Why did Franklin Templeton debt schemes hit?

ABOUT FRANKLIN TEMPLETON

- Franklin Templeton is the country's ninth-largest mutual fund house and manages assets worth Rs. 1.16 lakh crore.

- It has been an early and patient investor in India. They have worked to build a long-term business in India over our 25+ year history here. This is also reinforced by the fact that over 33% of its global workforce is based in India

- Franklin Templeton was very popular among investors as they used to manage the low rated debt instruments effectively and efficiently when compared to others. These low rates instruments yield high returns and pass on to its unit holders making investors happy. The basic principle of financial management is ' High Risk, High Returns'.

• Fund Manager (6 schemes) - Mr. Santosh Kamath
• Meaning Of Certain Terms:

Q. Who is a fund manager?

Ans Fund managers primarily research and determine the best stocks, bonds, or other securities to fit the strategy of the fund as outlined in the prospectus, then buy and sell them.

Q. What are debt funds?

Ans- The funds which invest in instruments like corporate bonds and securities, not in stocks are known as debt funds. Schemes that invest directly in stocks come under the 'equity' category and are unlikely to be affected right now.

Q. What Are OPEN-ENDED Schemes?

Ans- An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis.

Q. What Are Credit Risk Funds?

Ans- Credit risk funds bear among the highest risks in their category but also tend to deliver higher returns than fixed deposits. These funds can return up to 9% per annum i.e. higher than the returns from fixed deposits.

Q. Are Mutual Funds Allowed To Close Schemes As And When They Feel?

Ans- Mutual funds have trustees.
As per Sebi regulations when a trustee deems fit to close down the schemes they can do so.

Q. What Is Repo Rate?

Ans- Repo rate refers to the rate at which commercial banks borrow money by selling their securities to the Central bank of our country i.e Reserve Bank of India (RBI) to maintain liquidity, in case of shortage of funds or due to some statutory measures. It is one of the main tools of RBI to keep inflation under control.

Q. What Is Credit Rating?

Ans- An estimate of the ability of a person or organization to fulfill their financial commitments, based on previous dealings.

Ex- CRISIL, ICRA, MOODY'S, etc. Are popular credit rating agencies.

Q. What Happened At Franklin Templeton?

The credit climate was extremely challenging over the last quarter or so, and Covid-19 severely heightened the pressure resulting in a spike in yields and sharply reduced liquidity. Franklin Templeton chose to voluntarily wind up 6 schemes cumulatively, these schemes compromise of ?26,000 crores.

From March 31, 2020, to April 20, 2020, these six schemes witnessed redemption pressure worth Rs 4,075 crore. With a majority of their funds invested in instruments rated AA or lower, the fund had no option but to close these schemes after witnessing redemption of over Rs 4,000 crore in less than a month. Papers rated AA and lower will find almost no or very few takers amid the crisis in the financial system.

The Six Debt Schemes Closed Down Are:-

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

All six wound-up schemes were managed by Santosh Kamath, a 'star' fund manager who is also chief investment officer for fixed-income at Franklin Templeton.

Templeton's strategy was all along set up for failure. Running an open-ended scheme while investing largely in low-grade I.e. below AAA, illiquid investments with the objective of earning higher returns than most peers, is a prescription for disaster.

Kamath is credited with having helped create a market for buying debt instruments that are ranked below AAA i.e. AA, A, B.For credit risk funds, the promise of mouthwatering returns is so overwhelming that it can instantly blind even normally astute investors. There is now an alarming frequency about the fallout — investment calls going horribly wrong and investor money going up in smoke and almost every stakeholder groping in the dark.

What eventually happened at Franklin Templeton was that investors started pulling their money out of these funds that invest in risky debt i.e. instruments having rating below AAA, either because they needed the cash as a result of the massive economic hit India has taken or because they were concerned about how the schemes would perform.

The company at first attempted to borrow funds to pay back investors. But the redemption pressure ended up being too high, leaving the fund house unable to return the money. Additionally, because its underlying assets were in the risky category, it was quite likely that there would have been no other takers for those instruments either.

As a result, the fund house decided to wind-up the schemes and hope to gain back the value of the underlying assets either by selling them or waiting for them to mature.

Q. Who Got Benefited Those Who Sold Their Units Or Those Who Decided To Stay With The Fund?

ANS- It's the people who decided to sell off their units of mutual fund because those who thought of staying back their funds got blocked as the fund decided to temporarily shut the buying and selling of units and no further redemption is going to happen. The investors who didn't sell they will get their amount either when the company sells off the assets i.e. the instruments or when the instruments mature at that time the investors are going to get back their money.

Measures Taken By Reserve Bank Of India:

1. RBI announced Rs 50,000-crore liquidity support for mutual funds. The central bank's move has come following Franklin Templeton's decision to close six debt funds and put redemptions on hold indefinitely.

2. Under the special liquidity facility scheme,

• RBI will conduct repo operations of 90 days tenor at the fixed repo rate.
• The facility will be on-tap and open-ended, and banks can submit their bids to avail funding on any day from Monday to Friday, RBI said.

3. Funds availed under the scheme can be used by banks exclusively for,

• Meeting the liquidity requirements of MFs by extending loans,
• Undertaking outright purchase against the collateral of investment-grade corporate bonds, commercial papers (CPs), debentures and certificates of Deposit (CDs) held by MFs.

4. The Reserve Bank's efforts may have come too late for investors of the six Franklin Templeton schemes, but the central bank hopes it will reduce the chances of other mutual fund houses being forced into a similar situation.

Frequently Asked Questions:

Q. Does winding up of the schemes means that my money is lost?

Ans- This is factually incorrect. Their aim is to liquidate the portfolio in the shortest possible time having regard to market conditions and to return monies to investors. The schemes will continue to receive scheduled coupons and maturity payments, and they will look for all opportunities to seek pre-payments from issuers or to sell portfolio holdings, without incurring a significant impact cost.

Q. Will they prioritize amongst investors while returning the money?

Ans- All investors in each scheme will be treated equally in terms of payment of redemption proceeds.

Q. Will they prioritize amongst schemes while returning the money?

Ans- Each scheme has its own cash flows, coupon payments, and maturities. Hence investors in each scheme will receive payments in accordance with the cash flows generated from the scheme they are invested in.

Q. What will be the tax implications for unitholder?

Ans- The amount received by investors from of redemption of units and would, where such amount or part thereof represents a gain for the investor, be taxed as capital gain in the hands of investors depending on inter alia the period of their investment in the scheme.

Q. Franklin Templeton winding up its business in India?

Ans- They will continue to manage an additional 27 open-ended schemes, 24 close-ended and 6 funds of funds schemes with approximately INR 50,000 Crore of AUM. They will be operating with less then the current asset under management i.e. currently they were operating with 1.6lakh crores and now they will operate with ?50000 crores only.