Franklin Templeton shuts six debt schemes. What does it mean for debt investors?

It looks like the woes of debt fund investors are far from over. In an unprecedented move, Franklin Templeton Mutual Fund has announced the winding up of six of its debt schemes as it faced severe redemption pressure and illiquidity in the bond markets due to the ongoing covid-19 crisis. The schemes that Franklin Templeton Mutual Fund is going to close include Low Duration Fund, Ultra Short Bond Fund, Short Term Income Plan, Credit Risk Fund, Dynamic Accrual Fund and Income Opportunities Fund. According to data available on the Value Research website, these schemes collectively hold assets of ₹30,853 crore in their collective portfolio, as of end of March.

Investors in these schemes can’t exit

While this news is alarming for investors in the schemes, they have no way out. No investments or redemptions will be allowed in these schemes from today. Investors will not be able to redeem, switch out or transfer money from these schemes or start any systematic investment plan (SIP) or make lump sum investments in these funds.

Investors will receive whatever proceeds the fund house is able to recover by liquidating the underlying investments in proportion of their holdings in the respective schemes . "From the investors' perspective, the fund house will give back whatever money they realize over a period of time," said Joydeep Sen, founder, wiseinvestor.in. So, how much money the investors gets back depends on their investments, as well as the amount the fund house is able to recover by liquidating the assets of the funds. When they will receive the money is also uncertain, as it will depend on how fast the fund house is able to recover the money.

What led to this?

The ongoing lockdown imposed to prevent the spread of the covid-19 has brought the businesses to near-complete standstill and is likely to severely impact its ability to service debt obligations. Fearing this outcome, many debt fund investors have resorted to redeeming their investments. Last month debt funds saw one of the highest ever outflow of ₹1.94 lakh crore. Poor liquidity in the debt markets has limited the ability of fund houses to sell the bonds in the markets and service the redemption requests. Many debt funds have resorted to borrowing in order to meet the redemption pressure. The Reserve Bank of India (RBI) has taken several steps, including opening rupee-dollar swap windows and conducting long-term repo operations (LTRO) to improve the liquidity in the bond markets. However, in the case Franklin Templeton, these efforts seem to have been too little, too late.

In a communication sent to its investors regarding shutting of the six schemes, Franklin Templeton Mutual Fund stated “Despite several measures taken by the Reserve Bank of India (RBI), the liquidity in certain segments of the corporate bond markets has fallen-off dramatically and has remained low for an extended period. In this scenario, mutual funds are facing unprecedented liquidity challenges due to a variety of factors-rising redemption pressures due to heightened risk aversion, mark to market losses following a spike in yields and lower trading volumes in the bond markets. These factors have together caused a significant and worsening liquidity crunch for open-end mutual fund schemes investing in corporate credits across the credit rating spectrum”.

What does it mean for investors in other debt schemes?

The closing down of these schemes will have a direct impact on the other schemes of Franklin Templeton Mutual Fund that had invested in any of these schemes, as they will not be able to exit these holdings. For instance, Franklin Templeton Asset Allocation fund was holding around 46% of its assets in the Short-term Income Fund, as per the March-end portfolio data available on the Value Research website.

Apart from this, experts believe that this event is going to severely impact the sentiments of investors in other debt schemes of Franklin Templeton, as well as debt schemes of other fund houses. So we may see further redemptions. A Securities and Exchange Board of India (Sebi) registered investment advisor who didn't want to be named said, “We had exited credit risk exposed Franklin Templeton funds last month. We still have money in Corporate Bond Fund and PSU Fund. We are redeeming the corporate bond fund today, just to be on the safer side and we will take a call on PSU fund later.”

This will certainly dampen the sentiments of the investors of other debt schemes as well. Saurabh Bansal, founder of finatwork wealth services, said, “The confidence of the investors have been shaken as liquidity is the fundamental promise that mutual funds offer to their clients. Rationally, each scheme is different as they hold different papers, but some investors would like to paint all the schemes with a broad brush.”

Investors in debt schemes shouldn’t take a hasty decisions based on this development. Instead, they should assess the credit quality of the portfolio of their funds before jumping to conclusions. "Choose a good quality portfolio and a fund house that is less likely to face a run," said Sen.