Franklin Templeton wrote off its exposure to problematic Vodafone-Idea bond papers which unpleasantly surprised investors.
Source: Tavaga Research
Pooled investment funds are a popular choice among retail investors. Most well-known are mutual funds which invest the pooled sum in assets as guided by their fund managers. But the portfolios are not transparent, ie. the investors don’t get visibility of or a say in where the funds are channeled.
But as yesterday’s development with AMC, Franklin Templeton, shows, MF investors may suffer due to this very lack of visibility. Unsystematic risks or company-specific risks can blindside an active-management product like an MF from an AMC, and investors become the collateral damage, as they lose money.
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Even if there are early signs or warnings, investors can’t act on them as they might not even know they are exposed to such instruments in the first place.
Franklin Templeton was the latest AMC to join the series of MFs which have been hit by unsystematic risk. It had a large debt exposure to Vodafone-Idea bond papers, which it marked down to zero in value yesterday.
The move, applauded by some and appalling others, came after the Supreme Court, on January 16, rejected the petition from telecom and Internet service companies for reviewing the AGR (adjusted gross revenue) dues on
licensing fees and spectrum usage charges, as ascertained in independent assessments of each of the companies, to be paid to the Department of Telecommunications (DoT).
Franklin Templeton had exposure to the bonds of Vodafone-Idea, which has dues to the tune of Rs 53,000 crores. The telecom company has to cough up the sum by the deadline of January 23, 2020, which is less than a week away, with no respite in sight. As it is, Vodafone-Idea had racked up a total debt worth Rs 1.15 lakh-crore by the end of fiscal 2019 (March, 2019).
We will get to know, sooner than later, if the woes of the beleaguered group (whose plight had even triggered speculation of Vodafone’s exit from India) will drive it to bankruptcy. But for now, it has caused a large, debilitating ripple among fund houses such as Franklin Templeton. Much like the defaulting NBFCs like IL&FS or DHFL created for MF houses like UTI,Tata,DSP etc with exposure to the two’s bond papers in 2018 and 2019.
The ripples usually end in the Navs of such MFs taking a huge hit, erasing wealth earned painstakingly.
And, who suffers the most? Why, retail investors like us, of course.
Retail investors in the lurch
Franklin Templeton did what had to be done, preemptively write off its exposure to Vodafone-Idea’s bond papers as a bad investment because it is all but given the corporate group would default on the dues of the debt instrument. The AMC has at least been proactive about it, even when other fund houses continue to drag their feet despite holding such bond papers.
But what is a retail investor to do but be caught completely unaware, as MFs, as actively-managed funds, don’t share the make-up of their investment basket with their customers. They may position their products as targeting a category of growth products but the constituents are never revealed and may keep changing, unlike those of passively-managed funds like exchange-traded funds (ETFs).
Single-day Nav fall
When Franklin Templeton announced its move, the panic among its retail investors was reflected in the beating the Navs of certain MFs from the AMC took:-
The fund house had to levy restrictions on fresh buying to prevent opportunity-seekers to enter the MFs at unusual low Navs/cost prices and also to safeguard existing investors.
Fresh purchases have been capped at Rs 2 lakh by an investor in an MF a day. According an official at the AMC, “A limit on purchases will help ensure that once clarity emerges and as resolution takes place, the interest of existing unitholders has not been significantly diluted in the interim through fresh purchase activity while limiting the inconvenience to retail investors,”
However there is no cap on redemptions and investors may exit by redeeming their units at the prevalent Nav.
How did Franklin Templeton get the exposure
Established companies may raise funds through the equity or the debt route. Equity funding that dilutes ownership works out to be more expensive than the latter, so they may opt for debt funding instead. Corporate bonds papers are one way of raising debt funds, the other being taking out a loan.
Franklin Templeton happened to be one of the biggest subscribers, of around Rs 2,000 crore worth of bonds issued by Vodafone-Idea.
Is it just Franklin Templeton?
No. Franklin Templeton was the first off the mark in addressing the crisis.
According to the research outfit, Value Research, there are three other AMCs with the exposure — Aditya Birla Sun Life, Nippon India, and UTI.
These three along with Franklin Templeton have a total exposure of Rs 3,390 crore to the telecom company’s debt papers, spanning 36 debt and hybrid schemes of mutual fund.
What should investors do?
The write-offs are a pre-emptive step by the AMCs and it may be premature to assume that they would not be able to recover the dues on the debt papers (though the chances are slim). If there is an extension of the deadline for Vodafone-Idea or a bailout of some other kind, it could bode well for the MF unit-holders.
Exiting now would mean a loss. The afflicted bond papers would be constituting a single-digit percentage of the MFs’ portfolios, hence it might not be as bleak as it may look now.
Passive investing – with visibility comes control
The retail investor affected by the news of the MF mark-downs would perhaps be feeling helpless as matters out of their control robbed them of their earnings and invested sum.
But there is a type of pooled investment fund which affords greater visibility than MFs – passive investment funds. Funds like ETFs allow the investor to know the constituents of the basket in which their investments are ploughed in.
It is a fact that MFs lack clarity and bank on the fund managers’ active involvement and personal judgment. The lack in terms of transparency in these funds begs the question at these times of crisis, ‘Why not invest in a benchmark like the Sensex or the Nifty?’ that ETFs, among others allow.
ETFs require minimum discretion of an individual person and are mostly market-driven, swayed by the benchmark they are linked to.
It is worth to remember the study by Spiva, a division of Standard and Poor, stating that 92 percent of the large-cap MFs in India underperformed their benchmark.