Investor interest in low-volatility derivatives-wrapped equity products has prompted US asset manager Franklin Templeton to work on launching a range of such strategies.

The US fund house has been working with its internal quantitative investment group to experiment with derivative wrappers that dampen volatility, said Norman Boersma, who overseas Franklin Templeton’s flagship global and international equity funds.

“Investors want the best of both worlds: all the upside and none of the downside,” he told AsianInvestor during a recent trip to Asia.

Investors can’t get the returns they want from fixed income, and the volatility of the global financial crisis in 2008-09 has scared many off usual equity products, added Boersma, chief investment officer of Templeton Global Equity Group and co-portfolio manager for the Templeton Global Income Fund.

“But the reality is that equities are subject to volatility," he said. "That is the ‘risk’ that investors assume to obtain what have traditionally been higher long-term returns from equities as an asset class.

"There are things we can do to attempt to hedge out the volatility from an equity portfolio, but it’s like buying insurance: you have to pay a premium. Theoretically, that premium eats into returns. So there are trade-offs.”

With regard to asset class opportunities, Templeton is overweight energy, including a mix of oil services stocks. This is because the rising cost of finding oil is creating a revenue stream for firms with the expertise required for activities like fracking and offshore drilling.

“US oil companies have re-rated slightly, but the Europeans really haven’t,” he said. “There are a number of names we have been buying in Europe. The European energy sector is trading at 9.8x cyclically adjusted earnings, its lowest level in three decades.

“For about a decade, as oil prices rose, companies were pulling low-cost carbons out of the ground from legacy oilfields," noted Boersma. "These companies have generated a lot of cash flow, part of which has gone on paying dividends, 5% dividends in general. But a lot of cash flow was reinvested in trying to find new reserves, with varying degrees of success.”

Exploration and production productivity has been falling as oil companies look further afield, which raises questions about return on invested capital.

“We have identified a number of companies where capex is declining and prospects for production growth are improving as former capital projects come on-stream, allowing management to refocus on shareholder returns,” Boersma said.

French oil major Total and Norway's Statoil are stocks Templeton has owned that have benefited from this trend. Last September, Total signalled that capex had peaked, while in February Statoil announced an 8% cut in capex. Both stocks went on to outperform the MSCI World Energy sector.

"This behaviour is being rewarded by the market, and we expect to see more of it across the energy space," said Boersma.

With regard to Asia, Templeton has for the past few months been gradually adding exposure to resource and infrastructure stocks in China, as their valuations have fallen against a backdrop of concerns about economic growth. 

And the firm has been selectively buying in Thailand amid the recent political unrest there. "Overall, the Thai market is trading on earnings and book value multiples that are about in line with its longer-term average," he noted. "There isn’t wholesale value across the market, but sentiment has deteriorated markedly in 2014, and we’ve found some selective bottom-up opportunities amid recent turmoil."

“Periodic bouts of unrest in Thailand haven’t impacted growth in a material way. For example, with financials you’d expect a spike in loan losses, but that really hasn’t happened to a material extent,” he said.

Meanwhile, finding value in Japan is a struggle, Boersma said. Franklin Templeton bought into a number of exporters, particularly autos, as valuations became attractive in the aftermath of the 2011 earthquake and tsunami, he noted.

But stocks have re-rated as the country recovered, to the point that they are now looking more fairly valued, he said. For example, the price-to-earnings ratios of Toyota and Nissan are 10.4x and 10.5x, respectively.

“That third arrow of Abenomics – structural reform – is really necessary to improve the profitability of companies to a point that justifies their stock prices,” Boersma said. “We have limited exposure to Japan across our portfolios.”