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Audited Annual Report October 31, 2015 Franklin Templeton Shariah Funds SOCIÉTÉ D INVESTISSEMENT À CAPITAL VARIABLE R.C.S. B société d investissement à capital variable AUDITED ANNUAL REPORT FOR
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Audited Annual Report October 31, 2015 Franklin Templeton Shariah Funds SOCIÉTÉ D INVESTISSEMENT À CAPITAL VARIABLE R.C.S. B société d investissement à capital variable AUDITED ANNUAL REPORT FOR THE YEAR ENDED OCTOBER 31, 2015 This report shall not constitute an offer or a solicitation of an offer to buy shares of Franklin Templeton Shariah Funds (the Company ). Subscriptions are to be made on the basis of the current prospectus and its addendum as the case may be, where available the relevant Key Investor Information Documents ( KIIDs ), a copy of the latest available audited annual report and, if published thereafter, the latest unaudited semi-annual report. The auditor s report refers only to the English version of the Annual Report and not to any translated versions. Contents General Information 4 Report of the Board of Directors 5 Report of the Shariah Supervisory Board 6 Report of the Investment Managers 7 Audit report 9 Fund Performance 10 Statement of Net Assets 11 Statement of Operations and Changes in Net Assets 12 Statistical Information 13 Notes to the Financial Statements 14 Schedule of Investments Franklin Global Sukuk Fund 18 Templeton Shariah Asian Growth Fund 19 Templeton Shariah Global Equity Fund 20 Additional Information - Unaudited 23 Franklin Templeton Investments Office Directory 24 Audited Annual Report 3 société d investissement à capital variable 8A, rue Albert Borschette, L-1246 Luxembourg, Grand Duchy of Luxembourg (Registered with the registre de commerce et des sociétés, Luxembourg, under number B ) General Information (as at October 31, 2015) BOARD OF DIRECTORS: Chairman James Hammond Managing Director Europe and Co-Chief Executive Officer FRANKLIN TEMPLETON INVESTMENT MANAGEMENT LIMITED Cannon Place 78 Cannon Street London, EC4N 6HL United Kingdom Directors William Jackson Director FRANKLIN TEMPLETON INVESTMENT MANAGEMENT LIMITED 5 Morrison Street Edinburgh EH3 8BH, Scotland United Kingdom James F. Kinloch Director FRANKLIN TEMPLETON LUXEMBOURG S.A. 8A, rue Albert Borschette, L-1246 Luxembourg Grand Duchy of Luxembourg Hans-J. Wisser Independent Director Kälberstücksweg Bad Homburg Germany MANAGEMENT COMPANY: FRANKLIN TEMPLETON INTERNATIONAL SERVICES S.à r.l. 8A, rue Albert Borschette, L-1246 Luxembourg Grand Duchy of Luxembourg SHARIAH SUPERVISORY BOARD: AMANIE ADVISORS SDN BHD Level 33, Menara Binjai No. 2, Jalan Binjai Off Jalan Ampang Kuala Lumpur Malaysia Dr. Mohamed Ali Elgari Dr. Muhammad Amin Ali Qattan Dr. Mohd Daud Bakar Dr. Osama Al Dereai SHARIAH STOCK SCREENING PROVIDER: IDEALRATINGS INC 425 Market Street, Suite 2200 San Francisco, CA United States of America REGISTERED OFFICE: 8A, rue Albert Borschette, L-1246 Luxembourg Grand Duchy of Luxembourg PRINCIPAL DISTRIBUTOR: FRANKLIN TEMPLETON INTERNATIONAL SERVICES S.à r.l. 8A, rue Albert Borschette, L-1246 Luxembourg Grand Duchy of Luxembourg INVESTMENT MANAGERS: FRANKLIN ADVISERS, INC. One Franklin Parkway San Mateo, CA , U.S.A. Franklin Advisers, Inc. manages Franklin Global Sukuk Fund. TEMPLETON ASSET MANAGEMENT LTD 7 Temasek Boulevard # Suntec Tower One Singapore Templeton Asset Management Ltd manages Templeton Shariah Asian Growth Fund and Templeton Shariah Global Equity Fund. SUB-ADVISERS: FRANKLIN TEMPLETON INVESTMENTS (ME) LTD Level 7, Precinct Building 3, Unit 5, Dubai International Financial Centre, Dubai United Arab Emirates FRANKLIN TEMPLETON GSC ASSET MANAGEMENT Sdn. Bhd. Suite 31-02, 31st Floor, Menara Keck Seng 203 Jalan Bukit Bintang Kuala Lumpur Malaysia Franklin Templeton Investments (ME) Ltd and Franklin Templeton GSC Asset Management Sdn. Bhd. have been appointed as sub-advisers for the Franklin Global Sukuk Fund. DEPOSITARY BANK AND LISTING AGENT: HSBC Bank plc, Luxembourg Branch 16, boulevard d Avranches L-1160 Luxembourg Grand Duchy of Luxembourg AUDITOR: PRICEWATERHOUSECOOPERS, Société coopérative 2, rue Gerhard Mercator, L-2182, Luxembourg Grand Duchy of Luxembourg LEGAL ADVISERS: ELVINGER, HOSS & PRUSSEN 2, place Winston Churchill, L-1340 Luxembourg Grand Duchy of Luxembourg 4 Audited Annual Report Report of the Board of Directors At October 31, 2015, total net assets of Franklin Templeton Shariah Funds ( FTSF, or the Company ) stood at USD million, significantly higher than the USD million under management at October 31, Interest in Shariah-compliant investment products has continued to grow in size and maturity over the past year, driven by investors need for portfolio diversification and by the economic appeal of Islamic investing principles. As the growth in