On Thursday, Franklin Templeton announced that it has shut down six of its credit strategy oriented debt mutual fund schemes. These schemes are Franklin India Ultra Short Bond Fund, Franklin India Short Term Income Fund, Franklin India Credit Risk Fund, Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund and Franklin India Income Opportunities Fund.
How serious is this problem and does that mean that you should withdraw your money from all other debt funds?
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Only six debt funds affected
Let’s get this straight. Franklin Templeton has just wound up six of its debt schemes. The combined size of these funds are Rs 25,856 crore as on April 22. This does not mean that Franklin Templeton is shutting down.
Even after these schemes are wound up, Templeton still has seven other debt funds in its stable, with combined assets under management of about Rs 17,800 crore as on April 22.
These apart, the house has 15 equity funds worth Rs 36,663 crore and 11 hybrid category schemes (those that invest in a combination of equity and debt) with assets of Rs 3,143 crore as on March 31, as per Value Research data. These funds will continue to function as usual. “Franklin Templeton has a long history of over 25 years in India, with 33 per cent of our global workforce based there. Our commitment to the market and our investors in India remains steadfast,” said Jenny Johnson, President and CEO of Franklin Templeton in a press statement that the fund issued on April 23.
You can remain invested in the other debt funds of Franklin Templeton. “We advise investors not to take any knee-jerk actions after the announcement,” says Gaurav Mashruwala, a financial planner.
STP investors get caught in the mess
Some investors that got caught in the Franklin Templeton mess unknowingly were those that had enrolled for systematic transfer plans (STPs). This facility works just like the systematic investment plan, but if you have a lumpsum amount already that is waiting to be invested in equities, then STP allows you to park it in a debt fund and carry out a monthly or weekly transfer to an equity scheme, within the same house. With Franklin Templeton winding up six schemes, even STPs have come to a grinding halt. This means investors who had planned to go to equity funds, via a short halt in Templeton’s debt funds, are now stuck in these schemes badly. Not only will their money not be invested in equity funds, their equity investing plans would also go for a toss.
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The idea behind an STP is that a liquid or a short maturity debt fund gives you a return kicker, than does a savings bank account where you would have parked your money otherwise. From the portfolios of the six Templeton funds that were shut down, it was clear that these debt schemes took credit risk. And even though it wasn’t a default that led to the closure, and only pure illiquidity in the markets, the heightened exposure to lower-rated securities made matters worse. “The choice of debt funds while doing your STP is too critical. Fixed income investors largely expect predictability in returns. You must go in for those portfolios that give you predictability. Credit risk is a fringe asset suited for some investors, not suited for some,” says Srikanth Bhagavat, managing director, Hexagon Capital Advisors.
Stay away from credit risk funds, for now
We’ve been saying this for quite some time that investors need to be cautious about taking too much credit risk. If you wish to invest in debt funds, then stay away from credit risks at the moment. Credit risk funds and few other debt categories have been facing the heat for the past year-and-a-half because quite a few companies have faced difficulty in paying regular interest to their lenders (mutual funds, banks, insurance companies and so on) and, in some cases, returning the principal too. Frequent downgrades in credit ratings took the net asset values of debt funds down.
The COVID-19 pandemic resulted in foreign investors selling off equities and debt holdings massively in India as well as other emerging markets. But there were hardly any buyers, especially for low-rated scrips. Banks weren’t willing to lend and so they parked their surplus cash with the Reserve Bank of India. Data from the RBI says that banks parked nearly Rs 7.215 trillion with RBI at just 3.75 percent interest (reverse repo rate under the liquidity adjustment facility), up from an average of Rs 2.371 trillion towards the end of March and just about Rs 506 billion by the end of January 2020 at a rate of 4.9 per cent back then. With no buyers for its securities and in the absence of market liquidity, Templeton was faced with no choice but to wind up its schemes.
For now, stay away from other credit funds.
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Are debt funds safe?
Debt funds continue to remain good investments. But as Ashish Shah, founder of Wealth First has repeatedly said, debt fund investors should not expect anything more than 1.5 percent points over inflation.
“Debt funds are still a great option. Just that we need to avoid higher risk, unless investors specifically want to take risk,” says Srikanth. For investors in the higher tax brackets and who wish to invest for three years or more, debt funds continue to give good tax-adjusted returns. Make sure you stick to funds that invest in AAA-rated and sovereign instruments such as corporate bonds and banking & PSU bond funds. Liquid and ultra short-term bond funds are still good for STPs, but make sure you invest in one that holds only highly rated securities.
The Franklin Templeton debt fund crisis does not impact bond schemes of other houses. Even equity funds that belong to Templeton will continue as before. Continue your investments as usual, but keep an eye on your debt fund’s portfolio quality. Till such time as your advisor suggests that you should exit a portfolio that holds too many toxic assets, we suggest you remain invested.