Background to the FT Fund Closure

Franklin Templeton has voluntarily decided to wind up six of its fixed income debt schemes effective from April 23rd 2020. Other funds – Equity and hybrid – are unaffected by Franklin Templeton’s decision. Starting April 24 existing investors in the scheme will not be able to withdraw their investments, make fresh purchases, do transfers to equity schemes or make systematic withdrawals to meet their monthly expenses.

All the 6 schemes followed high risk, high return credit risk strategy. The fund house will now sell the underlying securities of all these funds over time and pay off their investors in a staggered manner. This step has been taken as FT believes that the market will not return to normalcy soon because of the Corona virus disruption.

Several retail, HNI and corporate investors park money in debt funds due to higher returns as compared to bank deposits, easy liquidity and tax benefits of indexation if they remain invested for three years. With the fund house deciding to wind up these schemes, these open-ended schemes, which are available for buying or selling on a daily basis on every working day, will not be now available.

The list of schemes being wound up which are cumulatively Locking cumulatively are locking in Rs. 30,800 crore of investor monies is as follows:

1. Franklin India Ultra Short Bond Fund (FIUBF)

2. Franklin India Short Term Income Fund (FISTIP)

3. Franklin India Credit Risk Fund (FICRF)

4. Franklin India Low Duration Fund (FILDF)

5. Franklin India Dynamic Accrual Fund (FIDA)

6. Franklin India Income Opportunities Fund (FIIOF)

Ever since the COVID-19 was declared a pandemic in early March, equity markets all over the world as well as in India and bond markets here have collapsed. Foreign investors sold equities and debt securities in Indian markets because back home, companies faced a liquidity crunch. The massive sell-off in debt markets led to a crash in prices and rise in yields.

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.

As the schemes have been wound up the investors will have to wait almost as long as the duration of the underlying scheme.For instance, in Franklin India Low Duration Fund, the Macaulay duration as of March was 1.2 years. In simple words, it means the weighted average effective time period to get the cash flows back. Its investors will therefore have to wait around a year and 73 days to get all their money back from this scheme. Similarly, Franklin India Income Opportunities Fund’s Macaulay duration as of March-end was 3.22 years. This means that FIIOF’s investors will have to wait for close to three years and 80 days to get all their money back.

Templeton will keep trying to liquidate its portfolios as much as it can. Of the money it receives, Sanjay Sapre, President, Franklin Templeton – India has assured that the fund house will keep paying all investors, big or small, proportionately and in instalments.

What investors needs to know

1) FT will publish a Net Asset Value (NAV) for the schemes on a daily basis and eventually communicate more details on an exit strategy.

2) FT has clarified that you will not have to pay any asset management fee wef April 24th 2020, for as long as it takes for them to redeem the funds completely. However, you will be liable to pay tax on any gains you have made in the schemes when the money is returned.

3) FT will not open these schemes ever again. The schemes are wound down. The day the fund houses get any interest or maturity from any of the holdings, it will distribute to investors.The catch is that Templeton will distribute proceeds to unit holders only after it discharges liabilities of the funds

4) Since Templeton has stopped subscriptions and redemptions, your systematic investment plans (SIP) will stop automatically.

5) If you had enrolled for systematic transfer plans (STP, a facility wherein you invest a lumpsum in a debt fund, preferably a low risk one, before you transfer equal amounts once a week or month in an equity fund of your choice), your money is stuck. Your STP has just gone for a toss as the transfers to your equity funds will now not happen.

6) Sanjay Sapre, said :-  We will sell papers at a fair price. Funds will behave normally, accruals keep happening until then. Almost Rs 15,000-20,000 crore of book is a “high credit” book. We will be back, keep exploring opportunities in this market in future

7) SEBI eased valuation policies for debt MFs –Securities and Exchange Board of India (SEBI) on April 23 asked valuation agencies not to consider any lockdown-related delay in payment of interest or principal or extension of maturity of a security as default for the purpose of valuation of money market and securities held by mutual funds. SEBI in a circular said a differentiation in treatment of default, on a case to case basis, needs to be made as to whether such default occurred solely due to the lockdown or loan moratorium. Based on assessment, if the valuation agencies appointed by AMFI are of the view that the delay in payment of interest/principal or extension of maturity of a security by the issuer has arisen solely due to COVID-19 pandemic lockdown … creating temporary operational challenges in servicing debt, then valuation agencies may not consider the same as a default for the purpose of valuation of money market or debt securities held by mutual funds,” it added. However, if there is any difference in the valuation of securities provided by two valuation agencies, the conservative valuation shall be accepted.

8)  Pursuant to the decision to wind up Franklin India Ultra Short Bond Fund (FIUBF), Franklin Templeton will not charge any management fees. Base TER of Super Institutional Plan for FIUBF will change from 0.46% to 0.16% effective April 24, 2020. This reduction is being done with immediate effect in the best interest of Franklin investors.

Reactions to the whole story

1) If the crisis spills over, the lack of trust could result in an exodus of funds to safer assets including bank fixed deposits and gold. “Banks could see a flood of deposits in near term,” said Pratip Chaudhuri, former chairman of State Bank of India.

2) “The event will shake the trust of the investor and there is redemption likely. This money could go to banks till the time banks there is clarity,” said Siddharth Purohit, analyst at SMC Securities.

