Rahul Goswami, CIO &MD - India Fixed Income, Franklin Templeton Asset Management, on what investors can expect on the debt side from the AMC and on his rate cut expectations

The ultra short duration scheme is a new offering from the fund house after a long gap

Franklin Templeton shifted part of the blame for the recent winding down of six of its debt mutual funds on to capital markets regulator Securities and Exchange Board of India.

Market regulator SEBI, late Thursday night advised Franklin Templeton to focus on returning investor’s money after the fund house decided to wound up six of its debt mutual fund schemes.

Last month, the fund house had closed six of its debt funds, citing redemption pressures and lack of liquidity in the bond markets. 

Credit risk funds have seen assets decline by nearly Rs 19,000 crore in April as investors rushed to redeem their money after the closure of six debt schemes by Franklin Templeton Mutual Fund, data showed.

Can’t blame Corona for crisis, investment choice was poor

The fund house claimed that media outlets quoted its CEO Jenny Johnson out of context.

This is the first instance when a fund house is shutting its schemes because of coronavirus related pandemic.

The regulator had also observed that mutual funds should not depend totally on credit rating agencies but should do their own assessments.

Debt schemes of mutual funds for long have been seen as low risk, but shuttering six schemes and leaving investors in a lurch will impact investor sentiment.

Franklin Templeton MF also said that their commitment to India remains steadfast as they have been early as patient investors in India.

From wounding up six debt mutual fund schemes with an AUM of over Rs 30,000 crore, to dealing with the ire of investors, the fund house has been busy fire-fighting ever since the nationwide lockdown was announced.

COVID-19 has started showing its impact on the mutual fund industry. Few days ago I mentioned in my article, Debt mutual funds witnessed massive outflows of Rs 1.95 trillion in the month of March.

Though we could attribute most of that outflow to corporates redeeming funds to meet their quarter end obligations, high volatility and uncertainty as consequences of the pandemic could have also played a major hand in the redemption pressure for debt schemes.

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FII have been redeeming investments heavily in equity and debt segment ever since WHO declared COVID-19 a pandemic. In March, FIIs pulled out Rs 60,375 crore from the debt market.

High redemption and lack of buying interest has made debt mutual fund schemes vulnerable, especially those with higher exposure to low rated instruments.

This instability has claimed its first casualty in debt mutual funds...

Franklin Templeton Mutual Fund (FTMF) has decided to wind down six of its debt schemes with effect from April 23, 2020 due to COVID-19 related market dislocation. This is something that is unheard of in the mutual fund industry and has perplexed many investors and advisors.

The schemes that are wound up are:

• Franklin India Low Duration Fund
• Franklin India Dynamic Accrual Fund
• Franklin India Credit Risk Fund
• Franklin India Short Term Income Plan
• Franklin India Ultra Short Bond Fund
• Franklin India Income Opportunities Fund

Together these schemes have an AUM of 30,854 crore as on March 31, 2020. Notably, these are the very schemes which in the past had to create segregated portfolio for its exposure to downgraded papers of Vodafone Idea and Yes Bank.

What led to the move?

According to a statement to investors from FTMF, "Despite several measures taken by the Reserve Bank of India (RBI), the liquidity in certain segments of the corporate bond markets has fallen-off dramatically and has remained low for an extended period. In this scenario, mutual funds are facing unprecedented liquidity challenges due to a variety of factors-rising redemption pressures due to heightened risk aversion, mark to market losses following a spike in yields and lower trading volumes in the bond markets. These factors have together caused a significant and worsening liquidity crunch for open-end mutual fund schemes investing in corporate credits across the credit rating spectrum."

The schemes had to resort to continuous borrowing to fund redemptions during this time, and were unable to repay the borrowings through sale of portfolio securities due to the prevailing market environment. The Investment manager did not believe it was prudent to continue funding redemptions through potentially increasing levels of borrowings.

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FTMF follows a high-risk high-return strategy for the above mentioned funds - Meaning a major part of its portfolio is exposed to lower rated securities (rating below AAA). The market disruption due to the virus outbreak has impacted these securities the most.

Under conditions of high redemption pressure, mutual funds sell their liquid assets to meet the demand, leaving the portfolio highly exposed to illiquid assets.

Thus, investors who choose to stay invested are at a disadvantage here.

Anticipating continued liquidity stress to the funds, the fund house thought winding up the scheme is the only viable option for the unitholders to minimize erosion of value.

Table: Details of schemes being wound up

What does it mean for investors of these schemes?

Investors of these schemes will not be able to purchase/redeem investment, switch to other schemes or do systematic transactions. In short their funds will be locked. The fund will not charge any management fees for the funds that are being wound up.

The fund house will rely on coupon payments, maturity value of underlying securities, and selling of securities at realisable value. While the fund house expects to realise most of the proceeds as per maturities, there may be some low rated securities that may even default on the due date. The fund house may create segregated portfolios for such securities and pay back as and when the money is realised.

