Franklin Templeton, one of the major AMCs shut down 6 mutual fund schemes citing market illiquidity and high redemption pressure due to COVID-19 Pandemic. Yield oriented managed credit funds with total AUM worth Rs 25,856 crore have been winded up. These funds are Franklin India Low Duration Fund, Dynamic Accrual Fund, Credit Risk Fund, Short Term Income Plan, Ultra Short Term Bond Plan and Income Opportunities Fund.
The uncertainty due to the coronavirus epidemic has not only impacted the equity returns but also gave a major jolt to the bond market leading to liquidity crisis. Extension of lockdown accentuated the lack of liquidity because of the reduced inflows from investors as well as the risk averse banks that stopped lending. On the other hand, the redemption volume heightened beyond the levels of sustainability. Moreover, these funds had direct exposure to high yielding and lower credit securities. In times of economic slump, there were no takers of low rated or unrated papers.
*Credit Funds are high risk high reward debt funds which invest in low credit securities that give high returns unlike the high rated corporate bonds that offer lower interest rates but are more secure.
What does it mean to Investors?
Investors can neither invest nor redeem the units in these debt fund plans as these are locked. Systematic Investment Plans (SIPs), Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs) have been stopped. You do not receive any dividend and your STP is stuck and you will have to rearrange for it if you want to continue investment in any Equity Fund. They have stated that as the markets revive which will take time, they will liquidate the underlying securities without any distress sale and pay off the investors/borrowers in a staggered manner. As the extent of the problem is unknown, it is unpredictable when normalcy will be restored.
At the same time, Equity, Hybrid and other Debt Funds will remain unaffected by this decision.
Will Investors get their Money?
The idea is when bond markets stabilise and the appetite for debt securities returns then the assets will be sold at reasonable value. Investors will be repaid proportionately and in installments if required. The borrowers will be paid before the investors. Also, as the fund schemes mature, the fundhouse will receive the proceeds from the issuer and then pay the unit holders.
This repayment will be done as per the maturity of the underlying scheme. If the Macaulay Duration (weighted average duration) is 1.2 years/438 days, then you may have to wait for about a year & 73 days. Similarly, you may have to wait for three years if the Macaulay Duration is of 3 years. There is possibility of early payments if markets settle down post the pandemic is controlled but there is no specific timeline.
Why are the Funds Winded Up?
According to Franklin Templeton President Sanjay Sapre, there was no other alternative left to protect investor’s value but through managed sale. The ongoing turmoil and unprecedented withdrawals led to selling of bonds at very low prices thereby eroding the underlying value of the funds’ portfolios. They even resorted to borrowing within permissible limits yet it grappled with the liquidity crunch. Thus, the only option left was to shut down these funds. Sapre states, “Quick and decisive action was very important at this juncture”.