May 19, 2020

“Was winding up the best option for the 6 Franklin Debt schemes?” and other questions answered

Sanjay Sapre
President, Franklin Templeton
  1. Has Franklin worked out a worst case and best case scenario? If so, what is it?

We have shared the scheme wise projected cash flows with all our stakeholders through the following report in this link: Maturity profile as on 15 May 2020

However, these are conservative estimates as we have assumed only scheduled maturities and coupons. We aim to expedite the cash flows by looking for all opportunities to seek pre-payments from issuers, or to sell portfolio holdings in the secondary market provided we do not incur a significant impact cost so as to protect value for our investors. We will keep our partners and impacted investors updated on these numbers from time to time.

  1. Can you officially publish the maturity dates for the portfolios of the 6 schemes for communicating with clients about potential receipt?

Please use our latest report in this link on Maturity profile as on 15 May 2020 which provides this information for the 6 schemes.

  1. The present crisis is a big sentiment dampener. What steps is Franklin Templeton taking to rebuild investor confidence?

Our immediate priority is to assist the Trustees in managing the winding up of these funds in the best interests of our investors, and to support our clients and partners during this time. We have always taken all decisions in the best interests of our investors and have tried to keep investor interest paramount in all that we do. This decision, however difficult and challenging, is also taken in order to permit a managed and orderly sale of our portfolio holdings in an extremely challenged market environment due to the Covid-19 pandemic and related lockdown, to prevent the need to make distress sales of portfolio securities at steep discounts which could lead to significant value erosion for investors. We hope that our investors and partners, relying on our long track record, integrity and brand reputation built over many years in India, will agree that this decision, while difficult, was taken in the best interest of our investors.

We remain committed to the India business for the long-term. Franklin Templeton has more than 25 years of history in India, and our commitment to the Indian market and our investors remains steadfast. We also have 33% of our global workforce based in India including our global service entities that represent almost every functional area in Franklin Templeton.  We continue to manage an additional 27 open ended schemes, 24 close ended and 6 fund of funds schemes with approximately INR 50,000 Crore  of AUM in fixed income, equity, hybrid, overseas, feeder and multi-asset schemes which are not impacted by the winding up process.  These schemes will continue to be managed in line with their investment mandate with a view to delivering superior investment outcomes for our investors. There are no changes planned to our operating model as a result of this decision.

We remain aligned with our investors and partners and recognize that return of maximum value to investors is one of the critical ways for us to regain our brand reputation and our investor’s trust.

  1. Were there any other alternatives for Franklin apart from closing down the 6 schemes?

The following options were considered besides winding up the schemes:

Restricting redemptions / Suspension: We explored the possibility of suspending redemptions until market conditions stabilize without winding up the schemes. However, conditions for such a suspension under the current regulatory framework, such as a maximum suspension period of 10 working days (in 90 days) and the requirement to honour redemptions up to INR 2 lakh per day per investor, rendered this approach unviable to meet the severe and sustained impact of the current crisis.

Elongate the redemption payment: We have been making redemption pay-outs on T+1 basis from the date of receipt of redemption application, although regulations allow for a maximum of 10 working days for this purpose. We explored the option of elongating the redemption pay-out cycle by taking the benefit of the maximum period permitted under regulations. However, while this option may be suitable to tide over short-term liquidity issues, it is not adequate to address the severe and sustained impact of the current crisis.

Distress sale: We also explored the option of selling the securities at a discount to meet redemption requests. After careful consideration, this option was ruled out as it would have resulted in significant value erosion and placed a disproportionate burden on investors who would continue to hold their positions in the funds.

  1. What about the NAV of units which are locked under segregated portfolios of these 6 schemes?

A segregated portfolio is not connected with the winding up event. Such units would continue to be held in the segregated portfolio of the respective schemes. In accordance with SEBI regulations, money will be promptly returned to unitholders (who hold units in the segregated portfolio) whenever any realisation/ recovery of any amount is made. The amount recovered would be paid to investors in proportion of their share in the segregated portfolio in accordance with regulations.

  1. To avoid equity market volatility in the short run, investors often switch money from equity schemes to debt schemes when the financial goal is approaching (say the goal is 6-18 months away). What if investors’ money was parked in one of those six wound up schemes with the objective to redeem the accumulated corpus after 6-18 months?

We understand this challenge, but the choice was between value erosion and liquidity at any cost and we chose to preserve value. It is our endeavor to assist the Trustees to wind up these schemes and return unitholder money at the earliest possible time, having regard to the maturity dates of the underlying securities in the portfolio, and prevailing market liquidity.

