Puerto Rico, munis take $5.4 bln bite out of Franklin fund flows

Thu Oct 24, 2013 3:17pm EDT

Oct 24 (Reuters) - Investors in the Franklin Double-Tax Free Income Fund rejected the most lopsided bet on Puerto Rico debt in the U.S. mutual fund industry.

Since the end of July 2012, the municipal bond fund run by Franklin Resources Inc has shrunk to $461.2 million from nearly $900 million, according to Lipper Inc data. Net outflows from the fund during that time have totaled $308.3 million, escalating in recent months amid a sharp decline in Puerto Rico bond prices.

And on Thursday, Franklin Resources reported broader problems in its tax-free bond funds, which were hit with $5.4 billion in net outflows during the three months that ended Sept. 30. That performance, influenced by the bond selloff in Puerto Rico, weighed on the company's overall net new flows, which were a negative $2.7 billion in the quarter.

The S&P Municipal Bond Puerto Rico Index is down 16.3 percent in 2013, underscoring how the territory's plummeting bond prices have hurt fund performance across the mutual fund industry. A major issuer on the U.S. municipal bond market, Puerto Rico has $70 billion in outstanding debt that has been very popular with investors and fund managers because it is exempt from federal, state and local taxes.

The Franklin Double Tax-Free Fund has the largest percentage exposure to Puerto Rico-issued municipal bonds among U.S. mutual funds at about 60 percent of net assets, according to Morningstar Inc. The fund is down 14 percent this year and performing worse than 99 percent of the 236 funds in the national municipal bond fund category, according to Morningstar.

Franklin Resources Chief Executive Greg Johnson blamed selling pressure in his company's portfolio of tax-free funds on the rising interest rate environment and unflattering headlines about Puerto Rico and Detroit's finances.

The downdraft is hurting municipal bond funds of all sizes.

The $13 billion Franklin California Tax-Free Income Fund , with about 5 percent in Puerto Rico bonds, declined 6.13 percent during the five-month period that ended Oct. 1, according to Morningstar. Net outflows in the fund totaled $826 million in the third quarter, according to Lipper.

"Negative press on the muni bond market has been driven by narrowly focused headlines around Detroit and Puerto Rico and has further contributed to the selling," Johnson said in pre-recorded commentary about quarterly results.

Tax-free bonds accounted for 9 percent of the company's $845 billion in assets under management at the end of September.

The company was not available for further comment.

There is growing concern among U.S. regulators that investors in municipal bond funds laced with Puerto Rico may not have been aware of their investments have exposure to the island's fiscal problems.

Massachusetts' top securities regulator opened an investigation about two weeks ago and The Bond Buyer reported on Thursday that the U.S. Securities and Exchange Commission is investigating mutual funds with Puerto Rico debt.

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