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California-based Franklin Resources, Inc. is the nation's largest manager of municipal funds and one of the nation's fastest-growing and largest mutual fund companies. Although Franklin is a public company, nearly half of its stock is owned by the two brothers who lead the company, Charles and Rupert Johnson. With its purchase of Templeton, Galbraith & Hansberger Ltd. in 1992, Franklin controlled more than $87 billion in assets.
Franklin Resources began as a small fund business founded in 1947. When Charles B. Johnson took over from his father in 1957, the company managed assets of about $2 million. With a staff consisting of Johnson and one other employee, the company slowly began to grow. Much of Franklin's success has been attributed to Charlie Johnson's shrewd recognition that even the world of investment services could benefit from proper marketing--that is, by designing products for specific markets and then promoting those products appropriately to reach the target markets. Some industry insiders have suggested that Franklin was more important as a marketing success than for its investment success.
Franklin Resources went public in 1971. While a stock market crash in 1973-74 nearly wiped out the company, it bounced back stronger than before. Johnson started one of the first funds specializing in gold stocks; the fund gained momentum in the late 1970s as inflation rose. Franklin offered a succession of new fund products during the 1980s, a decade in which the percentage of families investing in mutual funds grew from six to about 25 percent. By the end of the decade, Franklin was running 73 funds.
In the early 1980s, while other fund companies anticipated a rush for equity funds, Franklin maintained that the action would be in fixed income funds. Franklin pioneered mortgage-backed securities and single-state municipal bonds. Franklin's $14.2 billion Franklin U.S. Government Securities Fund was the nation's first fund to invest in Government National Mortgage Association bonds. Then Johnson introduced the $14.3 billion California Tax-Free Income Fund, the first tax-free state bond fund in the United States; income from this fund earned by California residents was not subject to state or federal income tax. With high state income taxes and falling interest rates, the timing on this new product could not have been better. Investors were taking their money out of money funds and looking to invest in tax-free yields instead. By 1984, the state fund had grown to $825 million, doubling the assets that Franklin managed to $2 billion. By 1990, these two funds would account for half of Franklin's $49 billion in mutual fund assets.
During the mid-1980s, while other companies were starting overseas funds, Franklin continued to offer U.S.-based funds to U.S. buyers. Like many other investment companies, Franklin also planned to offer credit cards, consumer loans, and insured certificates of deposit. Furthermore, Franklin bought a real estate syndicate for $11 million. By this time, the company had become a real family business. Charles and his brother Rupert owned 40 to 50 percent of company stock. Four other family members also worked at Franklin, including Harvard M.B.A., Charles E. Johnson, and two of Charles's other children.
In 1987, while stocks were rising, Franklin stocks slipped, but when the market crashed in the fall, Franklin barely dropped, and its low-risk funds became a popular place to protect savings. The following year, Franklin announced that it would open an Adjustable-Rate Mortgage Securities Fund, which would still protect the investor's principal but would also pay higher returns on investment. Franklin funds remained conservative investments.
While most funds did little advertising directly to consumers, Johnson believed strongly in the power of advertising Franklin's funds. During the 1980s, Johnson dramatically increased the advertising for his fast-growing company and its funds. Unlike Fidelity Investments, the nation's largest mutual fund company, Franklin sold its funds through broker-dealers rather than directly to investors. In 1990, Franklin began a print ad campaign to make sure its name was familiar to investors and potential investors. Johnson told Forbes magazine, "Our feeling was that name recognition was important." Johnson even hired quarterback Joe Montana to peddle funds on television ads. Johnson noted that a celebrity such as Montana would reach people who ordinarily might not even pay attention to an ad for financial services.
