Franklin Templeton fiasco explained for a layman

Franklin Templeton decided to wind up around 28,000 Cr of debt funds after a liquidity crisis. Since to some extent, Covid-19 or Corona has played its role here, I will try to use corona as analogy to explain it.

1. What happened

Franklin Templeton has wind up six of its debt schemes. You can read notice from fund house here. What it means for you is if you have invested money in these schemes, you can not get it back immediately. Franklin Templeton will sell underlying assets in due course and then return money proportionately. Since we all now understand word quarantine very well now, you can think as if Franklin Templeton has put these six debt schemes in quarantine. Once in quarantine, no one can come in or go out of room. In similar way, no money now gets invested or redeemed on its own. Also if you are using these schemes to do STP (Systematic Transfer Plan) to regularly move money from debt to any Equity fund, that will also stop. This is because ultimately STP is redemption from one fund and purchase in another. Same with dividend option. It will stop paying dividends.

2. Which schemes are quarantined

As we know in corona infection, only positive people are quarantined. Similarly Franklin Templeton did not wind up all schemes. Not even even all the debt funds. Only below six schemes are winding up.

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

3. Which is the virus they are infected with

So you must be wondering why only these six schemes getting closed or winded up. Well, they are impacted with liquidity. Liquidity is ability to quickly sell anything. It seems there is unprecedented level of redemption requests from these schemes. As you might know, debt funds invest in underlying debt securities. So when there is request for redemption, either it needs to be managed against new investment amount coming into scheme or fund needs to sell some of its debt assets and return money. They can also take some loan but within SEBI limits. In normal situations, fund has inflows, some loans, outflows as well as some instruments maturing regularly. So managing redemption is generally not a big issue.

In current covid-19 lock down, fund may not have received lot of incoming money from investors. But at same time, it seems investors started withdrawing money from these scheme significantly. So now fund needed to sell debt assets that they were invested in. Due to current situation, they could not get buyers for the assets at fair price and hence Franklin Templeton took decision to wind up these schemes.

4. So why only these schemes

Right question. Why current situation impacting only these schemes. Franklin Templeton has even other debt schemes. Then why only these six. Low immunity? Yes. If you look at Liquidity as virus then immunity of fund is its Credit Quality. Better the credit quality, good immunity of fund and it can fight liquidity needs. Think of it like this, say a lender suddenly knocks on you door and asks to repay entire loan unexpectedly. If you have say a property in very prime area, you can quickly sell it and repay back. However say if you have a flat in some remote undeveloped areas then it will be difficult to sell quickly. This ability to sell quickly at right price is called liquidity.

Why low credit risk assets?

To be fair to these schemes, assets in them are suppose to be of little less credit quality. Look at one of the scheme name – “Franklin India Credit Risk Fund”. Name itself suggests it is taking credit risk. Credit risk in simple language is risk of defaulting by issuer of debt.

Why some funds take such risk? Simple answer is to earn higher returns. This is similar to say FD rates of nationalized banks like SBI vs say some small co operative banks. Since we have more confidence in say SBI Fixed deposit, if some other small bank needs to attract you, they need to offer better interest rates. Similarly when fund invests in sub AAA rated papers, investors get better returns.

There are investors who are willing to take little extra risk to earn better returns. These schemes are meant for such investors. By definition, credit funds invest 65 per cent of the portfolio in bonds that are AA rated or below. But these types of funds invest in large number of instruments may be 50 to 100 of these. In normal scenario, even if one or two default, rest of the instruments can give better returns than a very high quality debt funds.

But no one really anticipated a country wide / world wide lock down ever. Most of small to medium size companies are under pressure. Naturally there is worry there. That may have led to unprecedented redemption pressure in such schemes.

5. Worried. Will and when I get back my money

First and foremost, your investment is not gone. It is just that Franklin Templeton needs some time to sell assets at reasonable price. Of course there could be some assets which could actually default but that was going to happen either way – with or without this decision. So this is more like your money get locked for some time rather than really lost. As and when they will be able to sell the assets, they would start paying back to investors.

