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  • Writer's pictureSahastha

Franklin Templeton Debt Fund Crisis

Updated: Oct 4, 2023

There are fears of investors hitting the panic button after franklin templeton wound up six of its debt funds. Investors can neither buy more nor can they take their money out immediately. The funds are in suspended redemption.  This unprecedented step by the major global investment firm led to panic among investors in the mutual fund market. Now, we will look at all the details since the announcement of the voluntary wind up of six schemes.

The story behind this issue:

As of April 22, 2020, Franklin Templeton Mutual Fund announced that it would be voluntarily winding up six schemes with a total AUM of ₹25,856 crores due to high selling pressure from investors. Franklin Templeton has shifted part of the blame for this recent winding up of six funds on to COVID-19, illiquid markets and redemptions as the reason for pushing the stop button. True, markets have been turning illiquid. The depth of Indian corporate debt market is far less compared with global peers. But Templeton’s way of managing investor money, risk diversification strategy, and the selection of papers the fund chose to invest are questionable. Most of the investments that these funds made under the credit risk category were for AA and below rated companies. The cash flows of these companies were severely impacted in a slowing economy.

They designed the portfolio for good times, but didn’t prepare for the bad times. The cardinal rule every investment manager dealing with public money is “expect the best and prepare for the worst”.

They released notices on the unitholder’s meet scheduled on June. But several investors file writ petitions against the winding-up decision. The Gujarat High Court issued a stay order on the e-voting scheduled until SEBI’s forensic audit report was released. Franklin Templeton temporarily suspended the e-voting process and filed a special leave petition before the Supreme Court against the Gujarat High Court. the Supreme Court ordered the transfer of all pending cases to the Karnataka High Court with a deadline of three months to reach a decision.

Analysis of the judgement

In October, the Karnataka High Court released a judgment stating that the fund house should have ensured that they seek consent from unitholders before winding up the schemes. It restrained the trustees from taking any further decisions until the fund house obtains consent from the unitholders. It also stopped the AMC from making any borrowings, and investors from redeeming units for six weeks. Franklin Templeton said that it might have to file an appeal with the Supreme Court.

On December, the Supreme Court heard the case and ordered Franklin Templeton to hold a meeting of the unitholders for approval in the winding-up process. The Apex Court gave the AMC one week to take steps in this regard. The e-voting results were revealed to the Supreme Court on January 18, 2021. As per the report, around 96% of the unitholders voted in favour of an orderly winding-up of the six schemes.

Fund house to begin repayment of dues

By the end of January, the closed schemes managed to generate distributable cash flows of ₹9,770 crores since the winding-up was announced.

In February 2021, the Supreme Court directed the AMC to distribute the cash available under the schemes to unitholders. It also assigned SBI Mutual Fund to carry out the distribution. SBI Mutual Fund submitted an application detailing the distribution mechanism created in consultation with SEBI and Franklin Templeton. The SC approved the same. According to the proposed plan, SBI Funds Management Private Limited confirmed that it has made the payment to all KYC-compliant unitholders. The total distributable cash flow was ₹9,122 crores. However, not all the unit holders will get all their dues. The recovery percentage varies from scheme to scheme.

Since this is a partial payment and Franklin Templeton is yet to realize over ₹17000 crore worth of assets. The process can take time due to these bonds illiquidity, market conditions, and risk appetite. Review the situation:

You need to know the reasons behind this event and the implications it may have on your investments. Here are the following things you need to know.

  1. Franklin Templeton has a legacy of investing in high-risk, low-rated bonds. These bonds yield higher returns. This strategy works quite well when the economy is doing well. But the funds were already under a lot of pressure with IL&FS default and the subsequent shadow banking crisis. Exposure to companies like Yes Bank, Vodafone, Idea also had a role to play.

  2. Low liquidity and low-quality investments led to this fall. They had invested heavily in lower-rated corporate debt securities. Redemption pressure from the COVID-induced panic and an already illiquid debt market for lower-rated corporate securities slow down their ability to sell underlying debt papers.

  3. The pandemic resulted in foreign investors selling off equities and debt holdings massively in India as well as other emerging markets. But there were hardly any buyers, especially for low-rated scrips.

  4. With no buyers for its low rated securities and in the absence of market liquidity, templeton was faced with no choice but to wind up its schemes.

Conclusion:

“Rising defaults and frequent downgrades in credit rating, along with increasing instances of segregated portfolios by bond funds have made us wary of recommending bond funds. Yes, there’s no doubt that debt funds are fluctuating very high today and if you have invested in one that invests in lower-quality bonds, it will likely see some devaluation. We are very skeptical about all this, we advise the clients to exit from the liquid and short-term bond market, before the market crash and park in bank fixed deposits, recurring deposits for emergency purpose. It is wise to prepare for the worst and start venturing into avenues that will safeguard your investments from it.

Please read this blog to know how important debt is as part of asset allocation and why you should treat it as anchor of your portfolio.


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