“A bull market is when you get a stock tip from your barber…a bear market is when you get a haircut from your fund manager.” Thus tweeted corporate leader Lloyd Mathias in a particularly jocular vein on April 20. Little did he foresee the prescience of his witticism. Three days later, the lockdown necessitated by the COVID-19 pandemic marked its first casualties in the Indian financial market. The closure of six debt schemes by the Franklin Templeton (FT) Mutual Fund has resulted in eroding the confidence of investors to a large extent and has created a sort of crisis of confidence in the market. These six debt schemes together have Assets Under Management (AUM) worth over Rs 28,000 crore.

Through a notice dated April  23, 2020, FT MF announced its decision to wind up six of its schemes—Franklin India Low Duration Fund, Franklin India Ultra Short Bond Fund, Franklin India Short Term Income Plan, Franklin India Credit Risk Fund, Franklin India Dynamic Accrual Fund and Franklin India Income Opportunities Fund.

As per the fund house, “There has been a dramatic and sustained fall in liquidity in certain segments of the corporate bonds market on account of the COVID-19 crisis and the resultant lockdown of the Indian economy which was necessary to address the same (sic). At the same time, mutual funds, especially in the fixed income segment, are facing continuous and heightened redemptions.”

The closed MFs have been facing great redemption pressure, with net outflow of Rs 9,148 cr in March.

These funds have been facing significant redemption pressure, which intensified in the months of March and April, witnessing an estimated net outflow of Rs 9,148 crore in March alone. Franklin Templeton says that in this scenario, this is the best possible way to safeguard the interest of investors and is the only viable means to secure an orderly realisation of portfolio assets.

Hence from April 24, 2020, the trustee and the asset management company (AMC) have: (a) ceased to carry on any business activity in respect of the schemes; (b) ceased to create or cancel units in the schemes; (c) ceased to issue or redeem units in the schemes.

The impact of the furore was instant: The RBI on April 27 announced a special liquidity facility of Rs 50,000 crore for mutual funds in the wake of the winding up of the six debt funds by Franklin Templeton. Banks can avail of the 90-day funds from the RBI’s repo window and use it to lend exclusively to mutual funds or purchase investment grade corporate papers held by MFs. The scheme will be available from April 27 till May 11. This is third instance when the central bank has opened a special window for MFs.

Joseph Thomas, head of research, Emkay Wealth Management, says, “The erosion in investor confidence usually results in more redemptions and may lead to liquidity problems for the mutual fund industry, when many of them already have negative cash in debt funds. So, more than a crisis of liquidity, it is a crisis of confidence.” Though the RBI may have announced opening of a special window to help debt MFs to tide over liquidity problems, the after-effects of the low-rated credit risk fund portfolios may haunt mutual funds for some more time to come because of the economic slowdown and the resultant sluggishness in economic activity emanating from the pandemic, Thomas adds.

Amit Singh, Head, Investica, the online MF platform powered by Choice Broking, says, “The FT MF development has come as a shock to the entire mutual fund fraternity. This is clearly a casualty of COVID-19. Debt markets have been facing a lot of liquidity issues over the last month even in the high-rated papers. In low- rated credit papers, liquidity pressure was higher.  But at the same time, this does not impact the entire universe of debt mutual funds. Funds with high-quality papers have seen steady growth during this period. RBI is also doing its bit to maintain enough liquidity in the debt markets. Our recommendation to investors is to stick to debt funds which invest only in high-rated debt papers. These are uncertain times and financial advisors can help you navigate through this period”.

The RBI announced a special liquidity facility of Rs 50,000 cr for MFs. Banks can use it to lend it to the MFs.

In situations like this, any portfolio with exposure to credit risk debt instruments have risk of liquidity and will be adversely impacted. Further, debt funds are dominated by corporates and high net-worth individuals (HNI) from the investment side and most corporates have liquidity issues due to the lockdown and are therefore aggressively redeeming debt MFs to meet cash requirements.

Retail Investors should be prudent while investing in debt funds and should always look only for the quality of the portfolio and should completely ignore past performance, big names and big brands while making investments, Singh says.  

