Analysis of Franklin Templeton's Closure

 #17

Overview

• Franklin Templeton Mutual Fund closed 6 of its debt schemes in India:
• Franklin India Low Duration Fund (62.8% of assets invested in bonds rated below A+, 45.76% rated AA)
• Ultra Short Bond Fund (82.8% in AA rated, 23.9% in A rated)
• Short Term Income Plan (58.6% in AA rated, 57.5% in A rated)
• Credit Risk Fund (60% AA rated, 49.6% in A rated)
• Dynamic Accrual Fund (52.7% in AA rated, 44% in A rated)
• Income Opportunities Fund (63.97% in AA rated, 41% in A rated)

Reasons

• Illiquidity in bond markets
• Severe redemption pressure
• SEBI's opening of a window for AMCs to borrow to meet redemptions

Cause

COVID-19

What happened?

• The above 6 schemes of Franklin Templeton Mutual Fund (FTMF) took aggressive credit calls in their portfolios in the recent past
• Despite getting higher returns by taking on these high risks, the debt funds and a few liquid funds (safest of the lot) experienced tremendous volatility
• In the last 18 months due to COVID, worried investors withdrew money and exacerbated the problem

Which led to

• Shrinking of the portfolios
• Funds left with a higher proportion of less liquid (riskier) investments
• FTMF having to keep borrowing money to pay off the redemptions but reached the borrowing limit as per regulations

Outcome

Investors unable to:

• Withdraw or transfer their existing investments
• Start any SIP in those schemes
• Make fresh investments

Let's talk numbers

Debt funds:

• Outflow: Rs 1.94 lakh crore (March 2020)
• Inflow: Rs 43,431.55 crore into liquid schemes, corporate bond funds, banking and PSU funds, overnight funds, and gilt funds (April 2020)

Category-wise outflows:

• Medium duration funds: Rs 6,363.53 crore
• Short duration funds: Rs 2,309.05 crore
• Money market funds: Rs 1,210.35 crore
• Low duration funds: Rs 6,841.07 crore
• Ultra-short duration funds: Rs 3,419.32 crore

Credit risk funds:

• Outflow: Rs 19,238.98 crore (April 2020)
• Inflow: Rs 6,279.23 crore (March 2020)

What all did FT try before winding up?

Borrow

• FTMF AMC borrowed continuously to fund redemption requirements
• But were unable to repay the borrowings by selling bonds
• Will lead to gross asset-liability mismatch in the long run

Restrict redemptions

• Current terms for restrictions under the regulatory framework:
• Maximum suspension period of 10 working days limited to once in a 90-day cycle
• AMC needs to honour redemptions up to Rs 2 lakh per day per investor
• The above terms made this approach infeasible

Elongate redemption payments

• Redemptions pay-outs were being made on a T+1 basis with a maximum of 10 working days
• This approach too was unviable because it would only handle the short-term liquidity issues and not the sustained impact of the crisis

Distress Sale

• In a distress sale, the AMC would have to sell the securities at a discount to meet redemption requests
• If so, investors staying invested would have borne significant losses

Winding up was the only forced choice for FTMF.

So, when will the investors get their money?

Once:

• The macroeconomic situation improves
• Cash-flow pains will be relieved
• FTMF makes good on their debts
• Investors are allowed to withdraw their investments
• FT does an orderly sale of their investments in order to return the money to investors
• FTMF communicates an exit strategy for their schemes

Bright side

Debt fund redemptions slowed after RBI announced a Rs 50,000 crore credit support for MFs

FT can attempt to retrieve the value invested in those schemes either by selling the underlying assets (e.g. corporate bonds), or wait for them to reach maturity, when those companies will have to pay back what is owed to them.