In the 1990s, Franklin was looking for opportunities abroad. In 1992, it was able to gain an immediate presence abroad through acquisition of another major player in the mutual funds market--Templeton, Galbraith & Hansberger Ltd., a mutual funds management company. Franklin Resources acquired Templeton for $913 million and was thereby elevated from fifth to fourth place on the mutual-funds companies list in the United States. The only larger mutual funds companies were Fidelity Investments, Merrill Lynch, and Vanguard Group. Franklin alone already controlled $69 billion in assets, and the purchase of Templeton gave Franklin management combined assets of almost $90 billion. The sale also meant that Franklin could sell Templeton's overseas funds to U.S. shareholders and sell its own funds in the foreign market Templeton had established. The sale of Templeton to Franklin was the largest transaction ever involving an independent mutual fund company.
Franklin decided to operate Templeton as a separate subsidiary. Although Franklin and Templeton funds had little in common, they were excellent complements to one another. Templeton 80-year-old founder John Templeton, renowned in investment circles for his ability to pick stocks, told The Wall Street Journal, "The two organizations fit like a hand in a glove." They both sold their funds through brokers and financial planners and charged an up-front sales fee; Templeton emphasized equities, while Franklin stressed fixed-income funds; and Templeton mostly managed global funds while Franklin generally managed U.S. funds. Officials predicted that shareholders soon would be able to move funds between the two without penalty to diversify their holdings. At the time of the transaction, John Templeton's stock in his company was valued at $440 million, and he was expected to continue as an adviser to Franklin-Templeton.
Although the price for acquiring Templeton was high, Franklin was well positioned to handle it, having almost no debt at the time, $370 million in cash and other liquid assets, and financial backing from Chemical Bank and Hellman & Friedman. John Templeton and other Templeton shareholders were also willing to invest $75 million in the merger by buying restricted Franklin stock. The Templeton company also had the advantage of being based in the Bahamas where the tax rate on profits was far lower than that in the United States.
Franklin's negotiating team was headed by Charles E. Johnson, oldest son of Franklin's president and chairperson, Charles B. Johnson. The younger Johnson saw the acquisition as a key move, since he believed that any company that wanted to remain an important player in the fund market had to "go global." Johnson, senior vice-president and head of corporate development, was expected to lead the company when his father retired.
According to a 1992 Business Week article, the fund industry had grown 500 percent in the previous ten years. During that time, Franklin's total assets under management grew 3,000 percent, and its stock price skyrocketed by more than 42,000 percent, with much of this growth on a diet of fixed-income funds--U.S. government securities and municipal bonds. Franklin's staff also grew from 26 to more than 3,000 employees.
The immense profits of the 1980s had also prompted an excessive fee lawsuit against Franklin. Two shareholders, filing their suit in 1987, accused Franklin of charging excessive fees for managing its Franklin U.S. Government Securities Fund. This was the first excessive fee suit involving a bond mutual fund to go to trial, although five other suits had been filed--and dismissed--for excessive fees involved in management of money market mutual funds. In 1990, a judge dismissed the complaint against Franklin after a six-day trial, noting that the only main arguments presented by the plaintiffs was that Franklin "simply made too much money managing that fund." The judge ruled that Franklin's after-tax profit was "reasonable," and that the plaintiffs "failed to prove that Franklin realized economies of scale as the fund increased in size, or that economies of scale, if realized, were not shared with investors."
Fiscal problems in California caused some concern for mutual fund companies in the early 1990s. Franklin managed the $12 billion California Tax Free Income Fund, the nation's largest tax-exempt bond mutual fund, and the company was confident that few if any of the riskier bonds--known as Mello-Roos bonds--would default. However, Franklin remained the largest holder of Mello-Roos bonds, which were sold to finance infrastructure development in new communities in the state. According to The Wall Street Journal, Mello-Roos bonds did not trade often and were not rated by credit-rating companies; a default could send holders hurrying to sell. Franklin therefore remained cautious in its California investments.
According to financial experts, the dramatic growth that Franklin enjoyed in the 1980s would be difficult to maintain in the 1990s. While the company had earnings growth of 65 percent per year in the 1980s, earnings and asset growth were down to eight percent in 1990, a respectable growth rate for most companies but slow compared to the rapid growth that investors had enjoyed in the previous decade. Nevertheless, in the early 1990s, Franklin's growth rate was expected to continue at ten to 12 percent a year.
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