Why investors in wound-up Franklin funds may have to wait 3-4 years to see their money again

Franklin Templeton winding up six of its debt funds has put investors in a tight spot. Not only has the fund house’s move rattled investors, leaving them with no exit option, but it now appears that investors may have to wait three to four years before getting their entire money back in most of these funds.

According to information put out by Franklin on its website, based on the maturity dates of the bonds held in the portfolio of the six debt funds, only two — Franklin India Ultra Short Bond Fund and Franklin India Low Duration Fund — are expected to return a notable portion (45-50 per cent) of the money back to investors within a year. In the case of Franklin India Dynamic Accrual Fund, 21 per cent of the money is expected to be returned within a year, while for Franklin India Credit Risk Fund, it is 15 per cent. In the case of Franklin India Short Term Income just 1 per cent of investors’ money may be returned, while for Franklin India Income Opportunities Fund, projections show that investors may not get any money back in a year and only 5 per cent within two years.

The cash flow projections given by Franklin are based on the maturities of the bonds in the funds’ current portfolio. Sale of securities (in the secondary market), payments of coupons, prepayment etc., are not considered in these projections and can increase the payout to investors. However, a default by corporates issuing these bonds would lower the payout to investors.

What gives?

The fund house had to wind up the funds as it was unable to meet redemptions without destroying value in the funds on account of selling the bonds in the portfolio at very low prices. Franklin expects to liquidate the portfolio as and when the bond market comes back to normalcy and it is able to sell the assets at a reasonable value. But this could take a long time owing to the Covid-led turbulence in the bond market, particularly in the low-rated bond segment (towards which Franklin funds have high exposure).

That said, the fund could make interim payments as and when the underlying bonds in the portfolios mature or coupon payments/pre-payments happen.

Ideally, a debt fund’s Macaulay duration (time taken for the money invested in the bond to be repaid by the cash flows) or average maturity (which is typically longer) gives an indication of the maturity period of the underlying bonds in the portfolio. Schemes with shorter portfolio Macaulay durations or maturity should be able to return money sooner than those with a longer maturity.

Within the six debt funds, Franklin Ultra Short Bond Fund (duration of 0.38 years as on April 23) and Franklin Low Duration (1.17 years) have the lowest duration and hence money is expected to be returned sooner. Franklin Dynamic Accrual (1.97 years), Franklin Short Term Income (2.43 years), Franklin Credit Risk (2.36 years), and Franklin Income Opportunities (3.92 years) have a longer duration (maturity), implying that investors may have to wait much longer to get back their money.

But even in the case of the first two funds, it would take two years for a chunk of the money (74-81 per cent) to be returned to investors, despite having a maturity of less than 1 year to a little over a year.

Why the delay?

There are two reasons for the delay in payments to investors.

One is the varying maturities of the bonds in the portfolio. For instance, in the case of Franklin Ultra Short Fund, only 37 per cent of the assets have maturity date falling in 2020. In fact, 32 per cent of bonds mature during 2022-29. Hence, given that over half of the portfolio’s maturity falls after a year, chunk of cashflows are expected only within two years. But then how does the fund have such a short duration of 0.38 years (or 4.5 months) and average maturity of 5.3 months?

There are few points to be noted. The average maturity is calculated by taking the weighted maturities of the bonds in the portfolio. The fund’s average maturity may be short, but the maturity of some of the underlying bonds could be much longer. In other words, these funds follow a barbell strategy (investing in very short and long bonds). Franklin appear to have followed this strategy across the six debt funds with bonds maturing as long as in 2028-30, even in its relatively lower duration funds.

Next, even if a bond matures in 2030, if it has a put call option it reduces the effective maturity or duration of fund significantly. For instance, in the case of Franklin Ultra Bond, the fund has a 2 per cent exposure to A-rated Pune Solapur Expressways bond, which matures in March 2029. But the bond has a put call option falling in September 2020. Hence, when the overall maturity of the portfolio is calculated, the put call option date is reckoned, which lowers the fund’s maturity substantially.

The other key reason for the delay in payments from Franklin funds for investors is that the fund will have to first repay borrowings before paying money to the investors. Remember, most of the six funds have borrowed to meet large redemptions over the past two months. These will have to be repaid first.

For instance, as of April 23, Franklin Short Term Income Fund had about 28 per cent of assets, or ₹1,582 crore as borrowings (negative cash component), while Franklin Income Opportunities had about 26 per cent of assets as borrowings. While the former expects only 1 per cent of money to be returned within a year (based on cashflow projections), the latter expects 5 per cent within two years. Franklin Credit Risk Fund (16 per cent) also has significant borrowings. These funds were forced to sell their more liquid short-term bonds in their portfolio to meet redemptions, which has accentuated the problem.

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