So next question is what is timeline to get this all sorted. That is difficult to answer. This may take some time due to current situation. We have to wait and watch. We will need improvement in liquidity in market to let fund sell these assets. Most likely that will happen only after India opens up its economy and work starts.

6. What about other Franklin Templeton funds

Do check portfolio of fund you are invested in . If quality of majority assets is good like investments are in sovereign bonds, or AAA rated companies, you should not worry at this stage. Each scheme assets are managed separately. So its very unlikely Franklin Templeton will wind up any other schemes.

There are few Fund of Fund schemes. These schemes don’t invest in stock market directly but invest in other mutual funds. If you are invested in such FOF, you need to check if they have exposure to above schemes. So you would know likely impact.Do consult your financial advisor before exiting other schemes in hurry. No point in paying exit load and may be also booking losses due to current market situation.

7. What about credit risk debt schemes in other fund houses

Yes, this is likely to have negative impact on the even other mutual fund houses. People may get nervous and start redeeming their money. This may trigger a chain reaction and put more pressure on the debt market. I think SEBI and government will soon come up with some assurance to clam the investors. Do consult your financial advisor before taking any decision in hurry. No better time to seek advice for the fee or commission you pay.

8. All bad. Or anything good in this decision for me

This is still my guess work. Let us think logically. Retail investors are not that smart to understand the level of risk and could not have started redeeming to an extent of putting pressure on a fund. Neither I have seen many advisors / distributors warning against such funds in last month or so. All they were focusing on convincing you to continue SIP, buy low sell high etc. So who are these sellers.

So I feel these are likely to be FII or High Net-worth Investors. They invest large amount in debt funds as even 1 -2 % extra returns makes lot of difference to them. Plus generally they have a dedicated person or team to monitor their portfolio. They might have sensed the risk due to lock down and started getting out. Another possibility is that some companies may have parked surplus profit in such funds. Now that all the cash flow stopped due to lock-down, they may needed their money back for operational activities, wages, bills, rents etc. So they might have started withdrawing big time.

Now if Franklin Templeton had not taken this decision to wind up these schemes, they had to sell assets at a cheap rate to meet withdrawal demands. NAV would have dropped and there could have been significant losses to smaller investors. If they had allowed this to go on for more days, retail investors like us could have suffered more damage. Say when fund would have started selling, first they could have sold is relatively better quality assets. So what would have left for smaller and not so proactive investors would have been further low quality papers. So in a way, it looks a reasonable decision to me. This will cause some inconvenience to investors if they had immediate redemption needs or someone dependent on dividend income. But loss otherwise could have been even more damaging.

This is all just my opinion or guess at this stage. Will need to wait for SEBI and government to come out with more details as how LL this started. Will update article as I get more information.

9. Any advice?

As mentioned in all my posts, this blog is just my personal hobby and I should not advice before I understand investor, their goal, risk ability etc. So no advice but my personal view is if I were in your place now, I could be looking at safety over returns at this stage. Credit quality is more important than interest / returns in today’s situation. Do your own research or have a discussion with your financial advisor. Let me know your views on Franklin Templeton decision to wind up. Was it correct or there was better option

10 Lessons learnt

Know the risk

Two things we could learn and use it in future investments

  • Understand category of fund before investing. If your advisor has not explained the scheme properly before making you invest, that is a big mistake. Don’t think all credit risk funds are bad. Just that you need to know the risk before you invest. You can learn basics of debt mutual funds in one of my previous articles – ABCD of Debt Mutual Funds
  • Diversify money across mutual funds. Don’t be heavily invested in single scheme or fund house just because it is giving good returns currently

Hope this was helpful for you in some way. If you like the information, please subscribe to blog. This will help you get notified when a new article is written. It will also motivate me and keep me going. Also share blog within your network if you think it could benefit them.

Leave a Comment