Why the ₹103-crore Vodafone interest payment offers little respite to Franklin investors

For investors in the six debt funds of Franklin Templeton that are proposed to be wound up, Vodafone Idea making an interest payment on one of the bonds issued by it is good news.

These bonds (8.25 per cent, maturing July 10, 2020) form part of the six funds’ segregated portfolios which were created this January, when the bonds were downgraded to below investment grade.

But the ₹103-crore interest payment made by Vodafone Idea — to be received by Franklin across six of its debt funds — offers very little respite to investors in these funds. Aside from the fact that the interest forms a very small portion of the money stuck in these funds, the wait to recover the entire money has only gotten longer. The e-voting process on the winding up of the schemes stands suspended (post a Gujarat High Court order), and with several cases filed in various courts, there is now huge uncertainty over the fate of the schemes.

As such the cash flow projections given by Franklin, based on the maturities of the bonds in the funds’ main portfolios, had suggested that investors may have to wait three or four years to recover their money in many of the funds. While the sale of securities (in the secondary market), payments of coupons, prepayments, etc, could have shortened the recovery period, adverse market conditions made this less likely.

Also, the specific Vodafone bonds on which interest payments have been received are due to mature in July. Hence, whether Franklin and the other fund houses are able to receive the full amount on these bonds on maturity will be critical. Franklin also holds other bonds issued by Vodafone (10.90 per cent, maturing September 2023) and YES Bank in the segregated portfolios of certain schemes. Future recovery on such segregated portfolios will be critical for investors.

What lies in the segregated portfolios?

SEBI allows debt funds to create segregated portfolios of bonds that are downgraded below investment grade by rating agencies. The fund house separates its main portfolio of the scheme — comprising investment grade bonds — from the segregated portfolio. It issues an equal number of units in the segregated portfolio as held in the main one.

Recovery of money, partial or full, in the segregated portfolio, is distributed to the investors in proportion to their holding in it.

Franklin had created segregated portfolios across its schemes holding Vodafone Idea bonds in January. In March, it also created segregated portfolios for YES bank bonds.

Hence, across all its debt funds proposed to be wound up, Franklin carries one to three segregated portfolios comprising one or more of these bonds (YES Bank and Vodafone).

For instance, Franklin India Ultra Short Bond Fund has a segregated portfolio consisting of 7,990 units of 8.25 per cent Vodafone Idea bonds (on which interest has been paid now to the tune of ₹65.9 crore). Franklin Low Duration Fund has two segregated portfolios, with 1,970 units in 8.25 per cent Vodafone bonds and 1,510 units of 10.9 per cent Vodafone bonds (maturity September 2023). Franklin Short Term Income Plan has three segregated portfolios comprising the two Vodafone bonds and 3,523 units of YES Bank bonds. Franklin Income Opportunities has two segregated portfolios holding Vodafone bonds, while Franklin Credit Risk Fund has three, holding Vodafone and YES Bank bonds. Franklin Dynamic Accrual also has three segregated portfolios.

It is thus evident that the ₹103-crore interest payment received by Franklin from Vodafone is only a very small relief to investors, representing some cash inflows. Aside from the critical question of how much more recovery can be expected from these segregated portfolios, the graver concern for investors is on the fate of the main portfolio of the six debt funds.

Inflows into main portfolios

The fund house has been receiving cash flows into most of its six debt funds since April 24 (until May 29). For instance, Franklin Ultra Short Bond has seen around ₹890 crore of inflows since April 24; Franklin Low Duration has seen ₹35 crore and Franklin Short Term Income, ₹31 crore. Franklin Credit Risk and Franklin Dynamic Accrual have seen ₹345 crore and ₹147 crore of inflows so far, respectively. Franklin Income Opportunities has seen none so far.

But these inflows have been used to first repay borrowings. According to regulations, the schemes must discharge their liabilities — pay off borrowings — before returning the money to investors. Most of the six funds had borrowed significant amounts to meet large redemptions over the past two or three months. So, the inflows into the funds have been used to repay borrowings, interest and expenses (if any).

Still, some funds continue to have sizeable borrowings — Franklin Low Duration (11 per cent of AUM as of May 29), Franklin Short Term Income (33 per cent), Franklin Income Opportunities (39 per cent), Franklin Credit Risk (11 per cent).

Long wait

The winding up process of the six debt funds is in limbo now. How this will impact the return of money to investors will need to be seen. But even ahead of the legal wrangle, investors had appeared to be in for a long wait to get their entire money back.

Based on the cash flow projections of each of the six funds based on the maturities of the bonds in their portfolios, Franklin India Ultra Short Bond Fund and Franklin India Low Duration Fund are expected to return 49 per cent and 45 per cent, respectively, of the money back to investors within a year (April 2021). In the case of Franklin India Dynamic Accrual Fund, 25 per cent of the money is expected to be returned within a year, while for Franklin India Credit Risk Fund and Franklin India Short Term Income, it is 13 per cent and 3 per cent, respectively. Franklin India Income Opportunities Fund investors may get 18 per cent within three years, projections show.

However, these projections do not take into account the sale of securities (in the secondary market), payments of coupons, prepayments, etc., which can increase the payout to investors. But given that the market (particularly for low-rated bonds which the funds hold) is unlikely to return to normalcy any time soon, the sale of securities in the secondary market may not happen in the next one year. In fact, default by corporates issuing these bonds could lower the payout to investors.

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