Last Updated on June 3, 2022 at 11:11 pm
On 17th Jan 2020, Franklin AMC announced a 100% markdown of Vodafone Idea bonds. As a result, the 16th Jan NAV of their debt funds holding these bond fell by 4-7%. Many investors are angry about this development and SEBI is said to be probing this action. Did Franklin AMC do the right thing or should they have wait for the bond to actually default? A look at both side of the picture.
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Update Jan 24th 2020: Crisil has now rated Voda Idea bonds BB. This is now below investment grade. It will be interesting to see how AMCs react to this. It should be noted that Franklin has not fully written down the bonds. The future payments have not been included in the write-off. We shall update this article with relevant developments.
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Update Jan 25th 2020: Franklin has now announced segregated portfolios in Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund.
Why did Franklin AMC write down Vodafone Idea bonds by 100%? When the Supreme Court refused relief to telecom companies in paying dues to the GOI, it became clear that Vodafone would be under severe financial stress and the possibility of default seems imminent. Franklin AMC proactively devalued the bonds themselves without actually waiting for a delay in interest payment or the rating agencies to mark them as “default” or “non-investment grade”.
Did Franklin AMC break any SEBI rules in doing so? The 8th schedule of SEBI Mutual Fund 1996 rules (page 90) set the framework for valuation of securities by AMCs. This states:
The responsibility of true and fairness of valuation and correct NAV shall be of
the asset management company, irrespective of disclosure of the approved
valuation policies and procedures i.e. if the established policies and procedures of
valuation do not result in fair/ appropriate valuation, the asset management
company shall deviate from the established policies and procedures in order to
value the assets/ securities at fair value:
Provided that any deviation from the disclosed valuation policy and
procedures may be allowed with appropriate reporting to Board of Trustees and
the Board of the asset management company and appropriate disclosures to
investors
In other words, an AMC has the right to deviate from using the market value of securities, provide justification is provided to the trustees and disclosures made to investors. This is a prior example in the case of stocks: Is PPFAS right to value Noida Toll Bridge lower than market price?
So, Franklin was well within their rights to markdown the bonds and SEBI’s probe should not do much.
However, this does bring to the for some technical issues. If an AMC is free to mark down a tradeable security as zero due to special circumstances, there is no requirement from their side to mark it back up if the situation normalises.
While rest-assured Franklin will mark it up once Voda can pay, to stay in business, the rules on special situation valuation requires a re-look and it is possible SEBI may refine these rules. It is notable that only Franklin has devalued the bonds 100% while other AMCs like Nippon, UTI and Birla have opted for a partial write-down.
Franklin may not have broken any laws, but did they do the right thing?
This was a special situation where in spite of the negative development, the bond remained “investment grade”. Franklin’s actions can be argued both ways.
Yes, it was the right move: After the supreme court judgement, mass redemptions could have hurt the existing investors. It is important to remember that Franklin holds other low-quality paper and selling these to meet redemption requirements could have resulted in more trouble. By down writing the bonds, Franklin has protected their interests and investor interests.
We always crib about mutual funds not looking beyond credit ratings and how “big investors” tend to escape before a credit event. In this case, all investors faced the blow.
No, it was the wrong move: Why create a side-pocket option first and then not use it? However remote, there was a non-zero possibility of Voda Idea avoid default and Franklin should have waited and created a side-pocket in the event of default. This will ensure new investors cannot benefit from the default.
Now, in principle, a new investor can benefit if Voda Idea pays up. They have limited the investment to Rs. 2 lakh a day but this could have been avoided with a default.
Bottom line: Since this was a speculative move, the argument is never-ending. Those who argue in favour a side-pocket assume they would not lose anything if Voda Idea pays up and the portfolio segregation is removed. However, due to the time value of money, returns would go down. See for example: Delay in EPF interest payment: Is there a loss to subscribers?
Opinion: In my view, Franklin has handled this badly. If they had not made the side-pocket provision and written it down, public opinion could have been less harsh. To be frank, I expected Franklin to buy the Voda Idea papers themselves as they did in the case of Jindal Steel. Although this option is still available with them (and other AMCs), it was perhaps wishful thinking.
At the same time, considering the credit quality of the affected fund portfolios, waiting for credit agencies to declare a default rating could have affected investors even more in case the big investors redeemed. Therefore painful as it is, I think it is the right move.
Plumbline Status: This is freefincal’s list of hand-picked mutual funds This contains two funds of Franklin affected by Voda idea. Readers have generally responded to this development well by pointing out that the risk has been mentioned loudly enough in the recommendations. Thank you for your support. The funds shall continue to be part of plumbline. However, I shall no longer expect Franklin to bail out investors in the case of credit events.
What is your view? Please comment below. Was Franklin AMC right?
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