Was Franklin AMC right in marking down Vodafone Idea Bonds?

Franklin AMC marked down Vodafone Idea bonds in their debt funds by 100% SEBI is said to be probing this action. Did Franklin do the right thing? Or should it have waited for the bond to default? A look at both sides of the argument.

Image showing an arrow pointing down in a staggered manner representative of the situation with Vodafone Idea bonds. The bond logo and Franklin AMC logo are also shown.

Published: January 25, 2020 at 11:12 am

Last Updated on

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.

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.

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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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16 Comments

  1. I still can’t believe why someone need to recommend this fund (even in plumbline with disclaimers).
    Even if the recommendation is to hold for long time(>3 yrs?), there are plenty of less riskier options available.
    Why invest in a fund that holds lot of low rated papers to fetch that 1pc extra return?
    In debt, best approach is to diversify across 2-3 funds of same category to reduce such negative impact.

    Also surprising fact is people invested huge amount in this fund few days before the impact in spite of knowing about Vodafone issue.
    They should blame themselves for taking that decision rather than questioning the AMC.

      1. Totally agree sir.
        But I would take such a risk with a balanced adv or an equity savings fund for a 3+ yr timeframe. I always felt debt funds are never for taking risks but more for capital protection. I revisited your videos on debt fund risks again 🙂
        I just can’t imagine someone putting 20-30 lacs in such a fund and never know when the time bomb kicks in.

        I think this incident should be a lesson to all irrespective of someone lost capital or not.

        Thanks.

        1. Absolutely agree. Invested my all FD in this kind of debt funds to save some amount of taxes and trusting Franklin. Learnt a lesson very hard way. I realized, it is better to put money in bank rather than debt funds for 1 or 2% extra income. After two years , the returns on my debt fund is 1%. What is the use of investment in debt funds and no returns with such kind of high risks. So bad decision. I seriously felt Franklin should have created side pocket instead of putting investment at zero. I don’t know seriously how much low quality papers are there in this fund. Purely gone through VR and morning star ratings and invested.

  2. Though I am also one of the investor who has lost in the episode, I still believe Franklin took a very pro active action which is not being appreciated well enough. If they had not done anything, big investors would have pulled out their money leaving small investors holding lemon in their hands and thereafter cribbing all over again.

  3. I still wonder when AMC gets money back from Vodaphone, who keeps track how much they got back, how much of that hey paid back to investors..etc. I see there is a potential for AMC to keep some money for them selves, unless SEBI monitors AMCs. This episode of AMC marking suddenly to zero and booking this as a loss to invesyor is a murkier business. Atleast in side pocket scenerio we get to see in NDSL CAS statement how much money is side pocketted.

  4. In this whole mark down episode, I am concerned about whether SEBI monitors AMCs. If Vodaphone pays back, how much paid back to AMC, how much paid back to investors, how much money went underground…no one knows. At least in side pocket scnerio, we see in NSDL CAS statement, how much money side pocketed, if there is a chance to get money back how much we will get back. Marking down as a loss and later getting back is a murkier business and I feel all AMCs may resort to this…..unless regulator closely scrutinize this.

    1. Happy to see this morning email from Franklin, atleast my concerns are addressed:

      Dear Investor,

      This is to inform you that in accordance with SEBI regulation on creation of segregated portfolios (side pocketing), we have received Board of Trustees approval to create a segregated portfolio in respect of securities issued by VODAFONE IDEA LTD 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 with effect from January 24 2020, due to a rating downgrade of certain securities issued by Vodafone Idea Ltd to CRISIL BB (Rating watch with negative implications) i.e. below investment grade by CRISIL.

      All investors who were existing in the fund as on the date of the rating downgrade (credit event) will receive units in the segregated portfolio.

      You will receive an account statement (within five business days) showing the value of your holdings in the main portfolio and segregated portfolio.

  5. Easy to say . Franklin has protected small investors from sharks and this is the best thing that they could have done. Vodaidea should pay up and go out if they cannot meet customer needs. Pity. They wanted a free lunch which has to be paid. Maybe they shd pay in five installments

  6. They killed dhfl like this and are now trying it with Vodafone. I sense this is financial mafia that is working to kill companies this way. Dhfl had good loans and still it was killed because its loans dried out after derating. The same technique is being used again. A cbi investigation into the person’s involved in such financial terrorism is required

  7. It’s a good lesson for me. And the lesson is diversification. I am hit very badly due to these developments but this is mostly my fault. I was first time investor. I thought I was diversifying my debt portfolio by investing in 3 debt funds of different “duration”. However all three of them were Franklin and were the ones having vodafone Idea papers.

  8. This is a very welcome move from Franklin. They new huge redemption could come in and make portfolio more concentrated just like what happened for Boi AXA credit risk. They protected the investors and now they are segreeating the portfolio. That’s how tough management behave in bad times. Good Going Franklin.

  9. sir,
    first of all thanks for educating people like me with mathematical, logical answers to the unpredictable world of personal finance.
    now as for as this episode of FT debt funds with VodaIdea bonds, please correct my understanding which is as follows:-
    (taking FI low duration fund – direct as example)
    1. amc marked down the nav of funds on 16 jan causing nav to drop more than 6.8% and rating agency downgraded them on 24 jan and amc created side pocket that day.
    2. so there were six working days between the two events during which amc restricted new investment to 2 lac. and during that period nav remained almost same (although creeping up slowly like normal).
    3. now in case, vodaidea bonds , now in side pocket, default, no more harm or advantage to anyone including old, new or who exited during these 6 days. (harm to the old and exited has already happened)
    4 but, in case (may be imaginary, but just to understand some concepts) these bonds don’t default and vodaidea pays back full as scheduled, following will happen for different investors, as per my understanding ( i request you to correct me for these )

    a. those who exited during this period , gone with losses permanently
    b. those old investors who stayed put will recover all their losses as if event was just a bad dream (except little loss caused by new investors during these 6 days).
    c. those new investors who entered with 2 lac daily for 6 days will be the biggest beneficiaries of 6-7% over and above.
    d. and who invest now onward will have no effect due to creation of side pocket

    sir, i request, please correct my understanding of the situation as this will clear lot many cobwebs for debt funds in my mind.

  10. I think Franklin has side pocket investor Fund. If vodaidea give money back some new investor get benefits of Current investor loss. This is not good for Mutual Fund industry it’s affecting all over MF Industry and investor trust.

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