“Investors affected by the current crisis have no choice, but to wait so that the liquidity gets back to the lower end of the system as and when the lockdown is over and economic activities restart. Only then the AMC will pay back the realisable money,” says Omkeshwar Singh, head, RankMF, Samco Securities.

FT has always maintained its image of managing low-credit high-yield debt funds. Many retail investors opted for these funds to get higher returns. Now that these schemes have shut down, existing investors cannot do any transaction in these schemes. At the same time, no expense ratios will be charged for these funds. Investors will get redemptions in the future when the underlying bonds mature or when they pay interest. Hence, existing investors can expect partial amount credits in their accounts if there are investments in any of these six schemes.

Frankly, Temptation Print ads by FT during better days.

Investors’ confidence towards credit risk funds was never high but, coupled with the uncertainty spawned by the lockdown as to the full resumption of the economy, that weak conviction dwindled further. Investors started redeeming in force, FT had to liquidate their holdings and eventually the scheme was left with illiquid, low- rated and thinly-traded papers.

“Investors shouldn’t chase returns disregarding the risk.”

Deepak Jasani, HDFC Securities

Explains Bhavesh D. Damania, founder and chief caretaker, Wealthcare Investments: “The situation doesn’t seem to be the same with other fund houses and their schemes. Most large players have already cleansed their books since default of IL&FS, DHFL, Zee etc. So I do not foresee similar run on other AMC’s credit risk funds. Even if they face huge redemption pressure like FT, most have already increased allocation to AAA, G-Sec and raised cash levels to combat such a situation. I feel now is the time to consider credit risk funds in a staggered manner. Volatility will be very high in credit risk funds and one should live with that. Existing investors should examine their portfolio and take action. Many debt fund categories are safer and stable, which can be considered in case one is fully risk averse”.

Indubitably, the development has shaken up the debt mutual fund industry. Coming on the heels of a series of NAV write-downs/segregation by various fund houses due to downgrades/defaults by investee companies, this will not do any good for the risk-on sentiments of retail and HNI investors. The FT episode once again highlights the weakness in the secondary debt markets in India as they tend to get illiquid by small bouts of micro and macro negative news.

Deepak Jasani, head of research, HDFC Securities opines, “Despite the categorisation by SEBI, a lot of debt schemes take on risks that are not reflected in their scheme risk-o-meter or their category names. Fund managers with a view to generate higher return tend to take higher risks in the portion of other investments permitted in even safe, low-risk categories. Investors would also do well to desist from chasing just returns without taking into account the risk taken by the respective schemes. AMFI (Association of Mutual funds in India) should educate investors on how to assess this risk. On a higher level, faster legal resolutions/recoveries will help in development of buying out of stressed assets and improving the depth and liquidity in secondary debt markets”.

With the RBI’s swift action to forestall any turbulence, there is hope that this is a one-off case, though the economic wheels are yet to roll out of this difficult phase. A sharp liquidity crunch can only be remedied by the solid, guttural roar of running engines.

***

Mutually Inquisitive

What just happened to Franklin Templeton’s yield-oriented credit funds?

Franklin Templeton announced the winding down of six of its debt funds (which had credit risk)—Franklin Low Duration, Franklin Dynamic Accrual, Franklin Credit Risk Fund, Franklin Short Term Income, Franklin Ultra Short Bond Fund, and Franklin Income Opps Fund­—with immediate effect.

What happens to our investments? Can we withdraw our money?

This is similar to a lockdown. These schemes will not allow any further transactions, purchases or redemptions. The entire scheme becomes a segregated portfolio. These six schemes in total have an AUM (assets under management) of over Rs 28,000 crore. This entire AUM is now stuck. Investors like you cannot redeem their respective investments. Simply put, you cannot withdraw any money right away.

Does this mean the money is gone with the closure of these schemes?

Not at all. The closed schemes will work like a segregated portfolio—the day they get any interest or maturity from any of the holdings it will distributed to all on proportionate basis.

Will we get our money back soon?

As and when the underlying portfolio instruments mature or the scheme receives the money back they will pay it back to investors.


By Yagnesh Kansara in Mumbai

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