Franklin Templeton AMC’s decision to wind up debt funds can trigger a crisis of confidence

| Updated on April 24, 2020

In an unprecedented move that has sent shock waves through fund investors, Franklin Templeton Asset Management Company (FT AMC) has announced the winding up six popular debt schemes with immediate effect. Investors in these schemes, however, have been given no specific commitments on the Net Asset Values (NAVs) or timelines at which they can expect their money from this ‘orderly’ winding up exercise. This is contingent on the AMC’s ability to realise value from its less than high-quality corporate bond holdings. FT has said that this drastic step became necessary after redemption pressure on its funds post-Covid depleted their holdings of better-rated paper. As honouring any further redemptions would force it to resort to fire sales, it decided to wind up its funds to protect residual value. The industry has sought to downplay this as an isolated instance of an AMC with an aggressive strategy running into trouble. But with ₹25,000 crore assets, FT accounted for well over half of the industry’s credit risk assets and was particularly popular with retail investors, who may not make fine distinctions between ‘managed credit’ and other strategies. This incident could well trigger a systemic crisis of confidence for other debt funds.

While Covid may have aggravated its problems, FT AMC cannot be absolved of blame for debt strategies that actively courted risks. While it is acceptable for an AMC to stock up on lower-rated bonds in a ‘credit risk’ fund, FT chose to saddle its ultra-short, short and low-duration debt funds — favoured by conservative investors — with such paper despite known illiquidity risks. Debt funds with credit risks have also been actively mis-sold to income-seeking retail investors, euphemistically packaged as ‘accrual’ or ‘high yield’ funds. Despite multiple accidents involving retail investors in debt funds in the last three years, SEBI has played a somewhat passive role in regulating the positioning of this category. Its categorisation rules, while bucketing debt funds on duration risks, do little to warn investors off credit risks that may lurk in innocuous-sounding debt funds. Revisiting these rules, cracking down on mis-labelling and mis-selling, and segregating debt funds run for institutional and retail investors can be some steps to avoid FT-like mishaps in future.

But Indian policymakers looking to throw a lifeline to the economy also need to pay attention to the systemic problems arising from vanishing liquidity for corporate bonds. As the lock-down aggravates the cash crunch for majority of Indian businesses, the already poor breadth and depth in the Indian bond markets is narrowing further. The RBI may need to take cues from its global counterparts, to open a special liquidity window for corporate/NBFC bonds, to provide lubrication to a frozen bond market.

Published on April 24, 2020

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