Franklin Templeton shuts down six credit risk strategy-oriented debt mutual fund schemes
Introduction
On April 23, 2020, India’s ninth-largest fund house with an average AUM of Rs 1.16 trillion(January-March 2020), Franklin Templeton announced the shutdown of six of its credit debt mutual fund schemes. The funds have locked down a total of more than Rs 25,000 crores of investors’ wealth. The fund house cited the slowdown due to the pandemic as the prime reason for the outflows from credit risk schemes, and of the subsequent shutting down of the funds.
No transactions, fresh investments, or redemption are allowed in these funds anymore. The money invested is locked and the investors can expect to redeem their money back as and when liquidity is available. Investors need to wait until the managers sell the illiquid securities in these schemes and distribute the realized value to the existing unit-holders.
The fund house expects a different time horizon for these disposals across the six funds. Franklin India Ultra Short-Term Fund aims to return around 9 per cent of its dues within three months, 39 per cent within six months, 50 per cent within a year and 81 per cent within two years. However, the worst-hit Franklin India Income Opportunities Fund aims to give back 5 per cent within two years and will take close to five years to give the entire amount back — if it manages to recover everything in the first place.
This is not a credit crisis; it’s a liquidity and solvency crisis.
The Aggressive Strategy of Franklin Templeton
Franklin Templeton Short Bond Fund, a debt scheme which was meant for 3–6 months’ investment tenure, had nearly 28 per cent of its assets in securities with a credit rating of ‘A’ and below. Similar schemes from other fund houses had just about 3 per cent in such securities on an average.
Another short-term fund, Franklin India Duration Fund, a debt scheme meant for an investment horizon of 6–12 months had invested around 44 per cent in such risky assets. Similar schemes of other fund houses had just 10 per cent in securities rated ‘A’ or below.
A report by B&K Securities showed that Franklin Templeton was the sole lender to 26 of the 88securities in its portfolio. 43 securities had 50% or more of their borrowings from the fund house. In such securities, Franklin Templeton may bear a larger share of the risk than other funds in the industry. The large share of securities held by one fund house also makes these securities less liquid.
What Franklin Templeton has to say about this?
Sanjay Sapre, the President of Franklin Templeton said that the decision to wind up six yield-oriented schemes was an extremely difficult one and taken only to protect investor interest. The Securities and Exchange Board of India (SEBI) guideline that allowed only 10 per cent investment in unlisted instruments was one of the reasons that prompted Franklin Templeton Mutual Fund to wind up six of its debt schemes in India, its global president Jennifer M. Johnson observed.
Franklin Templeton conducted its second-quarter earnings call on May 1. During the call, Johnson said: “We entered India 20-plus years ago. And we were a fixed income manager there or portfolio manager. In India, anything below AAA-rated is considered non-investment grade. And the high-yield market is still very immature there. So, we’ve had a large fund, it’s actually six funds, that were invested with a lot of this kind of private debt. And in October of 2019, unfortunately, SEBI came out with new guidelines saying that any investments in unlisted instruments should be less than 10 per cent. You can’t have more than 10 per cent in a fund, and you can’t trade them. So that orphaned about one-third of our funds there.”
Franklin Templeton said that this decision comes as liquidity has dried up in the Indian financial system in the wake of the coronavirus pandemic. “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. At the same time, mutual funds, especially in the fixed income segment, are facing continuous and heightened redemptions,” Franklin Templeton MF said in a statement.
Many investors with systematic transfer plans, wherein they shift money from the ultra-short-term funds to equity funds, are stuck. Valuations in equity are lower, but due to winding up of the debt plans, they cannot transfer this money. Since it is the first time a scheme is being wound up, retail investors have not understood what the move really means, and many panic-stricken investors were reportedly calling distributors about redemptions.
Progress made by fund Houses
Two of the six schemes (Franklin India Ultra Short Bond Fund & Franklin India Dynamic Accrual Fund) have repaid their bank borrowings and are cash positive and received a pre-payment of INR 420 cr. from Nuvoco Vistas Corporation Ltd (NVCL).
In one more scheme, Franklin India Credit Risk Fund, the borrowing level has come down to 11.25% from its original level of 22.27% on April 24, 2020.
Fund houses invested in a security issued by Vodafone with a maturity date of July 10, 2020, at an annual interest of 8.25%.
On 12 June 2020 Vodafone paid INR 102.71 cr.
On July 10, 2020 fund houses received full and final payment of 1252.88 cr against the principle dues of 1245 Cr.
Update on a case filed against Franklin Templeton
To reduce the Litigation and Complete the matter over 3 months Supreme Court (SC) considered the Special Leave Petition and the Transfer Petition filed by Franklin Templeton to a Division Bench of Karnataka High Court.
The Karnataka High Court has directed all parties that have raised objection to wind up of six debt schemes of Franklin Templeton to file their rejoinder by July 29.
Conclusion
With the circular of SEBI on 27th June 2019 to limit the maximum investment in unlisted Debt Securities to 15% by 31st March 2020 & 10% by June Franklin Templeton and many other debt funds started facing liquidity issues and the COVID Pandemic has added the fuel to the liquidity crisis prevailing in the market. SEBI in its recent circular has extended the dates due to COVID pandemic to comply with the limit of 15% and 10% to 3oth September and 31st December respectively.
The New circular by SEBI on June 10th to get the unlisted ones to listed ones in 3 months starting from 15th June 2020 will help the Debt mutual funds to reach their 10% limit with an increase in the liquidity. With the new measures that are about to come from the Government and Payments received from Vodafone and similar companies will help all those locked up investors to get their money soon than the time horizon given by Franklin Templeton.
References
https://www.franklintempletonindia.com/investor/market-insights/winding-up-of-specific-schemes
