SEBI rule for investment in unlisted NCDs a reason for fund fiasco, says Franklin Templeton global chief

The Securities and Exchange Board of India (SEBI) guideline that allowed only 10 percent investment in unlisted instruments was one of the reasons that prompted Franklin Templeton Mutual Fund to wind up six of its debt schemes in India, its global president Jennifer M. Johnson observed.

SEBI has set a limit and timeline for decreasing investment in unlisted instruments. The regulator, initially, had set March 2020 for 15 percent limit which has been extended to June. The deadline to comply with the highest investment limit of 10 percent is December 2020.  However, SEBI allowed mutual funds to keep existing investment until maturity. These instruments are mainly illiquid and it is not easy to sell in the market. Deals mostly happen off the market.

The chief executive officer of a mutual fund told Moneycontrol, "SEBI allowed mutual funds to keep existing investments until maturity. If Franklin Templeton is so confident about its underlying assets, why it did not sell out in November or December when market was good. From January, the market was expecting weakness. Why did Franklin wait till March? Even earlier also it claimed that the underlying portfolio was good, especially after the Vodafone paper write-down. Then what happened suddenly to wind up six schemes? Only a few mutual fund schemes took such risks through investing in unlisted instruments and Franklin took a higher risk in their schemes."

A source close to the Franklin Templeton development told Moneycontrol, "It is the fund manager who decides the amount of risk he can take in a fund. Fund managers are aware of liquidity conditions in such instruments. It is not right to put the blame on policy decisions. Everyone knows in the market that the fund manager took much higher risk. What happened now is due to higher risk and more investments in illiquid instruments".

Franklin Templeton conducted its second-quarter earning call on May 1. During the call, Johnson said: "We entered India 20-plus years ago. And we were a fixed income manager there, or portfolio manager. In India, anything below AAA-rated is considered non-investment grade. And the high-yield market is still very immature there. So we've had a large fund, it's actually six funds, that were invested with a lot of this kind of private debt. And in October of 2019, unfortunately, SEBI came out with new guidelines saying that any investments in unlisted instruments should be less than 10 percent. You can't have more than 10 percent in a fund, and you can't trade them. So that orphaned about one-third of our funds there."

She further added that "it really was about selling those assets at a fire sale, and there were very few buyers because this regulation was not permitting trading".

Quality of underlying assets

PK Bindlish, former chief general manager of SEBI told Moneycontrol: "Issue is the quality of underlying assets. It will be appropriate if Templeton creates a special purpose vehicle and take over illiquid assets, if the quality is good as being claimed".

"SEBI should investigate the reason for allocating money in illiquid instruments and forensic audit can also be considered," he added.

Johnson is worried about the impact of the decision on the firm’s $6 billion equity investment here. "We were worried about its impact on our equity business there, on our high credit business. There were initial redemptions in the high credit. We have about $2 billion in high credit and I think about $6 billion in equity," she noted.

In a reply to an email query on the subject, Franklin Templeton India spokesperson said: "We had to take this exceedingly difficult decision in the best interest of existing unitholders in these six high-yield managed credit funds, knowing the potential impact it could have on our reputation and broader business in India. We have emphasised to our clients in India that this action is strictly limited to these six funds that have been most impacted by the ongoing liquidity crisis in the market caused by the COVID-19 related lockdown. We continue to remind our investors that our other funds are managed by experienced independent teams of investment managers and continue to operate and perform as per their respective investment mandates."

However, according to Johnson, there is no solvency issue in underlying securities. "This is not a solvency issue. It's very good credit in the underlying holdings. It was really just timing of the redemptions versus our ability to create liquidity to meet them," she said, as per the con-call transcript.

The company blames challenging credit climate

The company cites unfavourable credit climate for the closure of schemes. “The credit climate has been extremely challenging, and the COViD-19 related national lockdown severely heightened this pressure, resulting in a spike in yields and sharply reduced liquidity across the lower than AAA-rated bond market. The ongoing global pandemic impacted business activity across a wide range of sectors and diminished portfolio companies’ ability to access funds and service existing debt. Factors like rising redemption pressures, mark to market losses due to spike in yields and rising illiquidity in portfolios following lower trading volumes continued to cause caused severe liquidity crunch for open-ended mutual fund schemes," the spokesperson said.

He further added: "Unlisted NCDs were one of the many factors that aggravated the illiquidity in these high-yield managed credit portfolios, due to the market dislocation caused by the Covid-19 pandemic and related lockdown. Heightened redemptions after the lockdown led to increased concentration of unlisted bonds which were needed to be held till maturity. Under these difficult circumstances, we believe that taking the decision to wind up the full suite of six yield-oriented funds, while very difficult, was the only viable option to preserve value for unitholders, to enable an orderly and equitable exit, in these unprecedented circumstances".

Vijay Bhushan, President, Association of National Exchange Members of India told Moneycontrol, "The parent company of Franklin Templeton, Franklin Resources Inc, has $717 billion of assets under management. It should invest only $4 billion to give exit to lakhs of investors trapped by its India subsidiary."

A former chief executive officer of a mid-sized asset management company also echoed this view. "As its global president feels that underlying assets don't have any insolvency issue, they should infuse capital and keep these underlying assets in their books separately till maturity or until they are able to sell as per the plan announced by Franklin. Through this process, they may earn much higher return as per Franklin Templeton India business unit. After all, they have earned an ample amount of money from the Indian business unit in the last twenty years," the person pointed out.

The firm is India’s ninth-largest mutual fund with average assets under management (January-March 2020) of Rs 1.16 trillion.

Aggressive strategy

Another industry player told Moneycontrol: "Neither global nor India head talked about investments in highly leveraged instruments. In their portfolio, there are investments in Future Ideas Company Limited, which is part of Future Group. The debt to equity ratio is very high and Future Idea’s net worth is negative. Similarly investment in OPJ Trading, which is part of Jindal Steel and Power Limited (JSPL) which has been in high debt for a long time. OPJ Trading’s debt-to-equity ratio was also high, which showed that the companies were already in deep debt. Surprisingly, the entire investment of JSPL was written down by the asset management company in 2017 and faced criticism also. Such type of investment raised concerns in the market and which needs to investigated by SEBI."

Moneycontrol has reported about the aggressive strategy of Franklin Templeton fund manger Santosh Kamath.Short Bond Fund, a debt scheme meant for 3-6 months’ investment tenure, had nearly 28 percent of its assets in securities with credit rating of ‘A’ and below. Similar schemes from other fund houses had just about 3 percent in such securities on an average.

Another short term fund, Franklin India Duration Fund, a debt scheme meant for 6-12 months’ investment horizon, had invested around 44 percent in such risky assets. Similar schemes of other fund houses had just 10 percent in securities rated ‘A’ or below.