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 recent 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. 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.
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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 on 17th January 2020.
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). However, on 1st September 2020, in a big relief to telcos, the Supreme Court of India granted a period of 10 years to clear the AGR dues.
Franklin Templeton had exposure to the bonds of Vodafone-Idea, which has dues to the tune of Rs 58,000 crores. The telecom company has managed to do a part-payment of Rs 7,854 as of 17th July out of the total dues of Rs 58,000 crore. 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).
Citing redemption pressure and illiquidity in the bond market, Franklin Templeton had to shut its six debt mutual fund schemes, namely, Franklin India Income Opportunities Fund, Franklin India Ultra Short Bond Fund, Franklin India Low Duration, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, and Franklin India Dynamic Accrual Fund. The NAVs of these funds have faced a lot of volatility mainly due to speculation and mark-to-market actions taken within the funds.
After shutting down six debt mutual funds in April, Franklin Templeton received around Rs 1,498 crores in August. Accounting for this inflow takes the total amount received between April and September to Rs 6,486 crores. The total AUM of shuttered schemes is estimated at Rs 25,000 crores.
Franklin Low India Duration and Franklin India Credit Risk Fund, two of the six schemes, have turned cash positive with 5 percent and 1 percent of their respective AUMs held in cash. Cash positions come off as positive news to retail investors who suffered from premature winding-up. The funds will be able to handle redemption requests as soon as the fund house is given the clearance by the Karnataka High Court to conduct e-voting and disburse payments. Cash positions in two other funds, namely Franklin Ultra Short Bond Fund and Franklin India Dynamic Accrual Fund, have been reported to rise to 31 percent and 14 percent of their respective AUMs last month.
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 to restrict buying, 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.
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.
Apart from Vodafone Idea Ltd., Rivaaz Trade Ventures Pvt. Ltd, a Future Group subsidiary defaulted on its scheduled debt obligation that was due on 31st August 2020. RTVPL had issued NCDs to four of the six wound-up schemes of Franklin Templeton. Post announcement of the acquisition of RTVPL by Reliance Retail last month, it was concluded that the NCDs will be settled by the amount realized from the sale transaction. The president of the fund house confirmed that the announcement of sale is a positive development.
As a result of the default, the securities of RTVPL were valued at zero as per the AMFI standards.
According to a report by B&K Securities, the fund house was the sole lender to 26 of 88 top borrowers in its six shuttered debt schemes. That is, these 26 companies had 100 percent exposure to the six schemes with total borrowing worth Rs 7,697 crore.
While it is easy to blame the companies for their failure, Mr. Kamath, the fund manager of Franklin Templeton too failed to diversify the portfolio risk and was fallen for lucrative yields. The names of companies that were responsible for this fiasco were – India Shelter Finance Corp, Renew Solar Power, Xander Finance, OPJ Trading Pvt Ltd, Vistaar Financial Services, etc.
It is also important to note that the fiasco at Franklin Templeton did not happen over a month or overnight, the redemptions began in August 2019 as the total AUM under the credit risk category dropped to Rs 58,361 crore in March 2020 from Rs 80,756 crore in April 2019.
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 the mutual fund.
What Should Investors Know?
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.
Another company update comes from Vodafone Idea after completing a payment of Rs 146 crores, which is distributed to the unitholders.
Despite the positive developments, the market regulator has been skeptical of the strategies followed at Franklin Templeton. SEBI has initiated a dialogue demanding an explanation of the investment decisions taken at the fund house.
The Economic Offences Wing of Chennai registered an FIR on 25th September against the trustees and senior management of Franklin Templeton India for allegedly carrying out fraudulent activities and defrauding 3 lakh unit holders stuck in 6 debt schemes. The FIR was lodged at the behest of a complaint filed by an investor community by name Chennai Financial Markets & Accountancy.
What does SEBI Plan to Reduce Risk in Debt Mutual Funds?
- Minimum Cash Holding: While liquid funds are required to hold 20% of the total assets in cash, there are no such restrictions on other bond fund categories. SEBI announced that interim regulations will be framed until the constituted committee to look into this matter gives its recommendations
- Swing pricing: A well-known concept outside India, swing pricing is a technique to impose a cost on investors, who in times of crises resort to large redemptions thus bringing down the NAV
- Backstop mechanism: During heavy redemptions, and not so good economic scenarios, the debt market generally turns illiquid as sometimes there are no buyers available to buy the debt papers which the fund house intends to sell. The creation of a backstop mechanism will solve the problems of these fund houses as this facility will buy those papers during the turbulent times and offload once there is an improvement in the economic environment
- Repo trading: While repos are common for government bonds, SEBI plans to make things easier for corporate bonds too. The MF houses in dire need of cash to meet redemptions can borrow against the corporate bonds. For this, the SEBI chief plans to open a central clearing corporation for repos in investment-grade corporate bonds
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.
Performance of Nifty 50 and SBI Nifty ETF
It is worth to remember the study by Spiva, a division of Standard and Poor, stating that 84 percent of the large-cap MFs in India underperformed their benchmark.