One of India’s largest fund houses, Franklin Templeton, announced on Thursday that it’s winding up six of its debt mutual funds from the same day, April 23. This was an unusual move as it meant that investors will no longer be able to invest or withdraw from these schemes anymore.
These six schemes are estimated to have assets under management (AUM) to the tune of Rs 28,000 crore, all of which are now stuck.
This action, Franklin Templeton says, was taken because these six funds have high exposure to securities that give high yields but have low credit ratings, but now have been most impacted by the ongoing liquidity crisis in the market.
Here are six things to know about Franklin Templeton’s fund freeze:
Which are the six debt funds
• Franklin India Low Duration Fund
• Franklin India Dynamic Accrual Fund
• Franklin India Credit Risk Fund
• Franklin India Short Term Income Plan
• Franklin India Ultra Short Bond Fund
• Franklin India Income Opportunities Fund
What are debt funds
A debt fund is a mutual fund scheme that invests in fixed income instruments like corporate and government Bonds, corporate debt securities, and money market instruments that offer capital appreciation.
Debt funds are usually seen as ideal investment instruments for those who are risk-averse, since they are less volatile than equity funds. Debt funds are usually seen as being as safe as a fixed deposit, but with better returns.
Why prompted this move
The massive impact of the COVID-19 pandemic on the global economy has been widely talked about. Economists across the globe have also said that the economic fallout of the pandemic will be worse than the 2008 financial crisis.
This uncertainty has caused stock markets (equity markets) across the world, including in India, to crash to their lowest levels. With many businesses having to suspend operations, companies across the globe are facing an unprecedented liquidity crunch. Banks are also being more careful in lending to companies due to an increased fear of defaults. As a result, equity and debt markets have lost the confidence of investors, especially those companies that have low credit ratings.
Low confidence in the market and an unstable economic environment has meant that investors have been redeeming (withdrawing money from) their mutual funds.
According to Sanjay Sapre, President, Franklin Templeton India, significantly reduced liquidity in the Indian bond markets for most debt securities and unprecedented levels of redemptions following the COVID-19 outbreak and lockdown compelled the company to take this decision.
In addition, the company says that this decision has been taken in order to protect the interests of the funds’ unitholders.
“The decision to wind up these funds was an extremely difficult one, but we believe it is necessary to protect value for our investors and presented the only viable means to secure an orderly realization of portfolio assets,” Sanjay said.
What happens to your investment in a Franklin Templeton fund?
With the six funds winding down, investors will no longer be allowed to transact on them. You cannot redeem (withdraw) any money that you have invested in these funds. All of the Rs 28,000 crore that these funds hold are now stuck.
This also includes systematic transfer plans (STPs), where money from your debt fund was being invested in an equity fund. This will also now stop since money can no longer be transferred from the debt fund to the equity fund.
The company has said that this action is limited only to the six funds, which have significant direct exposure to the higher yielding, lower-rated credit securities in India that have been most impacted by the ongoing liquidity crisis in the market.
“All other funds managed by Franklin Templeton Mutual Fund in India – equity, debt and hybrid – are unaffected by this decision. These other funds are managed by independent teams of investment managers and continue to perform as per their respective investment mandates,” the company said in a statement.
Will you get your money back? If yes, when?
Franklin Templeton will now try to liquidate the underlying assets of these schemes. Those who have invested in the fund will get their money back when their scheme matures. This is because Franklin Templeton will have to wait for companies it has invested in to return the money back. Once it receives the funds, it will start returning money to investors as well. However, the company hasn’t given a timeline regarding this.
However, as per experts, investors will now have to wait as long as the duration of the scheme. This can be calculated using something called the ‘Macaulay duration’, which is the measure of the time an investor would take to get back all his invested money in the bond through periodic interest as well as principal repayments.
The Macaulay duration for Franklin India Low Duration Fund was 1.2 years as of March. So, this would mean that investors will have to wait for 1.2 years to get their money back from the scheme.
According to a Moneycontrol report, the Macaulay duration for the Franklin India Income Opportunities Fund was 3.22 years, which means that investors will have to wait for three years and 80 days to get their money back.
However, it largely depends on the revival of the economy and the markets. FT believes that if the pandemic comes under control soon and markets revive, investors are likely to get their money back faster.
Does this mean mutual funds are no longer safe? What should you do?
The Franklin Templeton issue may create fear amongst investors, especially those who have invested in debt funds. Some experts anticipate an impact on the overall debt mutual fund market as well, since investors may now rush to redeem their investments, further reducing liquidity in the market.
While some experts are advising investors to stay vigilant, some are recommending revisiting their portfolios and reassess their risk appetite.
However, mutual fund industry body Association of Mutual Funds in India (AMFI) has assured investors that the majority of Fixed Income Mutual Funds AUM is invested in superior credit quality securities and schemes have appropriate liquidity to ensure normal operations.
AMFI has strongly recommended that investors continue to focus on their investment goals, consult their financial advisor and not get side-tracked by an isolated event in a few schemes of one fund company.
“While AMFI is in the process of collecting the data, many Mutual funds have informed that they don't have any outstanding borrowing,” it said in a statement.
It also says that it expects fixed income funds across the entire Mutual Fund Industry to continue their normal operation without any material impact.
Nilesh Shah, a renowned investment expert and Chairman of AMFI, said, “Banking liquidity in excess of Rs 7 lakh crore, Long Term Repo Operations (LTRO) conducted by the RBI, expectations of further rate cuts and Operation Twist by the RBI is likely to keep bond market liquid and normally functioning in current challenging times.”
“The Mutual Fund industry remains fully committed to investor interests and there is no need for them to panic and redeem their investments. The industry continues to remain robust like in 2008 sub-prime crisis or 2013 taper tantrum crisis,” he added.