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What Debt fund means to investors

  June 11,2020

Everything You Wanted to Know About Franklin Templeton Winding 6 Funds

In the last few days, debt funds and Franklin Templeton have been news. This has resulted in panic among debt fund investors.

In this article, we will explain the scenario and what it means to mutual fund investors in the simplest way possible.

What happened?

On April 23, Franklin Templeton Mutual Fund wound up six of its debt schemes. Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund were the schemes.

The schemes were wound up because of increasing redemption pressure, slowing inflows and worsening liquidity in the debt market.

To meet the redemption pressure, the fund house borrowed funds during the first phase of the lockdown. According to SEBI guidelines, mutual fund houses can borrow up to 20% of the AUM to meet their investor’s requirements.

As the government further extended the lockdown, the redemption requests from investors’ increased. Redemption requests along with reduced inflows aggravated the scenario.

To honour the redemption requests, the fund manager had to sell liquid papers or highly rated securities. This further increased the proportion of the lower rated or inferior papers. The concentration of these securities can affect the returns of the investors who stayed invested in the fund.

To protect the portfolio value of all its investors, the fund house wound up the schemes.  

What about other options?

Suspending redemptions till market conditions stabilise seemed like an alternative to winding down the schemes. However, the current regulations regarding suspension of redemptions, such as the requirement to honour redemptions of up to Rs. 2 lakhs, made this move unviable. 

Is there any background?

The last 18 months haven’t been smooth for debt fund investors of the fund house. Since the defaults by IL&FS and Vodafone in 2018, the fund house has created side pockets in their funds to hold securities issued by such companies.

What is the RBI doing?

RBI was quick to respond to the development. To ease the redemption pressures faced by fund houses and protect investors, RBI has opened a special liquidity facility for mutual funds of Rs.50,000 crores. Fund houses can opt for this facility till 11th May.

As stated earlier, fund houses can borrow up to 20% of their total AUM to meet redemption pressure.

What will happen to investors who have invested in these schemes?

As fund houses have wound up the schemes, it means that investors won’t be able to invest or redeem. Investors won’t be able to invest, transfer or redeem through Systematic Investment Plan (SIP), Systematic Transfer Plan (STP) and Systematic Withdrawal Plan (SWP).

Asdefaults by investing company is not the reason behind the closure of the funds, the fund houses will return the investor’s money in a staggered manner depending on the scheme’s portfolio maturity. The fund house aims to liquidate the portfolio holdings at the earliest.

The fund house has two ways: to wait for the securities to mature or sell the securities in a reasonable price.

As securities held by short term funds and ultrashort duration funds may mature earlier than instruments held by credit funds, investors of ultra-short and short duration funds may receive their money earlier than investors of credit risk funds. 

The fund house will look into early exits via sale or prepayment after the market recovers from the current situation.

What’s next for debt fund investors?

Market experts say that the episode should not rattle debt fund investors. They believe that it is a one-off situation, and the risk is imitated to funds with risky debt instruments such as credit risk funds.

Typically, credit risk funds invest a major part of their corpus in AA papers. AA is a notch below AAA, the highest-rated papers. Fund houses invests a small percentage of the corpus in instruments rated below AA.

Leaving aside credit risk funds, depending on the debt fund, fund managers invest a larger proportion of the debt funds in AAA rated top quality papers, government securities, treasury bills or certificates of deposits.

Conclusion:

As the scenario is not a credit or default issue, investors will receive their money slowly. Investors cannot invest or redeem their investments. By winding up the scheme, the fund house had protected the investor’s money and prevented their portfolio from tumbling.

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