Franklin Investment Grade Corporate ETF FLCO has embarked on a new era that holds some promise but that has yet to translate into reality, which keeps its People and Process ratings at Average.

The new era is tied to two recent acquisitions. In late 2021, Franklin Templeton bought Aviva Investors’ Chicago-based investment-grade credit team, including lead Joshua Lohmeier. Franklin then appointed him as head of investment-grade credit in early 2022, he was named as a manager on this fund in March 2023, and he became the firm’s director of corporate credit following the early 2024 closure of Franklin’s acquisition of Putnam Investments.

Lohmeier has implemented an intriguing, risk-controlled approach. It distinguishes itself by assigning each issuer one of three beta designations (high, medium, low), based on historical spread volatility relative to the Bloomberg US Corporate Bond Index, and associating that designation with an industry sector and credit rating. While taking minimal interest-rate risk, Lohmeier’s goal is to build a beta-neutral portfolio that can beat the benchmark and most corporate bond Morningstar Category peers, especially in down markets, because of the names it owns and the maturities at which it owns them.

The strong analyst input Lohmeier’s approach requires appeared to receive a boost from the Putnam acquisition, which grew the US corporate credit team to 20 analysts from 14, pending the April 2024 start of the newest addition. But the team’s average experience level dropped by five years to about 15. And with nine of the analysts coming from Boston-based Putnam, team members, including Lohmeier, are now spread throughout eight cities.

Good bond picks will be key because idiosyncratic events in any given year can weigh on results, even for names the team designates low beta. In 2023’s second quarter, for example, an adverse legal judgment and ratings downgrade to the Berkshire Hathaway BRK.B subsidiary PacifiCorp caused the price of its 5.35% 2053 bond to drop enough that it was the third-worst pick that year, next to two Silicon Valley Bank bonds.

The start so far has been slow, but this fund could in time become a reliable option.

Analyst Rating

A new era, and a slow start.

Director

Alec Lucas

Lead manager Joshua Lohmeier has implemented a risk-controlled approach that holds promise if the analyst team can surface attractive credits for Lohmeier and his comanagers, who must choose effectively between them and size them correctly. That’s yet to be proved, though, so the fund merits an Average Process rating. 

Lohmeier aims to keep the fund’s tracking error, or excess standard deviation, within 75-100 basis points of the Bloomberg US Corporate Bond Index and duration (interest-rate risk) in line with that of the benchmark. Credit risk, especially versus most peers, is muted by requiring purchase candidates to have at least one investment-grade rating. The approach distinguishes itself by assigning each issuer one of three beta designations (high, medium, low), based on historical spread volatility relative to the index, and associating that designation with an industry sector and credit rating. Problem-child issuers in an otherwise low-beta industry can receive a high beta designation, which helps beta designations to track with risk. Lohmeier’s goal is to build a beta-neutral portfolio that can beat the benchmark and most peers, especially in down markets, because of the names it owns and the years at which it owns them.

Still, idiosyncratic events in any given year can weigh on results, even for low-beta names. In 2023’s second quarter, for example, an adverse legal judgment and ratings downgrade to the Berkshire Hathaway subsidiary PacifiCorp caused the price of its 5.35% 2053 bond to drop enough that it was the third-worst pick that year next to two Silicon Valley Bank bonds.

Average

Process

Several management team changes since this fund’s October 2016 inception combined with an early 2024 overhaul to the analyst bench keep this fund’s People rating at Average.  

The latest iteration to the fund’s now five-person management team occurred in March 2023, when investment-grade credit expert Joshua Lohmeier joined the roster. He is now the lead here alongside credit investors Marc Kremer and Shawn Lyons, who have comanaged the fund since October 2016, and quant specialists Thomas Runkel and Pururav Thoutireddy, who joined in October 2019.

Lohmeier has climbed the ranks quickly at Franklin. The firm acquired him and his Chicago-based team from Aviva Investors in late 2021, appointed him as the sector team head of investment-grade credit in early 2022, and he became director of corporate credit following the early-2024 closure of Franklin’s acquisition of Putnam Investments.

The Putnam acquisition enlarged Franklin’s US corporate credit analyst team, but it’s not clear it improved it. The number of analysts increased to 20 from 14, pending the April 2024 start date of the newest addition, but its average experience level dropped five years to about 15. With nine of the analysts now from Boston-based Putnam, the team is also even more geographically diffuse. Including Lohmeier, US team members involved with this strategy are in eight cities.

Manager ownership could be better. Only Kremer invests between $10,001 and $50,000 in the fund.

People

Franklin Templeton Investments, the asset-management arm of publicly traded but family managed Franklin Resources BEN, has been busy with acquisitions. The struggle in streamlining these disparate capabilities underpins its Average Parent rating. 
Franklin’s July 2020 acquisition of multiboutique manager Legg Mason remains its largest as of March 2023, but the firm has continued to grow through acquisitions. Its April 2022 and November 2022 purchases of Lexington Partners and Alcentra, respectively, make it one of world’s largest managers of alternative investments (with alts comprising USD 231 billion of its USD 1.4 trillion assets under management as of December 2022), while its July 2022 acquisition of O’Shaughnessy Asset Management adds a novel direct-indexing capability to its managed account offerings. These purchases, however, do little to alleviate the operational complexity of a firm with dozens of investment teams split by asset class, region, and investment platform.   
Although there are several standout strategies at the firm, many teams have struggled with personnel turnover, succession challenges, and unappealing performance patterns. Shepherding these geographically disparate capabilities, which have varying levels of centralization of distribution and risk management, shall be quite the challenge for the firm to manage.

Parent

Franklin Investment Grade Corporate ETF

FLCO is an actively-managed fund that uses a combined top-down and bottom-up approach to select investment-grade USD-denominated bonds without a duration target.

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