Closure of 6 Franklin Templeton Debt Fund Schemes

Leading Asset Management Company (AMC) Franklin Templeton announced that it would wind up 6 debt mutual fund schemes effective 23^rd April 2020. These closed debt schemes are as follows:-

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

All these schemes had side-pockets or segregated portfolios, i.e. separation of good assets from risky assets (i.e. assets where there is significant risk default e.g. Vodafone).

What does this mean for investors of these schemes?

All new subscriptions and redemptions from this scheme have been stopped. Franklin Templeton will look to sell holdings at the best valuation they can get and return the money to the investors.

Will SIP and STP in these schemes continue?

No. SIP and STP from these schemes will automatically stop. If you are investing through STP from any one of these schemes to any Franklin Templeton equity fund and want to continue your STP, you will have to change your STP to a different debt scheme. Your Eastern Financier’s financial advisor will help you should you need any assistance.

When will investors get back their money?

Franklin Templeton will return money to the investors in a staggered manner. The AMC has indicated that they would liquidate the scheme holdings at the earliest opportunity taking into context the maturity of the instrument and the debt market conditions. On the maturity of the instrument, the issuer will pay back the face value (principal) to the investors, except in case of a default. It has to be understood that not all the papers in the scheme holdings are at the risk of default.

Apart from holding these schemes till maturity of individual bonds/securities, the AMC will try to sell these instruments in the debt market. However, the market for securities other than top rated ones, i.e. AAA securities, is generally very low in India. The lockdown due to COVID-19 has made the liquidity condition in debt markets far worse. Once markets normalise, the AMC will actively explore selling the securities at a reasonable price before the maturity of the instruments. Investors should understand that even when the lockdown ends there will be extreme risk aversion in the market and markets could take some time to stabilise. We have witnessed a similar liquidity driven situation and using the 2008 financial crisis and markets took about 3-6 months to return to normal. Hence, in the immediate term, investors need to be patient and wait for markets to normalise. For some instruments, the AMC and investors may have no option but to wait till maturity to realize best value.

How much money will investors get?

It will depend on the price / valuations at which the AMC is able to sell the assets in the market and further rating actions on these assets. Moreover, irrespective of mid-term fluctuations in bond prices, if held to maturity, the full price of the bond and interest payments is recoverable. Investors must appreciatethat the current credit situation is extremely complex due to COVID-19. The long and stringent lockdown will undoubtedly cause severe financial distress to many companies. A lot will also depend on the amount and kind of financial assistance provided by the Government and/or RBI to deal with the economic downturn caused by the pandemic. The AMC will have to take into account different factors for individual instruments / issuers to realize the maximum value for investors. The situation is challenging and it is difficult to estimate how much value you can realize from these schemes.

Why did this happen?

The six above-mentioned schemes had 97% or more of its assets invested in instruments rated below AAA or its equivalent. However, as mentioned earlier, the market for AA or lower rated instruments has much lower liquidity compared to AAA rated instruments. In normal times, fund managers would hold these instruments till maturity and accrue the yield (interest) of these instruments. In the face of high redemption pressures, the AMC was forced to offer these instruments in the market for sale,but they were unable to sell because the liquidity situation was exacerbated by the lockdown. If Franklin Templeton did not close these schemes, it would have been forced to sell these instruments at distress prices which would have caused high NAV erosion and harmed the interest of all investors. This is the reason why the AMC took this action.

Our take

• Franklin Templetonhas a strong track record in asset management and has delivered a lot of value to investors both in equity and fixed income.
• The AMC’s decision to close the funds is not driven by credit events or defaults, but due to extreme demand and supply situation in the market in the middle ofthelockdown.
• Franklin Templeton AMC took this decision to protect investor’s interest. By delaying liquidity of these schemes, Franklin Templeton has simply given itself more time to tide over the current extreme situation in the market is extreme. RBI has announced steps which will create liquidity (discussed in more details below) in the corporate bond market and enable investors to realize better value.
• As a measure to reduce costs for investors, Franklin Templeton has decided not to charge any management fees for these 6 funds with effect from 24th April 2020.
• Our outlook on debt funds remain positive for the following reasons:-
• Banking system liquidity: Banks have parked more Rs 7.3 lakh crores with the RBI in reverse repos. The reverse repo rate is only 3.75%. We expect this massive liquidity to be deployed at some stage in form of credit (loans) to companies and NBFCs. This will reduce yields in debt markets and increase debt fund returns depending on the duration of the fund.
• TLTRO facility of RBI: The RBI has announced Rs 1 lakh crores (in tranches) of targeted long term repo operation (TLTRO) by which banks can borrow from RBI at repo rate (4.4%) and lend to a specified category of companies. RBI wants to banks to deploy the funds received under the TLTRO facility within 15 days of receipt of the funds. We expect this will create demand for corporate bonds and benefit debt funds investing in corporate bonds. This should bring normalcy back in Debt markets and improve liquidity for all categories of bonds going forward.
• Further rate cuts: The RBI Governor has hinted they "will do anything to control the situation", which implies further rate cuts could be in the offing to aid economic recovery. The fall in crude prices will lower inflation expectations and make rate actions easier for RBI. Lower interest rates will benefit most debt funds, especially longer duration debt funds.