There are fears of investors hitting the panic button after Franklin Templeton wound up six of its debt funds. Increased redemption pressure in an already shrinking liquidity environment has led Franklin Templeton into taking such a call. Though this is expected to protect interests of existing investors in these funds, there isn’t much clarity on when they will receive their dues.
Debt fund woes
In an environment when debt funds are already faced with many challenges, this move may only add the investors’ worries.
“Going forward, investors will be scared to invest in mutual funds,” says Suresh Sadagopan, founder of Ladder7 Financial Advisories. Investors were looking at funds investing in relatively lower rated bonds as a means of earning a bit more for the risk being taken.
“Rising defaults and credit rating downgrades of issuers, along with increasing instances of segregated portfolios by bond funds, have made us wary of recommending bond funds. Sticking to overnight and liquid funds for short-term parking of money has saved us. I see an exodus of bond fund investors in the near term, especially from credit risk funds,” says Vinayak Kulkarni, an investment advisor.
Jitendra Solanki, a SEBI registered investment advisor, had recommended some allocation to Franklin India Ultra Short Bond Fund. He claims that today he received the highest number of calls in his career, from worried investors. His investors are asking him to assess if such as situation will occur with bond schemes of other fund houses as well. He foresees investors switching from bond funds to bank fixed deposits.
Today, Vinayak Savanur, founder of MoneyMintingMantra, was witness to his clients exiting their investments in liquid and bond funds of other houses in fear.
He had instructed his clients to invest in Franklin Ultra Short Bond Bond fund and to start systematic transfer plans into equity funds of the same house. “The STPs are yet to start and now that initial investment is stuck. Worse, there is no clarity on how much money will come back and when. If the fund house sells the securities held in the portfolio at a steep discount, then investors cannot even recover their capital,” says a worried Savanur.
When the liquidity in the system was good, it did not hurt investors. However, when the economic growth slowed down, the issuers of the bonds started feeling the heat and some saw credit rating downgrades. Some smart investors in bond funds chose to exit and that pressurized fund houses to sell whatever they could to honour redemption requests. After a point a fund house has no option but to wind up the schemes.
“We have advised our clients to exit these schemes given the high credit risk and relatively high exposure to individual issuers,” says Lovaii Navlakhi, founder and managing director of International Money Matters.
There is no ruling out of a contagion, with investors of other unaffected debt mutual funds running to redeem their units.
If investors decide to sell debt funds and opt for bank fixed deposits, there will be a situation of hardening of yields on bonds held by the mutual funds. That may lead to further fall in bond funds’ net asset values and create a vicious cycle of redemptions.
Though painting all bond funds with the same brush – terming them risky investments – is incorrect, it is likely to happen.
If the advisors fails to explain the nuances of the situation or wherever investors have chosen their investment on their own, there is a possibility of a sell-off.
“It is logical to protect yourself. This is equivalent to a situation of a bank, which says all of a sudden that you cannot withdraw your money,” says Lovaii. He expects that the memories of this incident will stay with investors in these schemes as they can’t access their money for their financial goals or emergencies.
Going slow on bond funds
Distributors too are expected to go slow on their bond fund recommendations. Credit risk funds will be the last on the recommendation list. “When you are recommending debt funds, do not give (credit) risk in it is the lesson for distributors,” says Anup Bhaiya, MD and CEO of Money Honey Financial Services. He had recommended Franklin India ultra-short bond fund to his clients. He hopes that his clients would recover their money soon.
A Balasubramanian, CEO of Aditya Birla Sun Life Asset Management Company, however, says that investors won’t shun bond funds altogether. “We have seen liquidity issues in 2008. But after that we have seen bond funds growing three-fold,” he says.
Advisors are also treating the current problem as a strategy specific issue and believe that Franklin Templeton AMC will continue to operate normally with respect to its other schemes.
“The current issue pertains to the credit risk investment strategy which has backfired. There is no adverse motive or fraud. Equity funds are separate and there is no connection between the two. As long as the company is not committing a fraud or any malpractice, I will stay by them,” says Suresh.
Anup concurs, “There is no questioning the intent of the AMC. This decision takes care of investors’ interests. We will continue our relationship with AMC.”
As the situation unfolds, the investors will decide their course of action.
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