro) Fund FTIF Franklin High Yield Fund FTIF Templeton Global High Yield Fund FTIF Franklin Strategic Income Fund Global Diversification Global bond funds invest in bonds from around the world. International fixed-income markets are subject to different interest rate cycles and economic conditions and can thus offer valuable diversification. FTIF Templeton Global Bond Fund FTIF Templeton Global Bond (Euro) Fund FTIF Templeton Global Total Return Fund Regional Diversification Regional bond funds invest in bonds from specific regions around the world. Regional fixed-income markets are subject to different interest rate cycles and can thus offer valuable diversification to a portfolio. FTIF Templeton Asian Bond Fund FTIF Templeton Euroland Bond Fund FTIF Templeton Emerging Markets Bond Fund FTIF Templeton European Total Return Fund Cash Plus Returns Short-duration funds invest in high-grade securities with durations typically under a year. While not cash or money market instruments, the yield advantages to be had from moving out slightly on the credit and yield curves typically help investors to achieve more income than they would otherwise. FTIF Franklin U.S. Ultra Short Bond Fund Absolute Return Absolute return funds typically aim to achieve positive returns regardless of market indexes or market benchmarks. Total portfolio risk is strictly managed around a risk-free benchmark, often cash. FTIF Templeton Global Absolute Return (USD) Fund FTIF Templeton Global Absolute Return (Euro) Fund

12 GLOSSARY OF TERMS Average Portfolio Maturity: The average maturity of all the bonds in a bond fund s portfolio. Bond: A bond is a loan, also considered a negotiable IOU, or debt security, issued by a corporation, government or government agency. Credit Risk: The possibility that a bond issuer may not be able to pay interest and repay its debt. Duration: The weighted average maturity of a bond. Duration is useful as a measure of the sensitivity of a bond s price to interest rate movements. Face Value: The amount that a bond s issuer must repay at the bond s maturity date. Inflation Risk: The risk that all or part of an investment s return may be offset by inflation. Interest Rate Risk: The possibility that a bond s or bond mutual fund s value will decrease due to rising interest rates. Weighted Average Maturity: Another term for bond duration. Yield: A measure of net income (dividends and interest) earned by the securities in the fund s portfolio less the fund s expenses during a specified period. A fund s yield is expressed as a percentage of the maximum offering price per share on a specified date. Investors should consider the Fund s investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other information about the fund. To obtain a free prospectus, please call Sales and Marketing at 800/ Investors need to read the prospectus carefully before investing. Not all funds mentioned may be available for sale through your firm. Franklin Templeton Investment Funds ( FTIF ) is an investment company with variable capital incorporated in Luxembourg and established as an umbrella fund with multiple sub-funds. Sales of shares of FTIF will be made on the basis of its current prospectus only, accompanied by a copy of the latest available audited annual report and, if subsequently published, the latest unaudited semi-annual report. This material does not and will not constitute an offer of shares of FTIF. An investment in FTIF entails risks, which are described in its prospectus. Investors may not get back the full amount invested and the net asset value of FTIF will fluctuate with market conditions. Exchange rate fluctuations, fund charges, taxes and any asset-based fee charged by third parties to clients who invest in FTIF through a fee-based account will affect the return to the investor. Past performance is no guarantee of future performance. Please ensure your client reads the Prospectus before deciding to invest. Any research and analysis contained in this guide has been procured by Franklin Templeton Investments for its own purposes and is provided only incidentally. Any views expressed are the views of the investment manager and do not constitute or form part of legal, tax or investment advice or an offer for shares or an invitation to apply for shares of FTIF. Shares of FTIF are not available in all jurisdictions. FTIF shares may not be directly or indirectly offered or sold to U.S. Persons and may not be offered or sold in any jurisdiction where such offering or sale is prohibited. FTIF has been authorized for public sale in certain jurisdictions and private placement exemptions may be available in others. Please contact Franklin Templeton if you are unsure of the availability of FTIF in your client's jurisdiction. For the definition of U.S. Person, see the current FTIF prospectus. Performance figures are not based on audited financial statements and assume reinvestment of interest and dividends. When comparing the performance of FTIF with a benchmark index, it is important to note that the securities in which FTIF invests may be substantially different than those represented by the benchmark index. Furthermore, an investment in FTIF represents an investment in a managed investment company in which certain charges and expenses, including management fees, are applicable. These charges and expenses are not applicable to indices. Lastly, please note that indices are unmanaged and are not available for direct investment. Certain data and other information shown have been supplied by outside sources. While we consider that information to be reliable, we give no assurance that such data and information is accurate or complete. BENEFITS OF FIXED-INCOME INVESTING WITH FRANKLIN TEMPLETON INVESTMENT FUNDS Research expertise: Extensive capabilities integrated into one platform. Extensive resources: One of the largest mutual fund organizations in the world. Relatively low expenses: Franklin Templeton has the ability to buy bonds in large blocks helping to reduce fund transaction costs and expenses. Flexibility: As investment objectives change, shares can generally be shifted between Franklin Templeton funds without fees or charges. Investment process: Multiple views incorporated into a single, coherent framework in the pursuit of diversified sources of alpha across multiple securities, sectors and markets. A copy of the FTIF prospectus and/or the latest financial reports can be obtained from Franklin Templeton International Services S.A., 26 boulevard Royal L-2449 Luxembourg - Tel: (+352) Fax: (+352) This publication has been made available to you for informational purposes only by Templeton/Franklin Investment Services, Inc., 100 Fountain Parkway, St. Petersburg, Florida Tel: (800) (USA Toll-Free), (877) (Canada Toll-Free), and Fax: (727) OA BGTBE 01/08