It will be prudent to check the average maturity of portfolios of each fund and expect major repayment within that period.

What should investors in debt funds do?

Debt mutual fund Investors are not as confident, due to incidents of exposure to toxic papers in the past. This event could make them even more wary about their investment in debt schemes. As a consequence, there may be some panic selling in other debt schemes by investors worried about their funds getting locked.

However, instead of taking any hasty decisions, it would be a great idea to check your funds for the quality of assets it holds.

Choose a fund house that follows prudent investment process and stringent risk-management system. In these uncertain times, it would be wise sticking to liquid funds and overnight funds for the fixed-income part of your portfolio. Alternatively, if you prefer safety of capital, invest in Bank fixed deposits.

Our friends at Quantum Mutual Fund have highlighted the secret behind their debt management strategy which has helped them provide safety and liquidity to investors when it comes to investing in quantum funds. Don't Worry, Quantum Liquid Fund always aims for Safety and Liquidity

The way ahead...

While the fund house has done this to protect investors' interest, it has made the funds illiquid from the investors' point of view. Many investors may lose faith in debt funds for their short-term goals.

Going further, investors may have to consider liquidity risk due to AMC action, while investing in any high credit risk oriented debt funds.

It is time for the regulator to step up and clarify the illiquidity part for other debt schemes out there to investors. Moreover, it needs to provide a framework of strict guidelines to restrict fund managers from putting investors' hard-earned money at risk by exposing them to low rated securities for higher yield.

Meanwhile, AMFI has assured investors that a majority of the fixed income fund assets is invested in superior credit quality securities, and the schemes have appropriate liquidity to ensure normal operations. It further stated that the industry remains fully committed to the investors' interests and there is no need for them to panic and redeem investments.

Author: Divya Grover

This article first appeared on PersonalFN here.

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PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Many investors park their surplus money in debt schemes in an attempt to earn higher returns than Bank FDs. However the recent incident of Franklin Templeton MF winding down six of its debt schemes has dented investor sentiment and sparked speculation about the safety of their investments.

The news came as a shocker to the investors because the six schemes, the fund house, and the fund manager had a good performance record. Investors in the wound up debt schemes of FTMF are now left with no choice but to wait for the fund house make repayments.

If you are one of them, surely you want to know about the timeline of payouts from the respective schemes.

Here is what you should know first...

Before returning the money to unitholders, the fund will have to repay the borrowings by the respective schemes that was taken to fund the heightened level of redemptions. Keep in mind that the repayment of borrowings does not impact the value of money to be returned to the unit holders, though it can delay the start of pay out to unitholders.

The repayment of the borrowings that the fund has taken, along with the cash flows it receives in the respective schemes based on the maturity of the underlying securities in the portfolio as well as coupon receipts will determine the payout to the unitholders.

Moreover, the fund will seek pre-payment from issuers of the underlying securities and will look to sell portfolio holdings in secondary market at fair value.

Table 1: Maturity profile of wound up FTMF schemes

Franklin India Ultra Short Bond Fund (FIUBF) and Franklin India Low Duration Fund (FILDF) are the schemes with shorter maturity. If you are an investor in this scheme, you may expect a significant payout within 2-3 years. However, to recover the entire amount you may have to wait up to 5 years.

If you are wondering why a scheme with average maturity of just 0.44 years and 1.45 years will take around 5 years to repay the entire amount?

This is because the maturity of some underlying securities is much longer (around 4-5 years), even though the schemes belong to low duration category. Additionally, the schemes have borrowings in the range of 6.5% and 8.5% respectively, which have to be repaid first.

Whereas, if you are an investor in Franklin India Dynamic Accrual Fund (FIDA), Franklin India Short Term Income Fund (FISTIP), Franklin India Credit Risk Fund (FICRF), and Franklin India Income Opportunities Fund (FIIOF) your wait will be longer. These schemes primarily invest in medium to long duration securities.

These funds had to sell a number of their short term and liquid securities in the portfolio to meet redemptions. Hence, to get a significant payout from these schemes you will have to wait at least 4-5 years. The year wise expected cumulative cash flows is given in the table below.

Notably, FIIOF is the longest duration fund from among the six funds that have been wound up. It will only be able to repay a very small portion (5%) in the next two years.

Another key reason that could delay the payout from these schemes is the high borrowing rate. FISTIP has 28% of its assets as borrowings, FIIOF has 26%; while FICRF also has significant 16% as borrowings. Furthermore, factors such as credit issues or payment delays faced by any of the investee companies could negatively impact cash flows.

Table 2: Cash flows expected by FTMF across different time period

Many of the securities with longer maturities have regular interim cash flows and features such as interest rate resets or call/ put options, which significantly reduce the effective maturity and the same has been factored into the calculation of the Macaulay Duration.

FTMF said that it would actively explore opportunities with a goal to facilitate repayment prior to the maturity of the portfolio investments. To do this it will seek prepayment from the issuers of the underlying securities and look to sell the securities in the secondary market.

