How will the debt fund market be affected after the Franklin Templeton India fund lockdown?

How will the debt fund market be affected after the Franklin Templeton India lockdown?

What’s the Franklin Templeton debt funds fiasco?

On 23rd April 2020, in an unforeseen turn of events, Asset management company (AMC) Franklin Templeton India, decided to shut down 6 of its very famous open-ended debt fund schemes. All these schemes followed a high risk, high returns – credit risk strategy. Credit risk funds are basically the type of debt funds that invest approx 65% of the investment corpus in less than AA-rated paper. By investing in lower-rated documents, they take a higher credit risk thereby producing high returns. Lower-rated papers generate instant high returns when their ratings move up enabling these debt funds to raise instant good returns. The only drawback is that they are highly liquid and volatile.

As per the President of the Franklin Templeton India, Sanjay Sapre, “Due to the ongoing novel coronavirus, or COVID-19, pandemic, liquidity in the bond market has dried up. Yields of debt securities have risen sharply and that has materially diminished the abilities of companies to service their debt. Mutual funds have also been getting a lot of redemption requests. We felt it best under these circumstances to wind up these funds and return the money to investors.” The total AUM of Franklin Templeton India is ₹1.04 trillion as of March 2020. As per the statistics, all these 6 debt schemes have 64.7% of their holdings in paper rated below AA.

What are the 6 debt fund schemes that are getting shut down?

Here’s the list of schemes that have been impacted:

  1. Franklin Low Duration Fund
  2. Franklin Dynamic Accrual Fund
  3. Franklin Credit Risk Fund
  4. Franklin Short Term Income Fund
  5. Franklin Ultra Short Bond Fund
  6. Franklin Income Opportunities Fund

Why did they shut down the 6 debt fund schemes?

It is clear from the statement above that the exiting investors were creating a tough situation for the ones who had continued their investments from these high credit risk schemes. The pandemic of COVID-19 has adversely affected the equities and bond market as well. To meet redemptions, the AMC either dips into its cash reserves or sells its underlying securities and investments but as per Sapre, for Templeton, even that wasn’t enough. In the debt market, the low liquidity and high redemption rates along with low capital inflow created a no-return kind of situation for the AMC forcing them to wind down all 6 schemes. 

What will happen to the money of the investors?

The total AUM of these 6 schemes was around Rs. 30,85,232 Crores as on 31st March 2020. With the shutdown of all these schemes, the redemption and investment has also stopped. The money will be returned on a staggered basis to the investors over the course of next few years as the schemes that they have invested in will mature.

How are other debt funds getting impacted?

After the Franklin Templeton India fiasco, Association of Mutual Funds in India (AMFI) has reassured all investors in debt fund schemes that they should continue with their regular investments in the market and aspire to create wealth over the longer term. AMFI has tried to calm nerves by announcing that most AUM for fixed instrument schemes is invested in superior credit quality securities. These securities have managed to maintain sufficient liquidity despite the rough times. Superior quality bonds have investments in more stable return generating instruments.

Coming down to how other high credit risk debt funds will be affected – our guess is the impact will be adverse. Credit risk funds have a set formula of investment. They invest in low rated papers which can generate high returns when the ratings of the schemes that they have invested in move up. This also means that in case the ratings go down, they suffer huge losses. This explains the highly volatile nature of these funds. Mostly, they generate returns in a couple of ways. First being, the returns that they generate by investing in high risk, low rated funds and secondly, they earn massive interests from the securities that they have invested in.

Chasing high yields while all the redemptions were happening has affected the credit risk fund market badly. This means, that in the current scenario with the COVID crisis and the huge redemptions in all schemes including debt funds, most credit risk debt funds will stop yielding.

What about the low liquidity in the market?

One of the biggest reasons why all this has come about is the low liquidity in the markets. The impact of the coronavirus from the economic viewpoint is scary and unprecedented. Markets, as they say, are the barometer of human sentiment. The high redemption rate of investors shows that they are losing faith in the market.

This low liquidity has mostly been a phenomenon prevalent in the high risk debt fund segment though. As per RBI, “Heightened volatility in capital markets in reaction to COVID-19 has imposed liquidity strains on mutual funds (MFs), which have intensified in the wake of redemption pressures related to closure of some debt MFs and potential contagious effects therefrom. The stress is, however, confined to the high-risk debt MF segment at this stage; the larger industry remains liquid”

What has RBI done to fight the redemption pressure and low liquidity?

In view of the high redemption pressure and absence of liquidity, being faced by the entire doubt fund management industry, RBI has decided to offer a special liquid facility  (SLF-MF) of Rs. 50,000 crores to all the mutual fund companies to ease off the pressure. This money is supposed to be strictly used by the banks to help the mutual fund companies to meet the liquidity requirements by either directly extending loans or by buying investment grade bonds, commercial paper, and certificate of deposits from mutual funds. .

As per the circular issued by RBI, “The scheme is valid today, from 27th April 2020 till May 11, 2020 or up to the utilization of the allocated amount, whichever is earlier.” RBI added that banks can submit their bids any day from Monday to Friday excluding holidays. The circular also states that national bank is vigilant and aspires to take all steps to mitigate the economic impact of COVID-19 and maintain the financial stability of the domestic markets.

Mutual fund industry accepts that the step taken by RBI will definitely be a huge confidence booster for the investors. They will gradually improve the overall market sentiment and hopefully slowdown redemptions as per the industry experts.

Written by

Priyanshi Bhardwaj