Templeton Mutual Fund – This time it is different!

During its 25 years Templeton has seen many cycles in the debt markets. But the latest decision to wind down 6 of its funds shows that this time may actually be different.

Apr 27, 2020 01:04 IST India Infoline News Service

The legendary Sir John Templeton famously said about the stock markets, “The four most dangerous words in the financial lexicon are; This Time It’s Different” He was, of course, referring to the tendency of investors to justify irrational valuations in the market. In a way, Franklin Templeton MF has been a special fund for India. At a time when some of the biggest global names including Fidelity, Morgan Stanley, Deutsche, Goldman and JP Morgan opted out, Templeton opted to stay on and consolidated its position in the top-10 funds in India. During its 25 years Templeton has seen many cycles in the debt markets. But the latest decision to wind down 6 of its funds shows that this time may actually be different.

Why are the 6 Templeton funds being wound down?

On April 24, 2020, Franklin Templeton officially announced that it would wind down six of its debt funds as under:
Name of Scheme Fund Category No. of Segregated Portfolios
Franklin India Low Duration Fund Debt 2
Franklin India Ultra Short Bond Fund Debt 1
Franklin India Short Term Income Plan Debt 3
Franklin India Credit Risk Fund Debt 3
Franklin India Dynamic Accrual Fund Debt 3
Franklin India Income Opportunities Fund Debt 2
Data Source: Franklin Templeton AMC

The AMC has cited COVID-19 as the main reason arguing that the pandemic had led to liquidity virtually vanishing from the corporate bond markets. Hence, the fund just could not keep pace with redemption requests. This scenario is not hard to fathom. Most debt funds keep minimum liquidity to handle outflows. The problem arises when the redemption requests build up and the fund is forced to sell these bonds to generate liquidity. In the case of G-Secs, liquidity is never a problem. But all the above funds have a strong credit risk component to them. That means; a big chunk of these portfolios are invested in corporate / NBFC bonds which are either “AA” rated or even “A” rated. In such cases, if the fund forces liquidity then they may have to take a huge haircut, exposing investor to further losses. The winding up of these funds was taken up as the last option.

What it means for investors in these debt funds?

For investors who are having exposure to these 6 funds, they must reconcile to the fact that the funds are locked in for the time being. Here are some implications.
  • Any fresh purchases or redemptions in any of these six funds will not be entertained by the fund effective from 24 April. However, all redemption requests up to 23 April will be honoured by the fund.
  • Existing investors will be locked into the scheme. The fund will appoint an administrator to systematically sell the bonds either in the market or through private deals and any monies realized will be distributed proportionately.
  • Since the fund has frozen all inflows and outflows, any systematic investment plan (SIP), systematic transfer plan (STP) or systematic withdrawal plan (SWP) mandates will not be valid any longer. Investors must intimate their banks accordingly.
  • While the extent of haircut for investors is not clear, it is clear there will be a haircut in this case. One indication could be that the Templeton FOFs exposed to these 6 funds have taken a 50% write-off. That could be indicative of the haircut for investors.
  • Lastly, the total AUM of these 6 funds is estimated at Rs.28,000 crore, which is nearly 25% of its total AUM in India. That raises questions over Templeton’s other funds and also credit risk funds at other AMCs.
What forced this decision by Templeton MF?

Was it just about COVID-19 and the secondary market liquidity or is there a larger story to the redemption pressures? Check the chart on returns and redemptions of the 6 funds.

Redemptions at Franklin Templeton have been massive in March 2020 in these six funds

Data Source: AMFI / Value Research

In all the six funds that are being wound up by Templeton, the AUM has seen a sharp fall in AUM in the month of March. Apparently, a similar trend was continuing in April too. We will get the AMFI data only in May but looking at the 1-year returns on these six debt funds, it would be hardly surprising if the redemption pressure has continued in April too.

Are there bigger implications for debt funds?

We really need to wait to find out, but one thing is clear. This is not like a few bad investments that can be written off and forgotten about. This time the crisis in debt funds actually looks to be different. A combination of illiquidity, redemption pressure and poor returns can be lethal for debt funds. More so; when investors are habituated to believing that debt funds are risk free and debt fund managers are infallible!

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