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MUMBAI : Franklin Templeton India’s decision to shut down six debt schemes can be traced to its recent predilection for taking credit risks and chasing yields, particularly in schemes where the fund was ideally not supposed to take credit risks. The worsening economic situation has further soured the credit risk in the fund's books, leading to huge redemption pressure, forcing the fund to shut down the debt schemes.

The six Franklin funds have combined asset under management (AUM) of 25,856 crore as on date. The total AUM of Franklin Templeton is 1.04 trillion as of March 2020. As per the data analysed by Mint, these schemes have 64.7% of their holdings in paper rated below AA.

For instance, Franklin India Low Duration Fund has 64.7% of its holding in below AA-rated paper, Dynamic Accrual Fund 44.6%, Credit Risk Fund 50.2%, Short Term Income Plan 58.9%, Ultra Short Term Bond Plan 23.9% and Income Opportunities Fund 41.3%.

Industry body Association of Mutual Funds in India (AMFI) has rushed to assuage investor concerns and stem any cascading redemption pressure on debt funds floated by other mutual fund houses. In a press statement, AMFI said that action is limited to only these six funds. "Liquidity, maturity profile and credit quality for other debt funds is appropriate for day-to-day operations to continue uninterruptedly," it said.

While Franklin Templeton has decided to wind up these 6 schemes, there is a legal catch. As per regulations laid down by Securities and Exchange Board of India (Sebi), a winding requires four level of approvals: from trustees, 50% of unit holders, from Sebi and finally refunding investors. So far, the fund house has done only one that is taking an approval from trustees. "It looks like an exercise to be completed in coming years. Most of the necessary approvals are pending," said a senior lawyer, declining to be named.

Debt funds which take aggressive credit calls need an improving credit environment to generate and deliver stable returns. However, the markets due to the impact of Covid-19 pandemic impact have been facing an extremely high level of redemption pressures and illiquidity. To meet these redemption pressures, debt mutual funds had to either sell some of their holdings or borrow from the market. Even the FT funds had to borrow from banks in the face of mounting redemption demands.

“So far, in the past couple of months, these funds have raised 29,500 crore. Out of this, 21,000 crore were raised through selling paper, which was AA and below rated paper. We had a committed borrowing line of 5,000 crore from banks which we had to rely on heavily," said Sanjay Sapre, president, Franklin Templeton - India to Mint in a call with journalists on Thursday. Mutual funds can borrow up to 20% of their net assets from the market to meet redemption pressures.

The worsening credit environment in April led to these Franklin funds facing 7000 crore of redemption pressures during the previous week This led to concerns that savvy investors could get out quickly and other investors could be left holding the bad papers.

Typically savvy investors are able to gauge the credit risk in a scheme simply by looking at the publicly disclosed portfolio. However, retail and not-so-savvy investors were incapable of gauging the complex risks in this case since Templeton had mined the regulatory grey zones by mixing high risk debt paper in what was nominally sold as low risk schemes, such as ultra short duration, low duration and short duration.

"Credit funds may be small part of the overall debt AUM but they are a much higher portion of retail & HNI investor portfolios. This is because due to the higher running yields (YTM), credit funds have been positioned better alternative to FDs (fixed deposits)," said Prateek Pant, Co-founder and head of products and solutions, Sanctum Wealth Management.

According to Dhirendra Kumar, founder and chief executive, Value Research the funds have been transparent in letting investors know of the credit risk. "The credit risk associated with these funds was known to investors. In fact, these schemes suffered from the number of side pockets they had to create since the beginning of the year, which also led to confidence erosion," said Kumar.

Three schemes out of the six have three side pockets each for accommodating Vodafone Idea and Yes Bank papers.

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