Frankline Templeton: A case filled with fear of default due to defaults

Updated: Jan 21


Whenever there is slowdown in the economy hiding of frauds and failures will be difficult. India now has a lot of such cases these days. Debts and defaults has increased enormously from 2018. Frauds committed by big players like Rana Kapoor, Chanda Kochar, Hari Shankaran and all those unknown managerial personnel and mediators have been coming out. Every time any fraud takes place lakhs and crores of public money gets out.

Cases like IL & FS with its subsidiaries (90,000 crore), DHFL (1,00,000 crore), PMC (13,000 crores), Altico Finance (3,000 crore), Yes bank (Government had to intervene and bailed out), Reliance Capital, Karvy have shown the loopholes in the financial system in the country. Only in bailout of banks government has lost around 3.5 lakh crore of public money. Now a mutual fund has entered the list.


What is Franklin Templeton ?

Franklin Templeton is a mutual fund. These mutual funds invest in various portfolios like bonds, debentures, deposits and any debt instruments issued by the financial institutions by raising money from public. In simple words they take money from public and invest in market. In return, they pay out earned Income to them which generally is more than the bank rates. 


What has happened ?

On 24th April 2020, Management of Franklin Templeton has announced closure of six debt schemes. This means investors of those funds cannot redeem nor purchase now and the money stands frozen till cutoff time. Management said that it shall wait for a buyer or shall sell its assets to pay the redemption of those six funds. This means, there could be staggered payments in the upcoming months or quarters. Further the Investors were said that if everything goes as planned by Fund house, for the first 50% of redemption money would reach investors ranging as early as 1-3 years and for the full redemption it would take five or more years.


The model of Mutual funds mostly depends on its inflows from the Unit buyers (Mutual Fund Investors). Due to slowdown in the economy in pre COVID-19 period and an unexpected lockdown made their Inflows reduce further to zero. There was an unexpected rise in demand of redemption of funds as Investor confidence has gone down due to which they preferred to deposit their money in banks. This results in increase is risk aversion due to lack of liquidity during such times. In simple words, investors sacrifice their returns to ensure safety of their investments.


Same was the case with Franklin Templeton. Their outflows were exceeding the inflows day by day. The pressure of redemption of units was building up. Because of these situations, one of the biggest mutual fund in India had to default payments.


An insight into the six funds that are closed


All the funds that are closed are categorized under Credit Risk Funds. These funds are raised from investors promising them of higher rate of returns and the money raised is invested in debt securities of companies which have low credit ratings. It’s a high risk game.


The yield on these securities is mere 1.5% to 2% higher than the usual rate in the market. The majority of Funds were of short term in nature but were invested in low rated corporates. These funds were already in the redemption crunch since a year for which Franklin Templeton sold of their ultra short term bonds.

Funds like Franklin India Low Duration Fund, Franklin India Credit Risk Fund, Franklin India Income Opportunities Fund have been majorly invested in companies which are now in default list or which are quite unknown and their credit rating was also very less. Five Star Business Finance Ltd, Ess Kay Fincorp Ltd, Essel Infra projects Ltd are some of them. Investment in these companies has led to high exposure to risk. 


Alongside they have good chunk of money invested in Debts of IL & FS, Vodafone Idea, Yes Bank which have gone all-time low in the D-Street.


Why did Franklin Templeton invest in these funds? 

This a question which many of you would get after knowing about them. This may be because of anticipation of higher returns. The root cause of this problem is Frankline Templeton’s operations. They were not monitored thoroughly. As I have said earlier, they mostly invested in the corporates which have very low credit ratings. Such investments raise serious questions. These questionable portfolios must be investigated by relevant regulatory bodies.


As per Franklin Templeton- COVID-19, lockdown, poor liquidity in bond market were major reasons. It also said that the closure was the best option to protect the investor value. 

AMFI (a nodal association of mutual funds across India) says that there is no need for panic. There is a need to be cautious because these schemes contributed around 1.4% of total assets of Mutual fund industry. It concludes by saying that there will be no contagion effect. 


Opinion:

AMFI assurance is not so convincing because of the blocked investor money, continuing lockdown, Unresolved COVID-19 Crisis, stressed NBFC’s and Banks. Liquidity crunch in corporate bonds is something which is adding fuel to the problem now. 

Although RBI Governor has said in previous meetings about enough liquidity in market but that is nowhere the scenario in real world because corporates which have high debt-equity ratio still find difficult to service the debt. In this scenario, why would they be go for an additional debt? Rather those companies including MSMEs would go for cost-cutting adding further to economic crisis.


Many more defaults are awaiting in other sectors too like defaults in micro finance companies, vehicle loans etc. The situation may continue due to slump in consumer durable sector post COVID-19 Scenario and may lead to more closures.

In fact, the closure can be the starting point of contagion effect and RBI or government should step in. That’s what RBI has done by providing 50,000 crores to Mutual fund industry to reduce the liquidity crunch. 


Solutions:

In short term, RBI and other apex institutions in relevant Industry shall monitor for any such crisis and should try to intervene and solve the crisis, if necessary. Also, RBI can order banks to halt operations (like adding of Interests, charges, fees etc) for stressed accounts. In short for stressed category of loan accounts they can entirely stop the procedure for interest calculation too for the said period.


The only long-term solution is to equalize the demand and supply of funds by establishing the lock-in periods for the IIs (Institutional Investors) and others. Government and Regulatory bodies should take appropriate measures in maintaining the Investor confidence by getting back growth in the economy.

Furthermore, the Individual Investors shall not anticipate the enormous CAGR(Computed Annual Growth Rates) but shall select their Mutual fund Portfolio by their Risk Appetite (the value of risk they are capable of and are strictly advised to go for some research prior to investing in Mutual funds too). 


– ANJAN KUMAR, VISHAL SV

(Opinion expressed by the author is his personal. The Generalist Insights take no responsibility of the opinion expressed.)