The Templeton Temptations

For the first time in the history of India, a mutual fund has announced winding up of its scheme. Yes, Franklin Templeton announces winding up of its 6 schemes on 23rd April 2020.

HISTORY

Franklin Resources Inc. is an American Multinational holding co. that together with its subsidiaries referred to as Franklin Temptation. It is a global investment firm founded in New York in 1947 as Franklin Distributors in honour of Benjamin Franklin for whom admired by the founder Rupert Johnson. In Oct 1992, Franklin acquired Templeton, leading to the name Franklin Templeton. FT has AUM of worth USD 717.1 Billion.

Franklin’s association with India dates back to decades when in 1996 Templeton Asset Management Pvt Ltd was set up.

THE MUTUAL FUND INDUSTRY

Let me try to explain you how the mutual fund industry works in a simple manner.

Regular investors in pursuit of avenues for investment but have :

·     Little or no knowledge of equity/debt instruments

·     Inherent complexity of markets

·     Time constraints

·     Ambitions of better returns

This is where mutual funds come to the rescue. They take your money, combine it with a common pool of funds mobilized from other investors.

This corpus is then used to invest in stocks picked by professionals having expertise and knowledge of the markets in lieu of a small fee, creating a WIN-WIN situation.

TYPES OF MUTUAL FUNDS

There are many basis for classification of Mutual Funds, however the most relevant one is based on the asset class. There are 3 types of mutual funds-

·     Equity

·     Debt

·     Hybrid

Investors who wish to invest in the company may go for equity MF’s. However, they are subject to market risks. Another way is to lend money to corporates and the government for returns (interest). Investors willing to follow this may invest in Debt funds. Hybrid funds means a combination of both.

Out of the corpus formed mutual funds lend to corporates who promise to pay the principal with interest, this agreement is known as BOND.

The returns generated are then distributed to investors. Debt funds provide more consistent returns than equity.

FT’s INVESTMENT METHODOLOGY

Franklin Templeton was the 8th largest mutual fund handling assets over 128576 crores of assets on 31st March 2020. It announced winding up of 6 debt schemes namely :

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)

FT has always had an image of outperforming its peers by 200 to 300 bps.

But remember the basic rule of investing, "higher risks higher returns."

So how did FT manage to outperform it peers? It is no rocket science to answer, they invested in riskier assets. For example, FT had exposures to ADAG group, ESSEL group, DHFL group, VODAFONE and YES BANK to name.

In recent past months all these 6 funds have written down their exposure to Vodafone and some schemes have also written down exposures to Yes bank. If you look at the list of funds mentioned above, it has all kinds of debt funds, including low duration and ultra-low duration. Now, while all AMCs take risks in funds like Credit Risk Funds to generate high returns, it is only Franklin that decided to follow this strategy even in short duration funds (low and ultra-duration) that are supposed to be low risk.

WHAT WENT WRONG?

What happens if the fund house to pay back the investors right now, and they've already invested the entire common pool (of funds) in corporate and government bonds? The fund-house can’t go to one of these corporates and ask them to pay back the debt. It will be a violation of the contract.

So how does a fund house honour your redemption request?

While there may be people who will want to redeem their funds, there’s also a bunch of new investors looking to park their money here. The funds house will always have some spare cash to pay out existing investors, no matter what.

And besides, each time you invest in a mutual fund, they also set aside a small portion of your investment in cash, just in case.

In order to ensure they have a steady supply of cash coming in at all times, the fund house often invests in bonds with different maturity dates. Some bonds that payout in one month. Some bonds that payout in two months. Some bonds that payout the next year. So, every few days, the fund house will have a bit of money coming in and they can choose to deploy it in any way they wish. They could either use it to buy more bonds and make some extra money on top or they could simply use it to honour your withdrawal request. Unfortunately, during times of crisis, that’s not always the case.

Low inflows and mounting redemption pressure started shaking the maths at FT. To make it worse, the bond market became ill-liquid especially for the low rated bonds. So, resorting to the sale of bonds even at discounts was not possible. FT decided to wind up 6 schemes.

WHAT DO YOU MEAN BY WINDING UP?

Winding up in no sense should be concluded as writing off the investments by fund.

It means these funds will cease to exist after all the holding has been sold-off, as and when that happens. And till that time, it happens, there will be no purchase or redemption or SWP instalments will be allowed from these funds.

WAS WINDING UP THE ONLY OPTION?

Let’s explore the other options FT had :

1. Borrow the money for redemption requirements: FT resorted to arranging funds from the bank to fund the redemption. They did borrow continuously to fund redemptions but weren’t unable to repay the borrowings by selling the bonds. Over the long-term, this is not the best way as the redemptions were flooding in and to create liquidity at any cost would have been an injustice to investors wishing to hold in the scheme.

2. Restricting the redemption: The regulatory framework allowed a maximum suspension period of 10 working days (limited to once in a 90-day cycle) and the requirement to honour redemptions up to INR 2 lakh per day per investor was also not feasible. Moreover, all investors holding INR 2 lakh or less would have availed the facility causing a further loss for investors who may choose not to sell at a loss.

3. Elongate the redemption payment: While redemptions pay-outs were being made on a T+1 basis, the regulation does allow a maximum of 10 working days. But 10 days were not sufficient enough to manage the crisis as caused due to pandemic.

4. Distress Sale: In a distress sale, the AMC would have to sell the securities at a discount to meet redemption requests. Had the AMC taken this route, investors who were staying invested would have to bear the most significant burden of this loss.

5. Using its balance sheet to fund the redemptions: management was clearly of the opinion that its balance sheet was incapable to fund the redemptions.

6. Reaching out to its parent for help: well the reasons would be best left to the management as to why not it reached its parent for help or whether the parent refused to help.

After understanding all the options and its possible impact on the existing shareholders the best way out of the crisis was to wind up the redemptions.

After the franklin fiasco, RBI launched a Special Liquid Fund of 50,000 Cr to tide over liquidity issues.

WHAT HAPPENS NEXT? WILL INVESTORS GET THEIR INVESTED MONEY BACK? 

Well, here is what will happen. While the funds have stopped taking redemption requests for investors, they still hold bonds in their portfolio. Now, these bonds will either be sold (if they get the right price) and value realized, or they will be held till maturity when the principal comes back. 

Whenever the funds get the money, they have to first pay-off the borrowed money and any other obligation and the remaining money is proportionately distributed among the unit-holders.

Regular payments when underlying assets reach maturity or receive coupon payments or are pre-paid. This will provide a more realistic picture or time frame as so when the investors can expect the money.

Investors were lured into the templeton temptations. Higher returns come with High risks. Before capital appreciation investors should learn about capital protection.

Return of capital is more important than return on capital.

Special thanks to Akash Gupta in compiling this article. Hope you all liked reading it. Feedback will be appreciated. Thank You!

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