assets under management shows, Franklin Templeton s long track record, recognized management expertise and extensive global network including in the Middle East and Southeast Asia means we have been able to establish ourselves as a market leader in these products. The future continues to look promising for Islamic finance, which encompasses insurance, private equity and hedge funds, as well as banks and mutual funds. However, a mismatch between buoyant demand and the availability of appropriate Shariah-compliant supply does present a challenge for Islamic finance. The Company stands in the vanguard of efforts to foster the growth of Islamic finance by continuing to grow FTSF s range of products, as well as the number of countries and currency share classes they are available in. While continuing to make changes to the range of FTSF sub-funds in the best interest of investors, the Company remains committed to retaining investment techniques that, over time, have been shown to increase shareholder value. Corporate Governance The Company is committed to high standards of corporate governance. The Board of Directors of the Company (the Board ) adheres to the principles of the ALFI Code of Conduct (as revised June 2013) and considers that it has been in compliance with its principles throughout the financial year ended October 31, Thank you for investing with Franklin Templeton Investments. Please be advised that the prospectus, the Key Investor Information Documents (KIIDs) and all Funds and share classes of FTSF may not be available in your jurisdiction. If you have any queries, comments or suggestions about your investments with us please contact your financial adviser or your local Franklin Templeton Investments office using the contact details on the last page of the report. THE BOARD OF DIRECTORS Luxembourg, November Audited Annual Report 5 6 Report of the Investment Managers Market Performance Global equity markets generally moved along the same lines over the 12-month reporting period, performing relatively well toward the end of 2014 and into the first half of 2015, but declining sharply over the summer months amid escalating worries about China s slowing economy and tumbling stock markets, as well as uncertainty about the US Federal Reserve s timing for raising interest rates. Developed-market equities generally fared better than their emerging-market counterparts, although the latter saw a short run of stronger performance early in 2015, especially in April. Global Sukuk markets, meanwhile, outperformed their global and emerging-market bond equivalents during the reporting period, underlining the continued low correlation between Sukuk and classic fixed income products. Factors that threatened Sukuk performance, especially in the Middle East, included an extended period of volatility in oil prices and ongoing turmoil in countries across the region. Despite these challenges, global Sukuk markets were able to record positive absolute and relative performance, reflecting their relatively low-beta characteristics as well as some of the fundamental strengths of Gulf Cooperation Council (GCC) countries, including low government debt levels, substantial currency reserves, the absence of currency risk and strong non-oil related economic growth. Fund Performance Franklin Global Sukuk Fund In the 12-month period ending October 31, 2015, the fund reported a gross return of 1.7% and a net return of 0.2% (in US dollars), underperforming the benchmark Dow Jones Sukuk Index, which returned 2.3%. Currency positioning was the main detractor from relative returns, followed by yield-curve positioning, while security selection and sector allocations were contributors. Currency positions detracted approximately 225 basis points (bps) from relative returns, due to holdings denominated in the Indonesian rupiah, Singapore dollar, Malaysian ringgit and British pound, as the US dollar continued its rise over the period. As the benchmark index contains US dollar securities only, the decline in those currencies had a notable effect on the fund s relative performance. The fund s global slant meant that, in terms of yield-curve positioning, it was relatively underweighted in the US yield curve in favor of others; this detracted 53 bps from relative performance. Allocation to credit risk proved positive, both in terms of sector allocation and security selection. In sector allocation, the fund s higher-than-benchmark exposure to industrial Sukuk added 36 bps to relative performance. The next-best contribution came from overweighting financial sector Sukuk. In all, sector allocation contributed 53 bps to relative returns in the period under review. Security selection added a further 165 bps, mostly within the financial sector. Broad-based gains came from subordinated bank Sukuk, with a particularly