When fear overtakes greed

Thanks to the evolving regulatory measures introduced by the Securities and Exchange Board of India (SEBI) from time to time, investors in debt-related mutual funds (MFs) are no strangers to the concept of segregated portfolios.

The mechanism of segregated portfolios involves separating illiquid assets, which have undergone default, from the liquid ones to prevent the troubled assets from eating into the returns generated by the productive assets.

However, on April 23, the trustees of Franklin Templeton Mutual Fund, one of the largest foreign fund houses in the country, announced that they have, after careful analysis and review, voluntarily decided to wind up their suite of six yield-oriented, managed credit funds. “In light of the severe market dislocation and illiquidity caused by the Covid-19 pandemic, this decision has been taken in order to protect value for investors via a managed sale of the portfolio,” the fund house said in a release.

The fund house clarified that the closure was limited to the specified funds, which have material direct exposure to the higher-yielding, lower-rated credit securities in India that have been most impacted by the ongoing liquidity crisis in the market. “All other funds managed by Franklin Templeton Mutual Fund in India—equity, debt, and hybrid—are unaffected by this decision,” the release said.

The six closed funds and their individual average assets under management (AAUM) as of March 2020 are Franklin India Low Duration Fund, with AAUM of ₹3,212.76 crore; Franklin India Dynamic Accrual Fund (₹3,389.44 crore); Franklin India Credit Risk Fund (₹4,863.76 crore); Franklin India Short Term Income Plan (₹8,375.1 crore); Franklin India Ultra Short Bond Fund (₹12,970.02 crore); and Franklin India Income Opportunities Fund (₹2,732.52 crore).

At the end of March 2020, these six funds reported AAUM of ₹35,543.59 crore and accounted for 63.39% of the fund house’s total income/debt-oriented funds’ AAUM of ₹56,107.23 crore. Considering the overall AAUM of ₹99,558.59 crore, the proportion of the six closed funds works out to 35.7%.

Clearly, such a move has no precedent in the history of Indian mutual funds. In defence of the closure, Sanjay Sapre, president, Franklin Templeton India, said; “The decision to wind up these funds was an extremely difficult one, but we believe it is necessary to protect value for our investors and presented the only viable means to secure an orderly realisation of portfolio assets.”

Sapre added that significantly reduced liquidity in the Indian bond markets for most debt securities and unprecedented levels of redemptions following the Covid-19 outbreak and lockdown have compelled the fund house to take the decision. “We remain fully committed and aligned with the interests of our investors and aim to assist the trustees to fully exit the managed credit strategy funds at the best possible value,” Sapre added.

Likewise, Santosh Kamath, chief investment officer, Franklin Templeton Fixed Income-India, added that the fund house had been managing many of these funds for over a decade and some for over 15 years. “While these funds are getting wound up, accruals into these funds should continue in the same way as now, as the underlying securities held by these funds remain sound,” said Kamath.

Kamath went on to add that while for many years, these managed credit funds have carefully invested in and supported growing businesses in India, unfortunately, the extreme drop in liquidity in the bond markets, coinciding with very large redemptions following the Covid-19 outbreak has compelled them to make difficult decisions in order to protect the interests of the funds’ unit holders.

Sapre and Kamath found support from San Mateo, California (U.S.), as Jenny (Jennifer) Johnson, the president and chief executive officer of Franklin Resources, the global investment management organisation operating as Franklin Templeton, said; “Our commitment to the market and our investors in India remains steadfast.”

Talking of Franklin Templeton’s long history of over 25 years in India, and also that the country accounts for 33% of the organisation’s global workforce, Johnson reiterated that taking this extraordinarily difficult decision during this unprecedented time was necessary and the right thing to do. “Quick and decisive action was imperative to protect the existing investors in these funds,” Johnson added. “And I continue to be proud of our team in India for focussing on our clients first.”

However, not all stakeholders in the asset management industry are kind to the development. In a statement, Arvind Chari, head of fixed income and alternatives at Quantum Advisors, which runs Quantum Mutual Fund, flagged to his investors about Quantum’s constant communication and recommendation over the last 18 months on avoiding risks in their fixed income investing.

