Aarati Krishnan

Lessons from the Franklin Templeton fiasco

Aarati Krishnan | Updated on May 03, 2020 Published on May 01, 2020

Caught unawares Even investors who did their due diligence missed the alarm bells

Four friends discuss what AMCs, advisors, investors and the regulator can learn from the fund house’s crisis

With the lockdown on, four Chennai-based friends — Srividya the investment adviser, KK the stock trader, Bala the retired banker and Arvind the young lawyer — had been skipping their dosa-filter coffee sessions at Sangeetha for over a month. But with Franklin Templeton’s shocker of a decision to wind up six of its schemes, they couldn’t hold off anymore. They did a Zoom call to dissect the news.

Bala: Hi folks! Hope you have your coffee and pakodas with you. This promises to be a long chat.

KK: I’ve got some aloo bondas to keep me company.

Srividya: Glad you guys are in such a party mood. I’m afraid Franklin Templeton has quite killed my appetite. I’ve been fielding desperate calls from my clients all week and ₹10 lakh of my own money is stuck in its Short Term Income Plan (STIP).

KK: Hey, same pinch. I park my trading surpluses in its Low Duration Fund.

Arvind: Ask me! My debt money’s in its Ultra Short Bond Fund.

Bala: I’m the odd one out. Never comfortable with credit risks in debt funds, knowing how the Indian bond market works. But my dad has a Systematic Withdrawal Plan in its Income Opportunities Fund. He was told it’s a tax-efficient alternative to bank FDs.

Lurking risks

KK: Well, your father has reason to complain, but I don’t. Went in with my eyes open. When I invested in September 2019, I even ran a check on the Low Duration portfolio. Apart from names I knew like Piramal Capital, JM Financial ARC and Shriram Transport, it had stuff like Greenko Clean Energy, Essel Infra and Dolvi Minerals, which I didn’t know from Adam.

But what wowed me was the portfolio YTM (yield-to-maturity) of 11.6 per cent. Thought those returns were more than enough compensation for risk. Of course, I’ve changed my mind now.

Srividya: It was thanks to those juicy returns that Franklin funds were so popular. Even after 2-3 side-pockets, today the Ultra Short Bond and Income Opportunities are sitting on returns of 8 per cent, STIP and Credit Risk 7.7-7.8 per cent and Low Duration 7.7 per cent.

Bala: To me, high YTMs and returns are a clear red signal of credit risks lurking in a scheme. I’ll say investors have no reason to crib. If they enjoyed such returns, they need to swallow risks when they crop up. You folks should’ve done your due diligence when you invested.

Arvind: Bala, usually I would agree with you. Caveat Emptor and all that. But even investors who did their due diligence have been surprised by how quickly things have gone down the tube with FT schemes.

What do experts ask you to check in debt funds? One, portfolio concentration. When I invested in October, Ultra Short Bond had a super-diversified portfolio with 75 bonds. Its top holdings were 3-4 per cent each. It had 34 per cent in single A bonds but also 30 per cent in AAA and AA+ bonds. For liquidity, it had 8-10 per cent in money markets. Its average maturity was 0.5 years, so no rate risks there. Two, there’s track record, which was great as Srividya said Three, with over ₹20,130 crore in AUM, this was a Goliath of its category. As to Santosh Kamath, he was a bond whiz-kid invited to every industry event. Even rival AMCs were slightly envious of him.

Srividya: Yes, this is true of the other FT schemes as well.

Bala: Ah! You have a point there. But when a corporate bond fund in India faces redemption pressure, its entire character can morph beyond recognition. Even in the best of times, AA and below bonds are not so liquid. In panic situations, with foreign investors fleeing etc, things go from bad to worse.

Smart money is typically the first to sense this and pull out. The fund ends up selling the only paper it can in such situations, namely A1+, AAA etc. The remaining investors, usually innocent retail ones, are left holding the baby. Haven’t we seen this script play out many times?

Red flags

Srividya: Here’s something from Ripley’s Believe it or Not. In the last couple of years, we’ve had one or two debt funds facing so much redemption pressure that their top holdings are now 25-30 per cent. Imagine losing 60-70 per cent of the NAV in a debt fund. I would say FT has done the right thing in at least stopping the music now, when there’s some hope of getting back capital.

Arvind: Hey, I won’t give anyone a free pass. If a fund is morphing from Dr Banner to The Hulk, shouldn’t the AMC, trustees or advisors raise some warning? I was looking at April 23 portfolios of FT schemes, and all kinds of risks have cropped up. Top holdings are 12-14 per cent in some funds and the bulk of investments are AA and below. STIP and Income Opportunities have borrowed 26-27 per cent of assets. They have overshot the SEBI limit of 10 per cent on single-bond exposures and 20 per cent on borrowings.

Srividya: When an AMC is caught between the devil and deep sea, what can the regulator do but mount a helicopter rescue?

Arvind: Well, I think schemes should be frozen the moment they fall foul of SEBI’s concentration or liquidity norms. Then liquidation would be fairer. What’s the point in prudential regulations if they can’t be enforced?

Bala: I also think mixing up retail investors, HNIs and corporate treasuries in the same fund is like asking lambs to live with wolves. Debt funds for retail investors must be separate.

KK: I’m also gobsmacked to know that a fund with an average maturity of five months will take two years to give back my money.

Bala: I think borrowings are the villain. When a fund borrows for redemptions, it is forced to repay its lenders ahead of staying investors. On winding up, initial sale proceeds go to lenders. Remaining fund investors face delays as they’re stuck with less-liquid securities. SEBI needs to rethink this borrowing idea.

Lack of clarity

Srividya: I would also argue for AMCs calling a spade a spade in naming their products and not using euphemisms like ‘accrual’ or ‘high yield’. With innocent names like Short Term Income Plan, Low Duration Fund or Income Opportunities, how would lay investors know the risks? Advisors may have known what went on in FT schemes, but did your father know, Bala?

Bala: Of course not. There’s a big communication gap here. That’s partly thanks to SEBI’s decision to categorise debt funds on duration risk, but not credit risk. And this risk-o-meter is so wishy-washy. How can credit risk funds and corporate bond funds both be ‘moderate’ risk?

KK: Fund descriptions in India are also so bland, like medhu vada without sambar. The Low Duration Fund is described as a fund that ‘focusses on the lower end of the yield curve’ and I frankly don’t know what that means.

Srividya: Vagueness is an industry problem. All equity funds invest in ‘equity-related instruments’ and all debt funds, haha, in ‘fixed income instruments’.

KK: Funds need to communicate scheme strategies better, not just to their distributors but to actual investors. With so many direct investors, it’s time AMCs did some of those Zoom calls and PPTs with poor retail folks like us. We have plenty of time to kill.

Bala: Well, Zoom time’s running out folks. Do throw me a party when you get back your money.

All characters and incidents mentioned here are purely fictional

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Published on May 01, 2020
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