However, the current market scenario is rife with risk aversion and illiquidity. The fact that wound up schemes have high holding of lower rated securities, FTMF will have to wait for the market conditions to go back to normal to liquidate the portfolio at the earliest, without causing value erosion for investors.

[Read: RBI Steps in to Take Some Pain Off Mutual Funds. Will It Help?]

Way ahead for debt fund investors

Keep in mind that debt funds are not risk-free. Investment in debt funds carry various risks relating to liquidity, credit quality, and interest rate. Therefore, before investing in debt funds understand the various risks involved and invest in schemes where the portfolio risk aligns with your own risk appetite and financial objective.

In this market environment, it would be preferable to invest in instruments issued by government and public sector enterprises, and stay away from those having high exposure to private issuers.

At PersonalFN, we arrive at top rated funds using our SMART Score Model. If you wish to select worthy mutual fund schemes, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.

Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.

If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!

Author: Divya Grover

This article first appeared on PersonalFN here.

Join Now: PersonalFN is now on Telegram. Join FREE Today to get 'Daily Wealth Letter' and Exclusive Updates on Mutual Funds

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

The fund house said the remarks made by Jenny Johnson, president and CEO, Franklin Templeton during their quarterly earnings call were quoted "out of context" by media outlets

Franklin Templeton: The fund house has not given any clear indication about the possible timeline within which it will liquidate all its investments and return investors' money

Franklin Templeton Debt crisis: FT investors can hope to get better realisation of their locked investment if the market sentiment improves

US asset manager apologises following comments by company’s president over debt rules

In April, Franklin Templeton India shut down six debt funds, locking in ₹30,800 crore of investor wealth after a surge in redemptions.Explaining the reason behind this, Franklin Templeton CEO Jennifer M Johnson said that this is a liquidity issue and not a solvency issue.Franklin Templeton India’s assets under management (AUM) declined by almost 43% – from $7 billion to $4 billion.Franklin Templeton India, one of the oldest asset management companies (AMC) in the country, decided to wind down six debt funds amounting to ₹30,800 crore in investor wealth. Now, in an earnings call, Franklin Templeton President and CEO Jennifer M Johnson has explained what exactly went wrong with its India business.“We're doing everything we can for those shareholders, to make sure they get all their money back.

Here's a selection of Business Standard opinion pieces of the day

Franklin Templeton Mutual Fund on Friday issued an unconditional apology to market regulator Sebi (Securities and Exchange Board of India) for remarks made by its president and CEO Jennifer M Johnson that new regulatory guidelines led to shutting down of its six debt funds last month.

Sebi also said 'some mutual fund schemes' continued to invest in high risk and 'opaque' debt securities despite the regulatory framework having been amended for safeguarding investors' interest.

Franklin Templeton Mutual Fund also issued an apology to Sebi and said that comments of its top executive Jenny Johnson were wrongly interpreted, diluting her responses about the reason for winding up of schemes.

His remarks came two days after Franklin Templeton Mutual Fund voluntarily decided to wind up its six debt schemes due to liquidity issues amid the coronavirus crisis.

The BSE Midcap index was down by 1.7 percent, while the Smallcap index fell 1.4 percent.

Ashwani Bhatia of SBI Mutual Fund feels it is a message largely to investors, mainly HNIs and institutions that this part of financial market is safe and RBI is looking at financial markets very carefully.

The regulators need to step in immediately to stop any contagion

The NAV of Franklin India Dynamic Asset Allocation FOFs (fell 16.6%), Franklin India Multi-Asset Solution (fell 22.42%), Franklin India Life Stage FOFs-20 (fell 6.59%), Franklin India Life Stage FOFs-30 (13.51%), Franklin India Life Stage FOFs-40 ( fell 17.81%) and Franklin India Life Stage FOFs-50 Plus (fell 0.52%).

"We are committed to doing all we can to return monies in the schemes that are wound up at the earliest to investors, and to regain your trust in our brand," Franklin Templeton Asset Management (India) President Sanjay Sapre said in a note to investors.

A study of the portfolios of five out of the six debt schemes which were wound up by Franklin shows all these products had features of credit risk funds — which predominantly invest in lower-rated debt securities — but they were being sold under different labels.

The fund's global CEO had blamed regulatory changes for its decision to shut 6 schemes.

US investment group halts withdrawals in move that could rock asset management industry

Franklin Templeton Mutual Fund on Friday said it is making every effort to ensure an orderly and equitable exit to all investors affected by closure of six debt schemes, a day after it was asked by regulator sebi to focus on returning investors' money at the earliest.

Over Rs 25,000 crore ($3.3 billion) worth of investments belonging to 300,000 investors are currently stuck in the six debt schemes wound up by the fund house

Stung by the comments made by the global chief, market regulator on Thursday issued a press release defending the new rules it introduced in October last year