3) Mere announcement of a credit line from the RBI will bring confidence to whole bond market. Huge amount of money still being parked in the reverse repo window – A Balasubramanian, MD & CEO, Aditya Birla Sun Life (ABSL) MF

4) MD and CEO of SBI Mutual Fund: “The panic will likely go away as even in the best of times the markets are often illiquid. However, there is a need to ensure that the liquidity crisis doesn’t turn into one a solvency crisis. A credit line from the RBI will do a lot of good for the industry. Nothing has changed overnight and we think RBI and SEBI are already working together to ensure liquidity. The mere announcement of a credit line in 2008 had boosted confidence tremendously. Franklin Templeton’s move is in the best interest of the investors.”

5) “It is bit premature to say what the impact of this action will be on bond market. This is, till now, a fund specific problem,” said Kumaresh Ramakrishnan, CIO Fixed Income, PGIM India Mutual Fund.

6) HDFC Mutual Fund to CNBC-TV18: The Central Bank (RBI) should consider a direct financing line for mutual funds. May need RBI to mull unconventional methods for boosting confidence as there is a need to keep investor confidence intact. The entire corpus of a credit risk fund does not comprise of weak  paper. Most of us have no borrowings so there is no need to panic.

Will RBI step in?

In 2008, in the aftermath of the global financial crisis, the RBI had stepped in to save the mutual funds industry. The central bank then opened a special window to provide banks with funds to support mutual funds.

The RBI then cut the amount of funds banks must keep in reserve, releasing more than $12 billion into the banking system,  injected $13 billion via its daily overnight money market operations and introduced a temporary funding window for mutual funds.

In the recent days, the RBI has been already doing that. Of late, it has actively engaged with markets to ensure liquidity in the market to nullify the impact of COVID-19 crisis. But, this has largely benefited the AAA-rated companies. The RBI did two rounds of Targeted Long Term Repo Operations (TLTRO) on March 27 (worth Rs 1 lakh crore) and April 17 (worth Rs 50,000 crore).

Press Release Reassuring Investors in Debt Mutual Funds

AMFI Advises investors to remain invested in Mutual Funds to create wealth over the long term

Mumbai, April 24, 2020: Following the announcement of winding up of six credit risk fixed income schemes by one of the asset management companies (AMC), Association of Mutual Funds in India (AMFI), the mutual fund industry body, today assured investors that majority of Fixed Income Mutual Funds AUM is invested in superior credit quality securities and schemes have appropriate liquidity to ensure normal operations.

AMFI strongly recommends 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.

The action taken by the particular AMC is limited to the six specific credit risk fixed income schemes managed by the said AMC due to the illiquidity of their portfolios. The assets under management (AUM) of these six schemes constitute less than 1.4% of the Indian Mutual Fund Industry’s aggregate AUM as on March 31, 2020.

Fixed income schemes of most mutual funds have superior credit quality as confirmed by ratings of independent credit rating agencies and continue to remain fairly liquid even in these challenging times.

SEBI regulations allow mutual funds schemes to borrow up to 20% of their assets to meet liquidity needs for redemption / dividend pay-out. While AMFI is in the process of collecting the data, many Mutual funds have informed that they don’t have any outstanding borrowing.

Liquidity, Maturity profile and Credit quality for Debt Funds is appropriate for day to day operations to continue uninterruptedly.

We expect fixed income funds across entire Mutual Fund Industry to continue their normal operation without any material impact.

Mr. Nilesh Shah, Chairman, AMFI, commented, “Banking liquidity in excess of Rs 700,000 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.” Mr Shah added. Mr.

NS Venkatesh, Chief Executive, AMFI, said: Mr. NS Venkatesh, Chief Executive, AMFI, said “The Mutual Fund industry has seen many cycles and its professional fixed income fund managers have managed crises efficiently over the years. Investors continue to repose trust in the industry and over the last 5 years the Indian MF Industry AAUMs have doubled from Rs. 11.88 lakh crores as on March 31, 2015 to Rs. 24.70 lakh crores of AAUM as on March 31, 2020.”

Most credit risk funds have pretty good credit quality and sufficient liquidity in today’s challenging times and continue to remain an attractive investment option for investors, Mr Venkatesh said.

Conclusion

Debt fund closures are symptoms of an illness that can be cured only by a strong stimulus. Investors in debt funds will be frightened by what’s happened at Franklin Templeton. The RBI and the government need to step in with strong financial measures to restore confidence.

To begin with, what Templeton has announced reflects a fund specific-issue and not an industry-wide problem, yet. These were papers suffering from lack of liquidity. But Templeton’s action could impact the trust of investors in other liquid funds even in those ones that are relatively in a better liquidity position, industry observers said. If the crisis spills over, the lack of trust could result in an exodus of funds to safer assets including bank fixed deposits and gold.

It is recommended that the 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.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. 

Author Bio

Qualification: CA in Practice
Company: Priya C V and Associates
Location: BENGALURU, Karnataka, IN
Member Since: 08 Apr 2020 | Total Posts: 4

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2 Comments

  1. RP says:

    Surprising that even a taxation website posts an article wihtout touching upon the taxation issue arising out of closure of Franklin 6 schemes – what they have mentioned is available everywhere!!

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