Wrong judgment or genuine liquidity crunch


By Shivanand Pandit

Nobody spotted it coming. April 23 was a sleepless night for many mutual fund investors after Franklin Templeton Mutual Fund suddenly closed its six debt funds. Templeton is India’s ninth largest mutual fund with average assets under management of Rs 1.16 trillion. Because of its robust past record nobody expected that the fund house would wind up its debt schemes.

The six debt funds are Franklin India Low Duration, Franklin India Dynamic Accrual, Franklin India Credit Risk, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund.

Templeton decided to disallow all purchases or redemptions through SIPs or Systematic Transfer Plans or Systematic Withdrawal Plans. Therefore, an existing investor can no longer redeem money and investment in these funds remains locked until the fund house makes further payments.

A liquidity crisis in the bond markets aggravated by the coronavirus lockdown and massive redemptions forced the fund house to wound up its debt funds with total assets under management (AUM) of Rs 25,856 crore as on April 22.

All six schemes had a high exposure to low rated debt securities and were being squeezed by the pandemonium in the bond market. Franklin fact sheet of March 31, 2020 reveals that Franklin India Low Duration had 62.8 per cent of assets invested in bonds rated A, and 45.7 per cent rated AA. In the case of Franklin India Dynamic Accrual Fund, 52.7 per cent was in AA rated bonds, while 44 per cent in A-rated bonds.

Franklin India Credit Risk fund has 60 per cent AA rated and 49.6 per cent in A-rated bonds. Franklin India Short Term Income Plan had 58.6 per cent in AA rated and 57.5 per cent in A-rated, Franklin India Ultra Short Bond Fund had 82.8 per cent in AA and 23.9 per cent in A-rated bonds and Franklin India Income Opportunities Fund-63.97 per cent in AA rated and 41 per cent in A-rated bonds.

Imprudent investment decisions

On the whole, investors of debt funds get a yield between six and nine per cent. However, debt funds of Franklin Templeton stayed ahead in the race by investing in corporate bonds of low-rated corporate entities. This trick works when the economy is flourishing not during recession. Taking a cue from Franklin many other fund houses also invested in bonds of low rated companies namely Dewan Housing Finance Corporation, Essel Group, Reliance Anil Dhirubhai Ambani group, Yes Bank and Vodafone-Idea.

Franklin Templeton was the solitary moneylender to 26 of 88 corporate bodies in its debt mutual funds. This raises the million dollar question, where were the regulators? According to the sources twenty six entities borrowed Rs 7,697.27 crore, which is 100 per cent of their borrowing, only from Franklin Templeton. Three entities have borrowed 90- 100 per cent of their overall borrowing amounting to Rs 2,411.52 crore and fourteen institutions have borrowed more than 50 per cent and up to 90 per cent of their overall borrowing amounting to Rs 9,601.07 crore.

The Franklin crisis is in the wake of Infrastructure Leasing and Financial Services (IL&FS) disaster leading to drastic reduction of liquidity in the capital market. This tragedy compelled many other companies to default on their interest and principal payments. Unfortunately large number of such corporate organizations were not absent in Templeton’s portfolios. Thus all the cookies crumbled at Franklin house.

Long wait to get money back

For sure it will be a long wait for investors whose money is stuck in Franklin debt funds. The fund house is said that details of the winding-up process will be communicated to the existing investors and they won’t be charged any investment management fee. Even though the fund house wishes to repay the money to the investors in less than a year only 26 per cent of the portfolio matures next year. It won’t be easy to sell illiquid papers if the market does not recommence normality.

The economy is still reeling from the lockdown crisis and it may take minimum six months to rebound to normalcy. Investors of Franklin Templeton will be quite fortunate if they get their investment back without any loss in the next six months.

COVID-19 lockdown shadow over the banking sector has mainly contributed towards economic adversities. As a result many financiers had to take a haircut on their debt exposure of defaulting corporates and therefore the probability of loss for Templeton investors can’t be completely ruled out.

Delayed action by RBI

A week after Templeton closed its six debt schemes the Reserve Bank of India announced special liquidity facility of Rs.50,000 crore for mutual funds. This does make us to recall the scene of police entry in Bollywood movies!

The scheme is available till May 11, 2020 or up to employment of the allocated amount, whichever is earlier. The RBI will appraise the timeline and amount, depending upon market conditions. Even though the RBI has taken action, whether the liquidity support will bring back the confidence in the minds of debt fund investors and discourage them from redeeming their investments is the question mark.

Although the RBI stepped to prevent other debt schemes from winding up, the Association of National Exchange Members in India (ANMI) has insisted that the finance ministry and Securities and Exchange Board of India (SEBI) should appoint a high-power committee to take over Franklin Templeton’s management. The brokers body also is of the same opinion and requested for Franklin’s investment judgments should be scrutinized.

Debt schemes of other mutual funds may also go the Franklin way unless immediate action is taken to check this and UTI type of bailout is initiated. A Yes Bank type of liberation package could also be considered for the mutual fund industry.

For investors in mutual funds it is best to keep certain pointers in mind:

v              Invest in certain categories like a liquid fund, ultra-short-term fund, banking and PSU debt fund and short-term fund. Other categories like credit risk funds, dynamic bond funds, gilt funds are meant for more evolved investors who can take the risks associated with these funds.

v              While choosing funds, compare the expense ratio, and yield to maturity by referring to the fund fact sheet.

v              Do not go by the past performance or past returns of the fund.

v              Compare the credit quality of the fund or the amount held by the funds in AAA bonds and below AA bonds. Funds with a higher allocation to AAA bonds are ideal. After the default by AAA-rated companies like IL&FS and DHFL, funds have become more cautious with their holdings.

v              Look out for your money and not just forget about it once you invest. Control the way your investments are spread between various assets and diversify further.

The writer is a tax specialist, financial adviser, guest faculty and public speaker based in Goa. He can be reached at [email protected]