good performance from the fund s holding in Turkey s Bank Asya. Templeton Shariah Asian Growth Fund The fund returned -13.4% in US dollar terms during the year ending October 31, The benchmark MSCI AC Asia Islamic Ex Japan Index returned -10.3%, also in US dollars. After posting a small absolute gain in the first half of the year under review, the fund lost ground during a difficult second half when worries about Chinese growth and uncertainty about the direction of US interest rates prompted a general sell off of emerging market equities before a partial revival in September and October. The energy and consumer discretionary sectors were the major detractors from absolute fund performance. Most oil and gas holdings lost ground in the face of weak oil prices due to market oversupply and a muted economic outlook. Thai stocks were particularly impacted by additional concerns about the direction of domestic energy regulation, while a Chinese integrated oil and gas company orientated towards gas production, import and transmission declined due to unease about gas prices and regulation. The energy sector return was somewhat alleviated by strength for a South Korean oil refiner and petrochemical business where weak fourth quarter 2014 results marked a turning point with new management, improving refining and petrochemicals margins and a gradual diminution of inventory losses as the year under review proceeded. Within the consumer discretionary sector, a South Korean sports outerwear and accessories business was unable to sustain a market high reached shortly before the year under review opened, and ended as a significant detractor. Weakness in October 2015 on fears that strong second quarter results might give way to weaker third quarter returns had a significant impact on the overall performance. Elsewhere, Indonesian and Hong Kong specialty retail businesses detracted in the uncertain market and consumer spending environment. The information technology and telecommunication services sectors also declined, while among individual holdings, an Indonesian cement business was pressured by a combination of a weak local market and concerns about regulatory interference in cement pricing. The defensive health care and consumer staples sectors both contributed to absolute fund performance. In health care, strong operating trends for a Malaysian disposable glove manufacturer generated a solid return for the year, while a Chinese pharmaceutical business also supported performance. The gain for consumer staples arose primarily from a Middle East based food processing business that was supported by a series of strong quarterly results with the firm s bottled water business the strongest of a number of buoyant business lines. Elsewhere, in addition to the gain for the South Korean oil refiner noted above, a Thai producer of ceramic wall and floor tiles enjoyed a solid year as a significant beneficiary of lower energy prices, which outweighed the impact on the stock of a sluggish local market. From a country standpoint, China was the largest detractor from fund performance, mainly due to weakness in energy holdings, while larger percentage falls also left Indonesia, Thailand and Singapore as significant absolute detractors. Gains for health care stocks helped Malaysia to a solid contribution and Vietnam to a more modest gain. Templeton Shariah Global Equity Fund For the year ended October 31, 2015, the fund underperformed its benchmark index, returning -4.9% in US dollar terms, while the benchmark MSCI All Country World Islamic Index posted a -2.8% total return, also in US dollar terms. Audited Annual Report 7 Report of the Investment Managers (continued) Stock selection and an underweight allocation diminished relative performance in the information technology sector. Within the sector, a lack of exposure to the internet software and services industry, stock selection in the IT services industry and investments in the electronic equipment, instruments and components industry had a negative impact on relative results. An overweight allocation in the energy equipment and services industry eroded relative performance in the energy sector. In the consumer discretionary sector, stock selection and an underweight allocation in the textiles apparel and luxury goods industry, in addition to a lack of exposure to the hotels, restaurants and leisure industry and the Internet catalog retail industry, undermined relative fund performance. In contrast, stock selection and an overweight allocation in the pharmaceuticals industry together with investments in the life sciences tools and services industry supported relative results in the health care sector. The consumer staples sector advanced relative results as an overweight allocation and stock selection in the food and staples retailing industry proved