Scheme Closure: Where Franklin Templeton Messed up

Though Franklin AMC had no option but to close down six debt funds, they should have handled it a lot quicker and a lot better

Published: April 24, 2020 at 4:24 pm

While the closure of six debt mutual funds announced by Franklin Templeton was necessary due to en masse redemptions, the AMC ought to have handled it much better.

If you are affected investor, this is what you need to know: Franklin to wind up Six Debt MFs: Next steps for affected investors. The AMC has announced in a mail to unitholders that they aim “to make regular payments to investors from portfolio maturities, coupon and pre-payments, once the borrowings in the funds have been paid back” also see Repayment Process pursuant to Winding-up. It is better to assume it would take months for repayment to be processed.

Did Franklin make a mistake in investing in so many low-rated papers? No. It is a perfectly legal thing to (btw the govt is trying hard to deepen these segments of the bond market).

Did Franklin make a mistake in borrowing money to meet redemptions? They had no choice! Redemptions were so high that the usual allocation to cash would not have helped. The argument, “why did they not hold a good amount of high-quality bonds to sell off” would mean the scheme would not have given such high returns!

The fund could handle more than normal redemptions via borrowing, but this was beyond that. If we expect them to be prepared for an extraordinary situation like this, then that is possible only by changing the very nature of the fund!

Did Franklin make a mistake in closing down the scheme? Again they had no choice. However …

Did Franklin act too late? If we can appreciate that we are passing judgement with incomplete information and with the full benefit of hindsight, yes. In their email, they state, “the extension of the lockdown has heightened redemption volumes and reduced inflows to unsustainable levels”.

It became quite clear by April 10th or so that lockdown extension was a certainty and redemptions quite possibly did not slow down. They should have acted upon the three choices they had under extraordinary circumstances such as this:

1: SEBI rules only permit a maximum suspension period of 10 working days (in 90 days) and the requirement to honour redemptions up to INR 2 lakh per day per investor. Franklin in its email has called this “approach unviable to meet the severe sustained impact of the current crisis”. So this is ruled out.

2: Suspend transitions indefinitely and possibly offer some form of gated redemptions. This would violate SEBI rules but those rules could never have factored in a month-long lockdown. SEBI would call for an inquiry and fine Franklin a few lakh. They would live and not antagonised investors as much. (I am not a legal expert, this is merely an opinion)

3: Close the scheme as done now.

While option two would have been a lot more acceptable, even three would have been tolerated better if it was implemented bet April 13th to 17th.

So where did Franklin Mess up? On 16th April just one week before the closure announcement, Franklins fixed income CIO, Santosh Kamath pens a “market insight” commentary giving the impression that the AMC is on top of the higher redemptions. This was quite likely in response to social media chatter about higher borrowing in the schemes.

The last sentence of the note reads, “Even at shorter end products like Franklin India Ultra Short Bond Fund provide great investment opportunity”. That is just baffling, to say the least! How can an AMC swing from “great investment opportunity” to “wound up” in a week? Were redemptions in the intervening period so much?

By 16th, the lockdown was extended and the AMC should have anticipated more redemptions and taken action immediately. At the very least they should not have resorted to damage control giving the wrong impression to investors via fund manager commentary. This is a big mess up.

Did investors make a mistake in choosing these funds? Yes and no. Yes if they wanted 2% more than FD returns without the risk.  Yes if they invested looking at star ratings. That is like keeping a lion as a pet and expecting it to behave like a common domestic cat(!).

No, if they knew what they were getting into. What happened with these six debt funds is an extreme situation that could not be imagined. So those who knowingly took on the credit risk should not beat themselves about it. We cannot envisage or prepare for every possible risk.

Did I make a mistake in including Franklin Ultra Short Fund in April 2020 Plumbline? Enough warning about the associated credit risk has always been provided with the inclusion (along with ample legal and technical disclaimers). In fact, ironically, that along with this review of Franklin UST Fund is responsible for many redemptions by investors who realised risk!

While I do not regret providing an appropriately labelled risky option, I did fall short on two accounts : (1) I did not anticipate/appreciate liquidity risk due to mass redemption from the fund in a scenario like this.  (2) My high-opinion of Franklin has now been proved wrong with the April 16th “insight” and delay in closing the funds. Plumbline April 2020 has been suitably updated.

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