“We had cautioned investors not to take risks to try and earn that extra 0.5%-1.0% in their debt funds,” said Chari. “Debt funds are only an alternative to other fixed-income instruments and the priority should be to invest in debt funds or debt instruments, which keep your money safe and liquid.”

Chari further warned that with the onset of Covid-19 and its economic uncertainty, he believes the sentiment in the bond market will turn adverse and it may be prudent to be as risk-averse as one can be in their investment portfolios. He further highlighted that over the past two weeks, the portfolios of Quantum Liquid Fund and Quantum Dynamic Bond Fund have reduced their exposures even in AAA-rated public sector undertaking’s (PSU) instruments; both the funds now hold a very large proportion of the portfolio in government securities and treasury bills.

“We believe that we will be holding this conservative stance for a long time, as we do not expect things to stabilise anytime soon,” Chari added, reiterating that these are not the times to try and earn that a little bit extra interest from fixed-income investments. “These are the times to be extra careful and cherish safety and liquidity.”

Similarly, the MF industry body, Association of Mutual Funds in India (AMFI), came out to assure investors that majority of fixed income MF’ assets under management (AUM) are invested in superior credit quality securities and schemes have appropriate liquidity to ensure normal operations. On the six closed schemes, AMFI, in its release tried to play down the impact by citing that the AUM of the closed schemes constituted less than 1.4% of the Indian MF industry’s aggregate AUM as on March 31.

AMFI also added that fixed income schemes of most MFs have superior credit quality as confirmed by ratings of independent credit rating agencies, and continue to remain fairly liquid even in these challenging times. Further, the industry body also highlighted that SEBI regulations allow MF schemes to borrow up to 20% of their assets, to meet liquidity needs for redemption or dividend payout.

While AMFI is in the process of collecting the data, it told many MFs have informed the industry body that they do not have any outstanding borrowing, and further added that liquidity, maturity profile, and credit quality for debt funds are appropriate for day-to-day operations to continue uninterruptedly.

While AMFI expects fixed income funds across the industry to continue their normal operation without any material impact, AMFI’s chairman, and Kotak Mahindra Asset Management Co.’s managing director, Nilesh Shah, said that [the move like] banking liquidity in excess of ₹7,00,000 crore, Long Term Repo Operations ( LTRO ) conducted by the Reserve Bank of India (RBI), expectations of further rate cuts and Operation Twist by the RBI are likely to keep the bond market liquid and normally functioning in the current challenging times.

“The MF industry remains fully committed to investor interests and there is no need for them to panic and redeem their investments,” said Shah. “The industry continues to remain robust like in 2008 subprime crisis or 2013 taper tantrum crisis.”

In a defensive tone, AMFI’s chief executive NS Venkatesh said the industry has seen many cycles and professional fixed income fund managers have managed crises efficiently over the years. Venkatesh spoke highly about investors’ continuing trust, which has led to industry AAUMs doubling--from ₹11.88 lakh crore at the end of March 2015 to ₹24.70 lakh crore at the end of March 2020. “Most credit risk funds have pretty good credit quality and sufficient liquidity in today’s challenging times and continue to remain an attractive investment option for investors,” said Venkatesh.

This move from the debt market had a bearing on the equity markets on Friday, as the S&P BSE Sensex and NSE’s Nifty 50 broke their pattern of gain at close as seen over the last two days. While the Sensex fell 535.86 points, or 1.68%, to close at 31,327.22, the Nifty 50 closed 159.5 points, or 1.71%, lower at 9,154.4 points. The overall market breadth was also negative, with both S&P BSE MidCap and SmallCap closing the day 1.77% and 1.4%, respectively, lower.

According to Siddhartha Khemka, head of retail research at Motilal Oswal Financial Services, the global sentiments slumped after the reports that the Remdesivir, a Gilead Sciences’ drug, disappointed in its first randomised clinical trial and the U.S. weekly jobless claims fell for a third straight week. On the domestic front, Franklin Templeton Mutual Fund’s winding up of six debt funds due to redemption pressure and lack of liquidity in bond markets amid the Covid-19 crisis, added to the selling pressure. “Even the media reports that the PM-FM meeting has got postponed and is likely to happen next week, dampened the sentiments,” said Khemka.

Clearly, the Covid-19 pandemic has been mounting immense pressure on the economy and the stressed fragments of the markets are now facing the music.