Franklin Templeton Debt Crisis explained

On the 23^rd of April 2020, Franklin Templeton Mutual Fund declared the closure of its following six schemes:

Franklin India Low Duration Fund

Franklin India Dynamic Accrual Fund

Franklin India Credit Risk Fund

Franklin India Short Term Income Plan

Franklin India Ultra Short Bond Fund

Franklin India Income Opportunities Fund

Covid-19 proved not only to be a health crisis but a crisis in general that spared no one. Equity markets around the world had seen a major correction. Speaking specifically of the Indian economy, foreign investors had withdrawn their equity and debt holdings due to a liquidity crunch. This massive withdrawal led to a crash in prices.

This in turn led to a collapse in investor sentiment, banks stopped lending and more so to companies with weak fundamentals and forecasts.

Franklin Templeton Mutual Fund also had their debt funds affected by this pandemic but then so were other mutual funds, so to blame the franklin mutual fund crisis purely on the Covid-19 pandemic would be doing grave injustice to the investors and their hard-earned money.

Additional reading: Click Here to read about the various types of equity mutual funds

What caused Franklin Templeton Mutual Fund to close these debt funds?

All the six franklin mutual funds were invested in high yielding category papers.
This is anyway risky during normal times but becomes all the more risky during a market correction.
Covid-19 affected the entire economy and not only portions or sectors of it.
The above strategy of investing in high yielding category papers was applied not only in the Franklin India Credit Risk Fund but across all the six debt funds of Franklin Templeton India that were eventually shut down.

This strategy was applied to gain higher returns and to outperform peers, this seems less risky (but still a risk) during normal times but becomes extremely risky during an economic slowdown.

As mentioned above, Covid-19 affected not only sections of economy but the entire economy as a whole. Liquidity is not a major issue during normal times but due to the economic slowdown, these lower categories where a high proportion of investments were made, struggled to secure funds from banks and NBFC’s.

This in turn affected their ratings and thereby the six franklin templeton debt funds.

Was this situation avoidable?

Yes, if these investments were not made in high yielding category papers with higher risks and no, this does not come with a hindsight bias.
To put it simply, higher the risk means more chances of higher returns but also higher risks, it’s a viscious circle.
The Debt mutual fund space is actually a lot more competitive for mutual fund companies as opposed to the equity fund space.
It has to charge a lower expense fee as opposed to equity mutual funds and therefore needs to gather a higher aum in order to compensate the lower expense fee.

Additional reading: Click Here to read how about the taxation rules on mutual funds.

The debt mutual fund is heavily dominated by the Corporates and High Net Worth Individuals (HNI’s), they invest to gain higher returns than fixed deposits.

In order to achieve higher returns than fixed deposits, the above 6 funds had invested in high yielding category papers in a higher proportion as compared to its peers.

This in fact had helped them gain higher returns during normal times as can be seen by the table below for 2017.

Franklin India Dynamic Accrual	8.50%
Category Average	3.85%

Franklin India Short Term Income	8.62%
Category Average	5.85%

Franklin India Low Duration	8.31%
Category Average	6.68%

Now when things got worse, the same Corporates and HNI’s started redeeming their investment to take care of their own cash crunch which put redemption pressure on these funds.

Franklin Templeton India thus had no choice but to close down these funds.

There were enough Warning signs

With hindsight bias yes, there were enough warnings.
All these funds were taking higher exposure to high yield category papers.
These were companies with low credit capabilities and therefore at a higher risk of default.
As on 31^st March 2020, around 88% of Franklin India’s Credit Risk Fund was invested in rupee corporate bonds that were rated AA or below.
Franklin India mutual fund had segregated investments of Yes Bank bonds in March 2020 and that of Vodafone Idea Ltd. in January 2020.

A Diversified Mutual Fund Portolio

Whenever you diversify your mutual fund portfolio, keep in mind that diversifying is a lot more complicated than it seems but at the same time quite unambigious too.

If you feel like you have a diversified mutual fund portfolio only because you have spread your investment between equity,debt,different schemes, categories, fund houses, fund managers, etc. then well, you’ve just committed a very big blunder.

All the six Franklin Templeton Debt mutual funds were belonging to different categories and yet they defaulted together, so let’s assume you had spread your investment among these 6 debt funds but then did that serve the purpose of diversification?

Two things here, one that this is quite an unprecedented situation so no debate on that but that still does not undermine the second and most important point which is that Diversification is not meant for higher returns but rather to protect against losses.
This sadly is lost on most investors if not all.
If a thorough study of the portfolio of these mutual fund schemes were made prior to investing then the uniformity in investing style and thereby the risks attached with it would have been clear.
This does not imply that a default like situation could have been predicted but rather it would have been clear that you hadn’t diversified your portfolio.

It’s a simple rule, if you cannot explain your diversification then you do not have a diversified portfolio.

What can Investors learn from this experience?

Not investing based on star ratings

This is one of the easiest way to lose money, be it with equity mutual funds or debt mutual funds.

The personal in personal finance is far more important than the finance.

You need to understand what works for you and what does not, therefore a personalised mutual fund portfolio is what is needed.

Understanding risks

Be it with fixed deposits or mutual funds, do not be greedy for that extra 1-2%. A non-vegetarian dish may be the most ordered dish at a restaurant but it would not matter to a vegetarian.

In the same manner whether a small cap fund is rated 1 star or 5 star should not matter if you are a conservative or moderate investor.

Understanding risks is far more important that anticipating returns, your mutual fund portfolio should revolve and be structured around both and not just returns.

Understanding how Diversification works

A well diversified portfolio does not only mean diversifying between different categories and fund houses, it is way more complicated than that.

As was seen with the case of Franklin Templeton debt funds, 6 different categories of debt funds had applied similar strategies so if you believed you had a well diversified debt portfolio only because you divided your investments between 6 different funds, well then you had to pay a heavy price to know you were wrong.

Same could be the case with your equity mutual fund portfolio, so make sure you know what you are doing.

FAQ’s

How will the 6 franklin India Debt funds return money?

The money would be returned back to the investors periodically based on the various scheme’s portfolio maturity.

The fund can either wait for the maturity of these schemes or sell the securities at a reasonable price, the former seems most likely.

Therefore investors in short term debt fund and ultra short term fund can expect their money quicker than those in credit risk fund.

What if I had a STP or SIP?

If you had a SIP then by default it gets cancelled but if you had a STP then this is where things get tricky. Your STP, most likely to transfer into an equity mutual fund slowly and gradually is now stuck too meaning you have no other choice than to wait for the securities to mature. The same applies for SWP.

Will the fund house continue to charge management fees?

All in all, if this sad and sudden event does not make you think as an investor about the shortcomings of investing in any fund be it equity or debt, based purely on the basis of star ratings, popularity of the fund house, paying heed to recommendations of unqualified professionals then it’s difficult to say what else will.

There are certain lessons in life that you cannot afford to learn twice.

For portfolio enquiries, email us with your doubts at info@themutualfundguide.com

Disclaimer : While due precaution has been undertaken in the preparation of this article, The Mutual Fund Guide or any of its authors will not be held liable for any investments based on the above article. The above article should not be considered financial advice and has been published only for your perusal. Due credit has been given in case wherever required, in case you feel any part violates any rights then do get in touch with us and we shall get it duly removed.

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