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Franklin Income Fund Update: Our Views on Energy, High Yield Bonds and Interest Rates Investment Team January 4, 2016 WHEN WE EARN OUR KEEP Markets are challenging. Short-term interest rates have been raised for the first time in over nine years. Oil prices have dropped to lows not seen since the financial crisis. High yield bonds have fallen out of favor, tainted by a challenged energy sector. Stock market volatility has picked up after years of relative quiet. Edward D. Perks, CFA Executive Vice President, Portfolio Manager, Franklin Advisers, Inc. As managers of Franklin Income Fund, we’ve seen this all before. Knee-jerk reactions are to pull out of troubled markets and let it all blow over. But as experienced investment managers, we know this is the time when opportunities may be greatest to identify investments with the potential to reward our shareholders over the long-term. So as we begin 2016, we again have turmoil and opportunity. Following is an update on some of these key themes as they pertain to Franklin Income Fund. OIL & ENERGY And Matthew D. Quinlan and Alex W. Peters, CFA Market Sentiment: Oil-related companies will suffer for years as overwhelming supply drives prices lower. Our View: Supply is being curtailed in the US, and demand estimates are rising. Our focus is on those companies with the operational and financial wherewithal to withstand a prolonged period of oil price weakness, in our view, and which we believe have the ability to perform well in a recovery. Strong production growth over the past several years contributed to over-supply in oil markets. The energy complex broadly has been swift to respond, cutting spending on new production efforts over the course of 2015. We expect this trend to continue into 2016. Current estimates show US production has declined by approximately 400-500k barrels per day since peaking in June 2015.1 We expect to see production declines in other areas of the world as well over the course of the next 12 months. Importantly, although inventories remain at elevated levels, demand also continues to be high. The International Energy Agency (IEA) and the US Energy Information Administration (EIA) increased their demand estimates for 2015 by 50% from earlier in the year. While we don’t anticipate that oil will recover to previous highs in the short-term, we also don’t believe it needs to in order to achieve compelling returns in the securities we hold in Franklin Income Fund. The majority of energy exposure in the portfolio is in equities. Our focus has largely been on multinational conglomerates, which entered the current period of weaker oil with some of the strongest balance sheets on record. In addition, members of this group generally have the ability to reduce significant production-related costs, while also engaging in five- to ten-year investment planning processes. As a result, these firms have more levers to adjust to a prolonged low oil-price environment and can be somewhat opportunistic in taking advantage of other sector participants who might be experiencing heightened business impairments and financial distress. In addition, many offer very attractive dividend yields, comparable in some cases to yields one might find in the high yield bond market, yet with the added benefit of potential long-term capital appreciation when commodity prices stabilize. (continued on next page) Not FDIC Insured | May Lose Value | No Bank Guarantee Franklin Income Fund Update: Our Views on Energy, High Yield Bonds and Interest Rates January 4, 2016 HIGH YIELD BONDS Market Sentiment: Lack of liquidity in the high yield market makes it an area to avoid. Our View: Challenges for some companies in the energy sector of the high yield market has led to opportunities in other sectors as all high yield has been painted with the same negative brush. In recent weeks we’ve seen media attention placed on liquidity in the high yield market, and have often received questions regarding the impact of longer term regulatory changes on market makers and dealers of securities within high yield markets. We’ve found that over the past several years, high yield markets have broadened out significantly and our ability to trade in these markets has not been challenged. Though much has been made of the energy sector within the high yield market, volatility has extended to other sectors as well, including industrials, health care and technology, creating potential investment prospects over a broadening opportunity set. We entered this recent period of high yield market volatility with the lowest high yield bond exposure in the fund over the past decade (roughly 26% of total fund assets as of November 30, 2015). We have taken a dynamic approach to managing the high yield exposure, and there have been cases where we repositioned into different bonds to attain a more favorable position in the corporate capital structure. There have also been cases where valuations (and corresponding yields) became more compelling during various points of increased market volatility creating attractive entry points. INTEREST RATES AND THE FED Market Sentiment: Rising rates may kill a slow, post-financial-crisis economic recovery that has never fully taken hold. Our View: Rising rates signal the Fed’s belief that the economy is no longer in a vulnerable post-crisis state, which we view positively. Ultimately, we think rising US interest rates will be a “normalization” event off an unusually long period of easy monetary policy. The Fed’s 25 basis-point increase in the federal funds rate at the December Federal Open Market Committee (FOMC) meeting was the first hike since 2006, before the financial crisis hit. In our view, the central bank’s historically accommodative monetary policy during the financial crisis of 20082009 amounted to an emergency response to emergency conditions. That emergency is now long past, so monetary policy needed to adjust. We think the Fed’s move to raise interest rates confirms its confidence that the US economy and financial system are no longer in a vulnerable post-crisis state. As investors, we view that positively. As we enter 2016, a key area of focus in the US economy is the robustness of job growth, with the national unemployment rate having fallen to 5% (often considered the “full employment” level) and wages rising at the fastest pace in roughly five years. Additionally, consumer spending—including auto and home sales—has been resilient and even strengthened in recent months. But we would point to language from the Fed accompanying its decision that suggests the pace of any future moves is likely to be gradual and measured. We recognize that rising interest rates may have some near-term negative consequences for interest-rate-sensitive equities such as utilities, banks and real estate investment trusts (REITs). Overall, however, we would expect many companies to successfully navigate a Fed rate-hike cycle, as the benefits from a continued US economic expansion and earnings gains should outweigh the potentially negative implications. Franklin Income Fund Update: Our Views on Energy, High Yield Bonds and Interest Rates January 4, 2016 WHAT ARE THE RISKS? IMPORTANT LEGAL INFORMATION All investments involve risks, including possible loss of principal. The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. The fund’s portfolio includes a substantial portion of higher-yielding, lower-rated corporate bonds because of the relatively higher yields they offer. Floating-rate loans are lower-rated, higher-yielding instruments, which are subject to increased risk of default and can potentially result in loss of principal. These securities carry a greater degree of credit risk relative to investment-grade securities. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. These and other risk considerations are discussed in the fund’s prospectus. This commentary reflects the analysis and opinions of the author as of January 4, 2016, and may differ from the opinions of other portfolio managers, investment teams or platforms at Franklin Templeton Investments. Because market and economic conditions are subject to rapid change, the analysis and opinions provided are valid only as of January 4, 2016, and may change without notice. The commentary does not provide a complete analysis of every material fact regarding any country, market, strategy, industry, asset class or security. An assessment of a particular country, market, security, investment, asset class or strategy may change without notice and is not intended as an investment recommendation nor does it constitute investment advice. Statements about holdings are subject to change. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. To obtain a summary prospectus and/or prospectus, which contains this and other information, talk to your financial advisor, call us at (800) DIAL BEN/342-5236 or visit franklintempleton.com. Please carefully read the prospectus before you invest or send money. CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute. Franklin Income Fund Symbols: Class A: FKINX Class C: FCISX Class R: FISRX Class R6: FNCFX Advisor: FRIAX 1. Source: U.S. Energy Information Administration, as of 12/16/15. Franklin Templeton Distributors, Inc. One Franklin Parkway San Mateo, CA 94403-1906 (800) 342-5236 franklintempleton.com © 2016 Franklin Templeton Investments. All rights reserved. 109 PERSP 01/16