Personal Finance

The Franklin Templeton Fiasco: AMC Back In News For All The Wrong Reasons

By: Tavaga Research

Background

On 23 April 2020, Franklin Templeton Mutual Fund announced to freeze six of its debt mutual fund schemes citing the difficult conditions in the bond market due to the onset of the pandemic.

The Asset Management Company (AMC) was the first one to close six funds – Franklin India Credit Risk Fund, Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin Ultra Short Bond Fund and, Franklin Income Opportunity Fund.

The reputed fund house thrust the confidence of investors when over Rs.30,000 crore of their money invested in debt mutual fund became immobile indefinitely. 

Debt Mutual Funds are generally considered to be less risker than equity funds, thus people park their funds even for a short term. Nobody saw this coming, this suspension was a dangerous turn in the deepening credit crisis of India.

Even though India has seen worse and more economic failures this freeze coupled with the lockdown, increasing uncertainty, and reducing income may have been a faulty decision. 

Developments

After the 2009 crash, Templeton’s debt schemes focused on corporate-focused short-term debt schemes which ensured that the investors stay locked in for at least a year. These schemes were innovative and had higher returns. Following the success of these schemes, Franklin Templeton decided to launch more low-rated, short-term securities which were a major attraction to investors. 

Source: FT & Tavaga Research

The nature of debt funds is tough and competitive, thus Templeton’s schemes giving a higher return. 

This strategy was unconscionable but was profitable. Franklin was followed by other debt fund houses to invest in companies and corporate houses such as Yes Bank, Vodafone-Idea, Essel Group, Anil Dhirubhai Ambani Group (ADAG), and likes. It was unnoticed until 2019 after investors started to uncover the defaults in underlying paperwork. Additionally, the IL&FS collapse reduced the liquidity in the market and was the nail in the coffin for these faulty schemes. 

Source: Tavaga Research
Source: Tavaga Research

A series of bad judgments or a real liquidity crisis?

The shun Franklin schemes were crumbling and the Covid-19 crisis made it worse. Investors started to redeem their money, Franklin was unable to sell its bad securities in a non-volatile market. Given all the unfavorable situations freezing schemes was the only feasible choice available. 

The overarching question is – Can the fund simply escape this fiasco by shifting the blame on the pandemic?

According to SEBI rules on portfolio segregation, a fund manager, as well as the chief investment officers, would not be eligible for their bonuses if their portfolios are segregated. This is the price fund managers are made to pay for taking bad decisions, but it is enough given they have played with a lifetime of savings of investors? 

SEBI Investigations

The Securities and Exchange Board of India (SEBI) on 3rd March 2021, summoned the senior officials of Franklin Templeton Mutual Fund on account of redemptions made by them right before the closure of the debt funds.

The Enforcement Directorate (ED) has also filed an Enforcement Case against the fund house. The ED is investigating different aspects of the case ranging from money laundering to nonexercise of a put option. 

In the courts

On March 4, 2021, the Supreme Court decided to postpone the Franklin Templeton hearing till July. The SC has done so to wait for SEBI’s conclusion on allegations of wrongdoings. The apex court is waiting for SEBI’s decision to seek more clarity on the issue.

The details of the winding-up regulations are expected to be passed in the next 7-10 days. Unitholders have received part of their investment from the cash positive schemes. The selling of the debt securities is likely to speed up the process of repaying the unitholders. 

Lessons for an investor

Even though the investors voted overwhelmingly in favor of winding up, the approval is still pending with the Apex Court. Franklin Templeton Mutual Fund may soon be able to sell the seized securities to return the money to its investors but given the illiquidity in the Indian corporate bonds market, the process may take longer than expected. 

This crisis is another reminder that debt mutual funds are not immune to market fluctuations. An investor must pay a closer look at governance, risk, and other fine print while deciding on a debt mutual fund. 

This fiasco could also be a wake-up call for SEBI to propose new regulations to create a stop to buy illiquid debt in times of crisis.

Tavaga is everything you need to start saving for your goals, stay on track, and achieve them in time. 

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