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5 Mins Read

4 things you need to know about the Franklin Templeton Crisis

Franklin Templeton Crisis

On April 23rd, Franklin Templeton, India’s ninth-largest mutual fund wound up six of their debt funds. Investors can neither buy more nor can they take their money out immediately. The funds are in suspended redemption! This unprecedented move has investors in cold sweats.

The six Funds that have been closed are:

  1. Franklin India Low Duration Fund (FILDF)
  2. Franklin India Dynamic Accrual Fund
  3. Franklin India Credit Risk Fund
  4. Franklin India Short Term Income Plan
  5. Franklin India Ultra Short Bond Fund
  6. Franklin India Income Opportunities Fund (FIIOF)

On April 27th, they marked down the NAV of six Fund-of-Funds (FoFs), as they had exposure to the closed-down debt funds listed above. The list is as follows:

  1. Franklin India Dynamic Asset Allocation FOFs
  2. Franklin India Multi-Asset Solution
  3. Franklin India Life Stage FOFs-20
  4. Franklin India Life Stage FOFs-30
  5. Franklin India Life Stage FOFs-40 
  6. Franklin India Life Stage FOFs-50 Plus

It is important for you to know the reasons behind this event and the implications it may have on your investments. If you’re wondering what happens next, here are 4 things you need to know before you jump to any conclusions:

1. Reason behind the crisis – Low-liquidity & Low-quality investments led to this fall

Unlike Equity Mutual Funds, wherein the fund pays investors back by selling stocks that it owns, in case of Debt Mutual Funds, the fund relies on the repayments (coupon or principal) of the underlying debt securities or its ability to sell debt securities (bonds) owned by it to other investors. Now, given the corona-laden economy at the moment, the bond market is extremely illiquid, meaning an investor can neither buy nor sell bonds. In other words, if a debt Mutual Fund tries to sell corporate debt securities now, it will not find buyers.

So what went wrong with Franklin Templeton Funds?

The six funds listed above had invested heavily in the lower-rated corporate debt securities. In normal times, this high-yield, lower-rated strategy would work just fine since the intent would be to hold the underlying debt papers till maturity. But a double whammy of redemption pressure from the COVID-induced panic and an already illiquid debt market for lower-rated corporates hampered their ability to sell underlying debt papers in recent times. Hence, they have stopped investors from withdrawing (redeeming) any money immediately.

Detailed analysis of the underlying debt holdings of Franklin funds reveals two key reasons:

a) Exposure to Low-quality Debt

Franklin funds, over time, had increased exposure to riskier AA and A-rated instruments which yield a few percentage points higher for the added uncertainty. The Fund has a history of lending to lower-rated companies thereby taking on additional credit risk for the extra juice. Adding to the problem, Franklin is also the major lender to these companies which means other lenders are either not willing or able to take their place.

b) Bond Market Liquidity Crunch

There has been a dramatic fall in liquidity in the Indian Bond Market due to the Covid-19 lockdown. The increasing redemption pressure on the funds (e.g. up to ~30% of AUM for the Franklin India UST Bond Fund) has mounted additional pressure on the fund managers to sell the more liquid bonds and pay the investors back. This coupled with a severe liquidity crunch, especially for the low-rated debt owned by Franklin Templeton funds, led to winding up of these funds as it would’ve been impossible to liquidate the underlying debt without a significant haircut.

The graph here shows AUM reducing with redemption pressures. While the blue line shows the total AUM of the fund, the orange line shows a month on month flow in AUM. Whenever the orange lines are negative, it means that most people withdrew money from the fund. Investors withdrew ~4,000 crores in March 2020.

2. You will get your money back, but it will take time

Franklin Templeton, in their official report, have declared that they will sell the underlying securities in a staggered manner to pay the investors back. However, the duration of the payment will depend on the maturity of investments. For example, Franklin India Income Opportunities Fund’s duration as of March-end was ~3 years. This means that it’s investors will have to wait for almost 3 years to get all their money back. Likewise, for Franklin India Low Duration Fund, the duration was 1.2 years. Therefore, its investors may have to wait for a year to get their money back. The good news is that at the moment, the underlying securities have not defaulted, hence the probability of you getting back your money is high.

To elaborate it further, the average maturity of Franklin UST fund is 1.89 years. 35.1% of it matures in 2020. So, in a scenario when the underlying debt is held till maturity and no issuer defaults, the unitholders will only get 35% of the total fund corpus in 2020. All in all, be prepared to wait a while before you get your money back.

3. Your debt funds may be at risk

Yes, there’s no doubt that any corporate debt fund is a huge flight risk today and if you have invested in one that invests in lower-quality corporate bonds, it’s likely that it will see some devaluation. If redemption requests increase, other fund houses will be under pressure to pause redemptions too. It may be a better idea to park your investments in government-backed securities like Bharat Bond ETF. Govt has also taken action by creating INR 50,000 cr fund to ensure that other funds don’t default.

If you are still unsure, share your latest CAS report with us at myscan@kristal.ai. We will screen them for any risk and tell you which positions to exit.

4. Don’t Panic! Your Kristals are safe

You will find relief in the fact that none of the funds on Kristal.AI platform have risks similar to the Franklin funds listed above. And It is not luck, but the result of a curation process that ensures that you always invest in the best quality funds. We have always believed in the “human plus AI” model to build the most reliable investing platform. Today that belief has been validated.

We suggest you look up our proprietary AI, GAIAA (Genetic Algorithm-based Iterative Asset Allocation) to know how it finds the best strategies for every investor that comes to our platform. GAIAA is a genetic algorithm that chooses and modifies strategies from a pool of thousands of permutations that are then tested against user-defined objectives, and only the ‘fittest’ strategies are chosen to finally evolve into a risk-limiting model which optimizes asset allocation and maximizes returns. We also use bootstrap and other algorithms to facilitate better portfolio planning.

Here’s our Algo’s performance in the last 2 years when compared with the Benchmark – 60% (iShares MSCI ACWI ETF) + 40% (iShares Core U.S. Aggregate Bond ETF).

Trust our algo, for there’s no room for error in judgments when it comes to your investments.

Summing Up

Who’s to say if and when there will be a reboot of the underlying problem or this is just a somber presage to what comes next. There’s no denying that the panic has settled in throughout the economy, and while we might be faced with more difficulties in the coming future, it is wise to prepare for the worst and start venturing into avenues that will safeguard your investments from it. Each one of us at Kristal is available to help you fight this downturn and emerge stronger from it.
Till then, stay safe, stay home, stay invested, and stay tuned to Tracking Covid-19.

Disclaimer

The materials and data contained herein are for information only and shall in no event be construed as an offer to purchase or sell or the solicitation of an offer to purchase or sell any securities in any jurisdiction. Kristal Advisors does not make any representation, undertaking, warranty or guarantee as to the update, completeness, correctness, reliability or accuracy of the materials and data herein. All opinions, forecasts or estimation expressed herein are subject to change without prior notice. Kristal Advisors and its affiliates accept no liability or responsibility whatsoever for any direct or consequential loss and/or damages arising out of or in relation to any use of opinions, forecasts, materials and data contained herein or otherwise arising in connection therewith.

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