Franklin Templeton and closure of 6 debt MF schemes
Franklin Templeton Mutual Fund’s announcement to wind up six debt mutual fund schemes came like a bolt from blue for investors and markets. The decision was taken in the backdrop of continuous erosion in value due to redemption pressures and lack of liquidity for some of the instruments on account of Covid-19 pandemic.
The 6 debt MF schemes wound up by Franklin Templeton
The six debt MF schemes discontinued are
1. Franklin India Low Duration Fund,
2. Franklin India Dynamic Accrual Fund,
3. Franklin India Credit Risk Fund,
4. Franklin India Short Term Income Plan,
5. Franklin India Ultra Short Bond Fund and
6. Franklin India Income Opportunities Fund
These six funds had total assets under management (AUM) of around Rs. 26,000 crore.
What forced Franklin Templeton to close its 6 debt MF schemes?
Due to the falling interest rate on the bank deposits and small saving schemes, many investors, especially senior citizens have been channelizing their savings and surpluses to debt mutual funds for better returns. High rated debt instruments carry low returns. To meet the expectation of investors of better returns than that offered by banks, MF schemes have been investing in low rated debt instruments with higher risk. Though such low investment grade debt instruments offer better return, the credit risk associated with them are high. MF schemes that invest in high risk debt instruments are called credit risk schemes. It is estimated that only limited portion (5%) of total AUM of debt MF schemes are mobilised under credit risk schemes .
How did Covid 19 affect mutual fund liquidity?
A major chunk (around 80%) of total AUM of debt mutual funds are invested in high-rated bonds of AA+ and above. High quality investment grade debt instruments (BBB- rated and above) have high marketability, especially after the Targeted Long Term Repo Operation (TLTRO 1.0) announced by RBI. However, illiquid, low-rated instruments in the credit risk portfolio of MF schemes have been facing liquidity issues. In times of uncertainty, as that created by Covid 19, investors and banks become risk averse and turn away from instruments below investment grade. This creates liquidity issues for schemes holding inferior investments when redemption pressures increases and inflows cease.
For the 6 schemes of Franklin Templeton, value was getting eroded on account of high redemption pressures coupled with less fresh inflows and mark to market losses following inadequate liquidity caused by Covid-19 pandemic. Value of their investments in high grade debt instruments was not impacted. However, value of low grade investments has been eroding at a rapid pace. Selling such instruments in a liquidity constrained market was not a prudent decision and to avoid further erosion in value, it announced closure of funds.
Franklin Templeton’s 6 debt MF schemes and investors
Franklin Templeton has barred both purchase and redemption of units in the six debt mutual funds schemes. Therefore, investors cannot redeem their investments for the time being. According to the MF house, their attempt is to return the ‘maximum value possible’ to the investors. Selling all the securities in a depressed market immediately would lead to forgoing a huge part of otherwise realisable value and they intend to wait for opportune times.
The fund hose will continue to announce the net asset value of the schemes on daily basis. Investors in these schemes will not be charged any investment management fee, in future. Franklin Templeton said that it would proceed with the liquidation of the assets and the funds with the shortest duration at the earliest. In addition, there will be some inflows by way of coupon payments and maturities. These amounts may be distributed to investors in a staggered manner on monthly / quarterly basis.
Investor sentiments and future investments
The present announcement by Franklin Templeton MF house will have a bearing on the investor sentiments. The announcement may lead to huge redemptions in debt schemes. However, Franklin Templeton issue is to be considered as a one-off instance and not an industry-wide phenomenon. As already mentioned, total AUM of credit risk funds is less than 5% of the total AUM of mutual fund debt schemes. Further, present regulations allow MF schemes to borrow up to 20% of their assets to meet liquidity needs. Majority of MF houses have not resorted to borrowing and such amounts may become handy in case of high redemption pressure. The announcement by RBI on Special Liquidity Facility for Mutual Funds (SLF-MF) provided a clear signal to the market and investors that the regulator is ready to support the industry in the crucial juncture and that there is nothing to worry much.