  1. If the 6 debt mutual fund schemes have been wound up from cut-off time of 23 April 2020, how come the NAV of Franklin India Credit Risk Fund has fallen sharply on the following days?

The change in NAV of schemes is a reflection of the changes in the valuation of underlying securities. This valuation is done as per SEBI regulations and factors in inputs from independent external valuation agencies. Several moving variables impact valuation of a security like (a) macroeconomic and market led variables such as interest rate movements, yield spreads across credit rating spectrum (b) issuer specific variables such as upgrade/downgrade, etc.

Additionally, the NAV of FICRF were also impacted due to a valuation mark-down on 28 April 2020 in securities issued by Future Group owing to a moratorium extended with respect to their NCD obligations. For more details, please refer to our update (link).

Please note, there is no change in our valuation policies or relevant regulations before or after the decision of winding up.

  1. Will there be changes in strategy in managing the remaining debt schemes of Franklin Templeton due to the current scenario?

Our high grade and hybrid funds are not impacted by the same liquidity issues that have impacted the funds being wound up. Funds investing in AAA, GSECs, T-Bills and other money market instruments continue to be liquid and we see no significant dislocation in the market for these funds. We continue to manage these schemes in line with their investment mandate with a view to delivering superior investment outcomes for our investors.

  1. Request you prepare a note on FOF status

The note is available in this link

  1. A con-call was conducted on 14 April 2020, where official representatives of Franklin Templeton assured us that everything is fine. Why were Mutual Fund Distributors/ Financial Advisors kept in the dark about the position of these 6 schemes?

Let me explain the sequence of events before and after the concall of 14 April. A financial year end (March) typically sees higher outflows and this year was no different. The month of March 2020 saw huge net outflows from the industry to the tune of nearly Rs.2 lakh crore for debt funds (Rs.1.11 lakh crore ex liquid). While we expected redemptions to ebb in April 2020 (which is historically the case), AMFI data of April indicates there were net outflows to the extent of almost Rs.30,000 crore from debt funds (ex- liquid and overnight).

This was because of the severe market dislocation and illiquidity caused by the unprecedented lockdown in the wake of the Covid-19 crisis which impacted livelihoods and businesses across the country (we discussed rising spreads and illiquidity issues caused by the covid pandemic in the concall as well). The extreme drop in liquidity, particularly for bonds rated below AAA, coincided with very large redemptions in debt funds (as seen above) due to heightened risk aversion following the pandemic, besides mark to market losses due to a spike in yields and lower trading volumes. We did speak about rising redemptions in the concall as well as mentioned that the funds received via TLTRO by banks if used to buy corporate debt may help to bring down spreads. However, redemptions and illiquidity continued unabated and caused a worsening crunch for open-end mutual fund schemes investing in corporate credits across the credit rating spectrum.

In this situation, we found our ability to liquidate assets at a reasonable price to fund redemptions for 6 of our yield-oriented schemes under severe stress and it was no longer possible for these schemes to generate adequate liquidity to fund daily redemptions. We even resorted to borrowings (which were also discussed in the concall) to fund redemptions. However, with increasing uncertainty about the length, severity and impact of the Covid-19 pandemic related lock-down, we did not believe it was prudent to continue funding redemptions through potentially increasing levels of borrowings. Therefore, we were required to make a difficult choice between continuing to fund redemptions at the cost of investors who remain invested, or to stop redemptions in order to prevent value erosion. We believed that the economic impact of the pandemic and related lock-down could be long-lasting, and bond market conditions were unlikely to return to normalcy in the immediate future. Hence, we believed taking the decision to wind up the full suite of six yield-oriented funds, while very difficult, was the only viable option to preserve value for unitholders and to enable an orderly and equitable exit for investors in these unprecedented circumstances.

Further, we wish to clarify that no decision regarding winding-up had been taken on April 14, 2020 and the continuous heightened redemption volumes faced by the schemes during the days prior to April 24, 2020 coupled with other factors such as market illiquidity informed earlier have resulted in the winding-up decision.

  1. When the schemes were open for transactions, did the ‘Risk Management Team’ not conduct simulation tests for scenarios related to raising liquidity to about 50% in a short period?

Franklin Templeton routinely reviews portfolios from a risk perspective. The Risk team conducts stress tests as per regulatory guidelines and has adhered to these guidelines. The schemes enhanced diversification and stringent measures were adopted to reduce concentration to issuers over the last couple of years. It is because of a risk-aware approach that the schemes have been meeting their redemption payment obligations since inception across all market conditions and were even able to do so during the initial phase of the Covid-19 pandemic related lockdown despite heightened redemption pressures and increased market illiquidity.

