Did the general liquidity crunch post COVID-19 alone kill Franklin Templeton India’s six credit-risk funds as the fund house claims? Or was it also a result of bad investment decisions that went unquestioned for long? The crisis triggered by the closure of Franklin Templeton’s six funds has opened room for questions.
While announcing the closure of six funds, Franklin Templeton blamed general liquidity crunch, illiquid markets and high redemption pressure for forcing the tough decision. But the profile of some of the companies the fund chose to invest and the terms of those investments are questionable, industry watchers said.
When market turned illiquid and slowdown gripped the economy, ultimately, there were no takers for these below AAA- rated papers in corporate bond market even at competitive rates. As the big banks too put a stop to lending, as they used to until a while ago, the mess worsened, finally forcing Templeton push the button.
Take a look at some of the names in the investment list of Franklin Templeton. The latest data available shows that the fund invested in Edelweiss Agri Value Chain papers at a coupon rate of 8.7 percent, maturing in 2027; Coastal Gujarat Power papers (9.9 percent, maturing in 2028), Nuvoco Vistas Corp (8.57 percent, 2020) and Uttar Pradesh Power Corporation (10.15 percent, maturing in 2021). It also put money into several lesser-known companies such as Aadarshini Real Estate Developers, Small Business Fincredit, Rishant Wholesale Trading, Northern ARC Capital, and so on.
“Which mutual fund lends money to an agri chain at 8.7 percent for 7 years? If you are buying that sort of companies for such funny coupon rates, what happened ultimately shouldn’t be of surprise,” said a senior treasury dealer in Mumbai.
An email sent o Franklin Templeton on Friday seeking the investment logic in low-rated papers of high risk companies offering low returns remained unanswered till the time of filing this story.
The overall assets under management in non-AAA-rated credits would be around Rs 1 lakh crore but the daily liquidity in these bonds won’t be even Rs 1,000 crore. That is a problem for a daily NAV, daily liquidity fund,” said Arvind Chari, Head of Fixed Income at Quantum Advisors.
“This needs to be questioned as, if small cap funds stopped inflows on not being able to deploy money in a judicious manner, why did credit risk funds allow their AUM (asset under management) to be built up to such levels (sic),” Chari said.
“Did that spawn risk-taking, compromising both the quality as well as the return that they were getting?” asked Chari.
Indeed, Templeton’s strategy of investing in some of the below AAA-rated papers would be justified given the high returns received in the past. But even for a credit risk fund, some of the investment decisions defy logic.
Also, low-rated papers turned riskier in the recent years when economic woes worsened impacting some of these firms have been facing severe cash flow issues. The COVID-19 lockdown and resultant stalemate in the financial markets further impacted low-rated firms. The writing was on the wall.
When the liquidity worries grew beyond a point and banks too turned reluctant to give further survival funds, the best, rather the only remaining option for Franklin to do was what it did on Thursday night—pull the curtain and blame on the liquidity situation.
Redemption pressure is hardly new or a bolt from the blue. Redemptions in the type of funds that Templeton shut have been rising since mid-2019. The total assets under management (AUM) under the credit risk category declined from Rs80,756 crore in April 2019 to Rs58,361 crore in March, 2020, according to AMFI data. Chari emphasised that the problem was not the liquidity but the sheer absence of appetite for these low-quality bonds and mounting redemption pressure.
Bad days started with demonetisation. Lower-rated firms started witnessing significant deterioration in the financials back in 2016 with the Narendra Modi government’s demonetisation of high currency notes hit the economy hard. That was when small companies became even smaller and riskier for investors due to the prolonged cash crunch. Investments in these papers backfired when the economy took further downturn, forcing the mutual fund to borrow from banks to repay investors. That strategy didn’t work beyond a point as banks turned wary.
In 2016, the overnight invalidation of 86 percent of currency in the system choked tiny firms, which already carried weak balance sheets. Informal economy was hit hard. Many had to shut shops. Things never really picked up from that point. The scenario worsened over the next few years with Indian economy taking multiple shocks one after another-- for reasons that were both domestic and global.
The collapse of IL&FS in 2018 made matters more difficult. Mutual Funds that invested in credit risk funds started witnessing continuing redemption pressure. The onset of the COVID-19 outbreak and the resultant liquidity crunch was the final nail in the coffin.
The IL&FS crisis was a turning point not just for the NBFC industry but also for the Indian financial system as a whole. Liquidity dried up significantly and smaller companies were the first to take the hit. A year later, the liquidity scenario improved for bigger, top-rated companies but smaller ones never made it across the survival line.
Borrow and pay
To manage funds to repay, MFs like Franklin Templeton relied on bank borrowing. According to industry sources, Franklin Templeton has borrowings of at least Rs3,000-Rs4,000 crore from a clutch of private and PSU banks. At one point, this too stopped. These lenders will have to be paid first before the investors will get their share. In short, investors’ money is stuck in the funds for now.
The total assets under management of the six funds Templeton wound down are estimated around Rs 25,000 crore.
What lies ahead?
Already, there is significant redemption pressure on the Franklin funds. According to CNBC TV 18, Adani Group has completed early redemption of bonds maturing October 2020 for Rs1,180 crore from Franklin Templeton Mutual Fund. The Franklin Templeton episode is likely to have major impact on other liquid funds also as the whole episode has created a trust deficit for investors in such funds. The market is expecting the Reserve Bank of India (RBI) to offer a window for mutual funds if the crisis spills over across the industry. The story is still unfolding.