Franklin Templeton winds up six debt funds.

In a big blow to debt fund investors, Franklin Templeton Mutual Fund announced the winding up of six of its debt funds late on Thursday night. The Covid-19 pandemic that has wreaked havoc in Indian bond market over the past two months has led to the fund house closing six of its debt funds with total assets under management of Rs 25,856 crore (as of April 22).

What this necessarily implies for investors is that there will no purchases and redemptions made in these funds post-cut-off time on April 23, 2020. If you are an existing investor in any of these funds, this means that you can no longer redeem your money and your investment is locked in these funds, until the fund house makes further payments.

All purchases or redemptions through Systematic Investment Plans / Systematic Transfer Plans / Systematic Withdrawal Plans will also not be allowed henceforth.

The six debt funds are Franklin India Low Duration, Franklin India Dynamic Accrual, Franklin India Credit Risk, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund.

According to the release put out by Franklin Mutual Fund, reduced liquidity in the Indian bond markets for most debt securities and unprecedented levels of redemptions following the COVID-19 outbreak and lockdown has led the fund house to wind up six of its debt funds. These debt funds have a high exposure to low rated debt securities that have been the most impacted by the ongoing turmoil in the bond market.

A few weeks ago, liquid and other short-term debt funds had also a seen sudden fall in their NAVs, as yields across money market and debt papers had spiked. Given the heightened risk aversion of banks, higher withdrawals from funds (leading to funds selling bonds at a lower price), poor appetite for various debt securities and very thin volumes, the problem has evidently accentuated for low rated corporate bonds.

In a nutshell, these debt funds have high exposure to low rated bonds, where liquidity is a big issue. Hence huge redemptions leading to the fund selling the bonds at very low prices, would have eroded the underlying value of the funds’ portfolios. By winding up these funds, Franklin Mutual states that it has sought to protect the value of investors.

“While we have the potential to create daily liquidity, it would come at the cost of eroding the value of the portfolio. Hence redeeming the units for certain investors would come at the cost of investors staying in the fund. Given that the impact of Covid pandemic is not going away soon, we felt that it would be better to preserve the value of the portfolio to protect interests of all unitholders,” said Sanjay Sapre, President, Franklin Templeton – India, in a concall late Thursday night.

Essentially the idea to wind up the funds and stop redemptions is to prevent further value destruction in these funds on account of selling the bonds in the portfolio at very low prices. As the bond market comes back to normalcy and the appetite returns, the fund could look to sell the assets at a reasonable value. The question is when the Covid pandemic will ease and when will markets return to normalcy?

Given that the extent of the problem is unknown and it could take a long while for markets across the globe to stabilise, there could be persisting challenges in selling down assets in the funds’ portfolios.

Two, the portfolios of these debt funds are run on staggered maturities (various bonds with different maturities). Hence irrespective of whether the fund is able to sell down its assets, there will be a certain amount of money coming in every month, in the form of maturities and coupon payments. Also, some bond issuers make prepayments (in advance of the maturity date), but this is unlikely to happen at this juncture.

Investors could continue to receive staggered payments from the wound up funds. Sanjay Sapre in the concall stated that investors would not have to wait until all the money in the funds are recovered. The staggered payments to investors in these funds could be made monthly or quarterly.

While continual coupon payments and maturity proceeds from bonds can offer some respite to investors in the six debt funds, defaults from corporates issuing such bonds can be a big dampener. Remember the ongoing turmoil owing to Covid has had a widespread impact across sectors and companies. Given that the six debt funds have high exposure to low rated bonds, credit risk emanating in these portfolios can hurt investors.

While the winding up of the six funds does not alter the status of the segregated portfolios, investors will now have to watch for recovery in both regular and segregated portfolios of these funds.

Above all, Franklin’s move could lead other fund houses to also look at closing down debt funds with high credit risk. This could lead to large redemptions and further accentuate the problem for low rated debt securities, making it difficult to realize the reasonable value in the near-term.

(With agency inputs)