You may note that, these schemes have followed a consistent investment strategy over a long period of time of investing in credits across the rating spectrum including active investments below AAA securities. Such a strategy was able to deliver meaningful outcomes for investors. Over their long history, these funds have been able to weather a number of market cycles and continued to provide daily liquidity.

In the last 6 months, we were able to manage all our redemption demands despite witnessing heightened redemptions in some of our yield-oriented funds since January 2020. We funded this through sale of assets, pre-payments, scheduled maturities and coupons. In fact, the schemes could generate significant cash from sale of assets, out of which a large majority was generated from sale of AA or below rated papers. However, the unprecedented situation arising out of the Covid-19 pandemic had further heightened redemption volumes and reduced inflows. It has also disrupted the normal functioning of the debt markets, particularly the credit markets, severely hampering the ability of the Investment Manager to liquidate securities held in the portfolio. The heightened redemption has affected the liquidity of the portfolio but with an orderly liquidation, the schemes aim to avoid any value erosion for investors in their best interest.

  1. What kind of haircuts can the investors expect from these schemes? Does Franklin Templeton have any plans of taking a hit on their Balance sheet and ensuring that the investors are paid at least the investment amount?

It is our focus to assist the Trustees to manage the orderly sale of securities in these funds in order to return maximum value to unitholders at the earliest possible time.

We have shared the scheme wise projected cash flows with all our stakeholders through the following report (link): Maturity profile as on 15 May 2020

However, these are conservative estimates as we have assumed only scheduled maturities and coupons. We aim to expedite the cash flows by looking for all opportunities to seek pre-payments from issuers, or to sell portfolio holdings in the secondary market provided we do not incur a significant impact cost so as to protect value for our investors.  The schemes continue to accrue the interest on the securities.

Nevertheless, the daily NAV declared during the winding up period will fluctuate as a reflection of the changes in the valuation of underlying securities. This valuation is done as per SEBI regulations and factors in inputs from independent external valuation agencies. Several moving variables impact valuation of a security and in turn the NAV like (a) macroeconomic and market led variables such as interest rate movements, yield spreads across credit rating spectrum (b) issuer specific variables such as upgrade/downgrade, etc. Our ability to liquidate the portfolio and preserve maximum value will depend on the economic impact of the Covid-19 pandemic and related lockdown but it is our endeavor to preserve maximum value for investors.

  1. What would be the taxation of such partial redemption coming from these 6 wound up schemes?

The amount received by investors are in the form of redemption of units and would, where such amount or part thereof represents a gain for the investor, be taxed as capital gain in the hands of investors depending on inter alia the period of their investment in the scheme. It is best to take advice from a tax expert as impact could vary depending on the investor status and income.

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Team Think Tank appreciates the support and coordination efforts by Mr. Amit Trivedi for making this article possible.


3 Thoughts to ““Was winding up the best option for the 6 Franklin Debt schemes?” and other questions answered”

  1. Avatar Anil says:

    The information regarding whether fund managers and other senior employees of the AMC are still invested in these six wound up schemes of Franklin or they redeemed there investments before winding up of the schemes will help in creating the confidence in unfortunate distributor/investor community.?

  2. Avatar Sri says:

    WRT the FOF – Franklin Dynamic Asset Allocation Fund – This Fund invested in the Franklin India Equity Fund (about 70%) and the Franklin Short Term Income Plan (about 30%). On April 24th for the purposes of calculating the NAV of this FOF, Management decided to bring down the value the Short Term Income Plan by 50% citing “Illiquidity” ! Existing shareholders while allowed to redeem their holding, were able to do so suffering a substantial erosion in their holdings value.

    On what basis was this percentage decided ? Was there a SEBI norm they complied with wrt the valuation of the underlying scrips in Short term income plan ? Was a valuation report prepared that provided the backup to declare such a valuation discount ? Everyone in this business knows that there are liquidity issues for lower rated scrips. However surely within the holdings of Short Term Income Plan, some will yield 100% and some below that. However, to ascribe a blanket reduction of 50% is not professionally justifiable and must be challenged collectively by the unit holders of the FOF and by SEBI.

    It is shocking that a fund house of such repute would dodge such decisions that affect their own unit holders !

  3. Avatar nikhil girme says:

    How will franklin ensure that fof investors dont loose out..franklin replies are convincing ..what about incentives given to fund managers..they should be taken back ..if not it can be fairly assumed that whole mgmt has made merry till time lasts..and we distrubutors have been really cheated and tarnished our image in front of investors..who is going to bear that credibility loss ? I will never ever work for franklin my entire life

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