Franklin Templeton Mutual fund closure: A warning bell for retail investors?

This week on 23rd April, Franklin Templeton Mutual fund (one of the top 10) in India announced to close its 6 yield-oriented Credit funds. The announcement came sudden & surprised many. A large number of people now have questions in their mind, why did it happened & Is it still safe to continue investments in mutual funds. 

Let’s get some clarity, I have clubbed most commonly received questions after this announcement. Feel free to ask any other uncovered question.

Questions:

1. What exactly are Equity, Debt & Credit risk funds?

2. Which Credit Funds got closed by Franklin Templeton?

3. Why Franklin Templeton choose to close those Credit funds?

4. Will investors get back their money?

5. Does this announcement affect any other Equity mutual funds run by Franklin 

Templeton?

6. Can such incident happen with other AMC’s (Fund house) credit fund as well?

7. Is it time to avoid Credit or Debt. mutual funds in current scenario, if yes -what is the alternative?

8. Is it a warning bell for retail investors to stay away from markets or mutual funds?

1. What exactly are Equity, Debt & Credit risk funds?

Equity Fund: An equity fund invests your money directly in the stocks or any other instrument related with equity.

Debt. Fund- A debt mutual fund (also known as a fixed-income fund) invests a significant portion of your money in fixed-income securities like government securities, debentures, corporate bonds and other money-market instruments. They are known as stable & low risk funds.

Credit Risk Fund- A special type of debt funds that play on the principle of high-risk-high-reward. By definition, credit funds invest 65 per cent of the portfolio in bonds that are AA rated or below. So, credit fund invests your money in to risky & relatively less secure corporate bonds.

2. Which Credit Funds got closed by Franklin Templeton?

Franklin India Dynamic Asset Allocation FOFs

Franklin India Multi-Asset Solution

Franklin India Life Stage FOFs-20

Franklin India Life Stage FOFs-30 

Franklin India Life Stage FOFs-40 

Franklin India Life Stage FOFs-50 Plus.

All Credit funds. No Equity fund has been closed.

3. Why Franklin Templeton choose to close those Credit funds?

The reason according to the fund house is – “There has been a dramatic and sustained fall in liquidity in certain segments of the corporate bonds market on account of the COVID-19 crisis and the resultant lockdown of the Indian economy which was necessary to address the same. At the same time, mutual funds, especially in the fixed income segment, are facing continuous and heightened redemption”.

In simple language: Due to COVID-19 impact most of the businesses are facing lockdown situation, they are not able to receive new orders or even service existing orders. Since there is less or no income in place, they are unable to pay back funding taken from Credit funds. 

On other hand, due to uncertainty on economic front – Investors are pulling back their funds from Credit funds. This is creating redemption pressure on Credit funds. Credit funds do have adequate cash to address redemption pressure. 

If Credit fund is trying to generate cash by selling out bond holdings. They are unable to trade or sell those because they already sold good quality bonds & now they are left with only low-quality bonds. There is no one interested to buy low quality bonds in secondary market. So, those bond holdings remained unsold. Credit funds are not able to generate cash which they can pay back to investors.

As a result, Credit funds are caught in Catch-22 situation. Hence Franklin Templeton had no other good option than to close fund which will not allow investors to redeem their investments as of now. It’s exactly same like putting restriction on withdrawal of funds from bank accounts.

Eventually, when situation improves – Credit fund will be able to liquidate low quality corporate bonds in secondary market & pay back funds to investors.

4. Will investors get back their money?

Yes (Could be partially)

It is expected that once the macroeconomic situation improves, credit funds will be able to sell bonds hold by them. Then the cashflow will be better, allowing investors to receive back their investments from funds. Time taken to happen that remain uncertain at this point of time.

Some portion of investment may remain non-recoverable. It is possible that investor might have to take some haircut on their investments.

5. Does this announcement affect any of the Equity mutual funds run by Franklin Templeton?

Equity fund is entirely a different basket. There is no as such indication by FT.

6. Can such incident happen with other AMC’s credit fund as well?

On Friday (24th April), Association of Mutual Funds (AMFI) chairman has categorically said - A majority other funds should not have any impact on operations due to an isolated instance of winding down at one mutual fund.

However, it is likelihood that panic created will lead to more redemption pressure. There is already dried liquidity in secondary bond market (more with bond ratings below AA), Macro-economic situation is not good. Credit funds will not have any other sensible option than to close the fund in case of mounting redemption pressure.

7. Is it time to avoid Credit or Debt. mutual funds in current scenario, if yes -what is the alternative?

Debt funds which invests only in highly rated government & corporate bonds (AAA) should be ok. There is very less chance of default in case of such funds.

It’s best to avoid Credit fund during current scenario.

Alternative could be – PPF or even Bank fixed deposits. Option of equity fund will solely depend on individual risk appetite.

8. Is it a warning bell for retail investors to stay away from markets or mutual funds?

As Mutual fund disclaimer says - Mutual fund investments are subject to market risks. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund.

There is a probability that, what happened at Franklin Templeton could happen with another AMC.

Credit or Equity funds may undergo capital depreciation, if COVID situation doesn’t improve & economic activities don’t get back to track soon.

In my opinion, that doesn’t mean you should completely stay away from markets or mutual funds, however should moderate your expectations & investment methodology factoring macro economic situation around.

If you are comfortable with more safety than any reasonable risk – Stay with bank fixed deposits. 

Feel free to express if you have any other viewpoints.

Disclaimer: I am not a SEBI registered investment advisor.