favorable. A lack of exposure to the utilities sector contributed to relative performance. Stock selection in the air freight and logistics industry, a lack of exposure to road and rail companies and positioning in the airlines industry lifted relative results in the industrials sector. Portfolio positioning in the construction materials industry and stock selection in the chemicals industry boosted relative performance in the materials sector. From a regional standpoint, an overweight allocation in China and stock selection in Japan hampered relative results in Asia. Stock selection and an underweight in the United States proved detrimental to relative performance. Conversely, stock selection in Europe augmented relative results. Within Europe, stock selection in Germany, the United Kingdom and the Netherlands together with overweight allocations in Ireland and Denmark proved beneficial. An underweight allocation in Australia positively impacted relative results. Outlook Looking ahead to the coming months and quarters, most global central banks are likely to cut or maintain low short-term interest rates and continue record liquidity injections, in our view, amid expectations for weak or uneven growth. In recent years, many European countries have continued to wrestle with high unemployment and weak industrial production data. Furthermore, central banks in China, India, Russia, Canada, Australia and South Korea have lowered key interest rates in While accommodative central bank action has been robust thus far in 2015 as monetary policies try to catalyze growth, the US Federal Reserve (Fed) and the Bank of England are among the handful of central banks that appear likely to raise rates in late 2015 or early These monetary approaches reflect generally strengthening economic conditions in the United States and the United Kingdom. Global investors have paid increased attention to the downward trajectory for China s economy during the past two years, a factor that had a significant influence on equity markets during the reporting period. China s economic growth rate for 2014 was revised down to 7.3%, the slowest annual pace in decades, and the economic growth rate was 7.0% in the first and second quarters of 2015, the country s slowest expansion rate in six years. Seeking to reverse this trend, in August the People s Bank of China (PBOC) decided to weaken the Chinese yuan against other currencies. This represented a substantial measure by the Chinese government to boost the country s slowing economy, in our view. While risk assets saw a fair degree of volatility during the reporting period, we believe this selloff could help mitigate one of the main overhangs in these markets: a belief that valuations had gotten too expensive. The prospect of a Fed rate hike was potentially another major overhang for markets, though with financial conditions tightening and stocks correcting recently, a move in interest rates may now be priced in as well. Indeed, risk assets showed notably stronger performance in October. With such concerns abating against a backdrop of broadly accommodative global monetary policy and excess liquidity, conditions may be favorable for renewed strength in Shariah-compliant assets. THE INVESTMENT MANAGERS November 2015 The information stated in this report represents historical data and is not an indication of future results. 8 Audited Annual Report Audit report To the Shareholders of Franklin Templeton Shariah Funds We have audited the accompanying financial statements of Franklin Templeton Shariah Funds (the Company ) and of each of its sub-funds, which comprise the statement of net assets and the schedule of investments as at October 31, 2015 and the statement of operations and changes in net assets for the year then ended and a summary of significant accounting policies and other explanatory notes to the financial statements. Responsibility of the Board of Directors of the Company for the financial statements The Board of Directors of the Company is responsible for the preparation and fair presentation of these financial statements in accordance with Luxembourg legal and regulatory requirements relating to the preparation of the financial statements and for such internal control as the Board of Directors of the Company determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Responsibility of the Réviseur d entreprises agréé Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing as adopted for Luxembourg by the Commission de Surveillance du Secteur Financier. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the judgment of the Réviseur d entreprises agréé, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the Réviseur d entreprises agréé considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also
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