Understanding Winding Up of Franklin’s 6 Debt Funds, its Impact and How to invest/ Redeem in Debt and Equity Mutual Fund

On April 23, late evening, Franklin India Mutual Fund shut down 6 debt mutual fund schemes. No financial transaction – Purchase, SIP, STP, SWP, or Redemption would be allowed after April 23, 2020 1:00 pm cut off time.

These schemes are:

  1. Franklin India Ultra Short Bond Fund,
  2. Franklin India Short Term Income Fund,
  3. Franklin India Credit Risk Fund,
  4. Franklin India Low Duration Fund,
  5. Franklin India Dynamic Accrual Fund, and
  6. Franklin India Income Opportunities Fund.

The combined size of these schemes is Rs. 25,856 as on April 22, 2020. As per Factsheet, the AUM of these schemes was Rs. 30,853 Cr as on March 31, 2020 and Rs. 41,121 Cr. as on February 29, 2020. It means redemption of Rs. 15,265 crores in less than 2 months.

Why Shut Down Scheme?:
These schemes used credit strategy i.e. invested in lower than AAA rated securities for earning extra yield (return). Due to Covid-19, the liquidity of these securities dried up and yields increased. There is extra liquidity in the system and RBI is doing a great job to have enough liquidity in the system. However, unfortunately, the liquidity is not being trickling down to the lower rated securities.

As a result, to honor the redemption requests, these schemes were having difficulties to sell lower rated securities and were using borrowed funds for the same. Also, with continued redemption pressure, outgoing investors were being paid full at the cost of the loyal investors, who were staying invested and were stuck with more and more illiquid or risky securities.

On April 23, the fund management realized that they would not like to keep borrowing to honor redemption, not like to sell the lower rated securities at discounted price and would like to protect the long term investors. As a result, they decided to wound up the schemes.

Impact on MF Industry as a whole:
This is an unprecedented event and I think it is a severe blow to mutual fund industry as a whole. Yes, it is related to only 6 funds of only 1 mutual fund companies in India, I think it may be difficult to market “Mutual Fund Sahi hai” now. Also, this severely affects the reputation of Mutual Funds and negatively affect the trust of the industry.

Also, the MF distributors have been selling the debt mutual fund without realizing the risks attached to it as an alternate to Bank FD. Also, they used past return as a guide for selling the product but as interest rates and NAV are inversely related, usually, future returns are usually very different than past returns. Now, the investors would appreciate the quality of advise and intelligence of an advisor.

Impact on Current Investors:
These schemes will act like a segregated portfolio. No purchase, sell, transfers will be allowed and as and when the securities are matured or sold at a reasonable rate when market stabilizes, the unit holders will be paid on a staggered manner. However, the lenders will be paid first and only thereafter, the unit holders will be paid. The money will be directly credited to the bank account.

All mandates related to STP, SIP, SWP stands cancelled. If an investor had given the schemes as a security for loan and lien was marked, the Lien stands removed and accordingly, the DP (Drawing Power) limit will also go down. The investor would have to provide additional security or work with lower DP, a major blow to the liquidity.

How to Invest / Redeem other Debt Mutual Funds:

  • As Interest Rates are very low (G-Sec yield 6.06% on April 23, 2020), it may be advisable to redeem medium term, medium to long term, long term or G-sec debt funds. However, the quality of portfolio of respective schemes, period of holding, taxation, etc. needs to be checked.
  • Yes, the yield could decrease, but if you have invested when G-Sec yield was 8% or more, it may be a good time to redeem. While yield may go down further, it may not get lower than 5% i.e. max 1%.
  • Investments in Ultra short term, Short term, Money Market funds are to be carefully evaluated and may be carried on or invested. However, if these schemes see heavy redemption, care should be taken to redeem those funds as you don’t want to be caught with illiquid securities.
  • For emergency and urgent fund requirements, money is to be invested in the overnight funds. Liquid funds are also to be carefully invested.

In short, it is time to be careful with debt investments and also to work with intelligent advisors.

Personally, My advice would be to review the portfolio of debt mutual funds and if required, redeem debt funds held for 3+ years except for short term or lower duration debt funds. Also, keep a close watch on other debt funds and take decisions accordingly. Since most of the long term funds were invested when interest rate was 8%+, redeeming now would still result in average return on debt funds of about 6–9% CAGR.

The funds so redeemed needs to be invested in the equity funds of various selected schemes for long term over next 6 months. This could be a great time to move from debt to equity as a tactical asset allocation, provided there is no requirement for funds for long term (next 10+ years).

Good Luck and Happy Investing……

About Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)

Mr. Jigar specializes on NRI Investments and Taxation. He is proud to be one of only 21 CFA Charterholders in India working as consultants. (In 2011, when he became CFA Charterholder, out of 97,173 CFA Charterholders in the World, only 697 Charterholders were in India and only 3% work as consultant; Source: www.newcfa.org). He received his MBA (Finance) from University of Illinois, Chicago, USA, CPA from USA and a Chartered Accountant from India. Jigar has over 15 years of professional experience including more than 4 years with KPMG USA’s Risk Advisory Services. Currently, he provides Wealth Management and taxation consulting serving clients from USA, UK, Americas, Europe, Middle East, Asia, Africa, Australia and India.
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