Franklin Templeton Asset Management (India) Pvt. Ltd on Monday, 28 June 2021, got a breather with the Securities Appellate Tribunal (SAT) staying the order granted by the Securities Exchange Board of India (SEBI). The order barred Franklin Templeton from launching debt schemes for two years.
The ban on Franklin Templeton by SEBI came after an investigation that showed the fund house has enacted serious violations and lapses in managing shut debt schemes. SEBI has further ordered Franklin Templeton to refund investment management and advisory fees together with the interest at the rate of 12 per cent per annum which amounts to Rs 512 Cr. Along with this, a penalty of Rs 5 Cr was also imposed on the asset management company. Franklin Templeton challenged the order by SEBI and stated that it disagreed with SEBI’s findings. In the provisional order, the SAT announced that the fund company should not be debarred from launching any debt schemes. Justifying the order by stating that Franklin Templeton was still managing 21 debt schemes and no complaints about those had come so far.
The story so far
The year when Covid-19 set foot in India, was not an easy year for the already weak economy of India. Not a single sector has remained untouched by the economic devastation it brought along. Markets appeared to be in fear as uncertainty crawled worldwide. The pandemic sent the markets all around the globe falling to levels not witnessed since 2008, the year of the Global Financial Crisis.
Franklin Templeton is India’s ninth-largest mutual fund company. On April 24, 2020, it announced that it was shutting down six debt schemes. Franklin India low duration fund, short term income plan, dynamic accrual fund, ultra-short bond fund, credit risk fund and income opportunities fund, are the schemes that the fund house decided to shut down. These schemes together had investor assets worth Rs 36,000 crore (approximately).
This is almost the same number as one fourth (a quarter) of the total assets managed by the company. The fund house’ such a decision was totally unexpected and unprecedented for India. The last time India saw a mutual fund was forced to wind up a scheme was due to legal and regulatory orders. In 2018, Sahara Mutual Fund was ordered by SEBI to wind up all its schemes. But, this time it is different. Franklin Templeton, which is among India’s top ten Mutual Fund companies, has voluntarily chosen to wind up the schemes.
Not only that, but side-by-side it also reduced the investments in six other schemes. These schemes were fund-of-funds and had investments in the schemes were shut by the company. A fund-of-funds (FOF) scheme is a pooled fund that invests in other funds. FOFs generally invest in other hedge funds or mutual funds.
These schemes which were shut down by Franklin Templeton, are debt schemes or debt funds. These debt funds also referred to as Fixed Income Funds or Bond Funds, these schemes invest in fixed income instruments. Corporate and Government Bonds, corporate debt securities, and money market securities among others are some of the fixed income instruments where the debt funds invest.
The few advantages of investing in a debt scheme are high stability, low-cost structure, stable returns and relatively high liquidity. Investors who aim for regular income always finds investing in debt funds as the best option. These funds are less volatile and less risky than equity funds- which were unlikely to be affected eventually. An equity fund is a mutual fund that invests directly in stocks.
So what did winding up mean for the investors? Putting in simple words, it implied that the investors who put their money into those six debt funds can no longer withdraw their cash based on the value of the asset. Their money was frozen. Franklin Templeton will try to get back the money invested in those schemes either by selling off the underlying assets (such as corporate bonds) or will wait for them to attain maturity when the companies will have to return the money owed.
Sanjay Sapre, president of Franklin Templeton’s Indian unit in a letter to the investors wrote: “Each scheme has its own maturity profile. These schemes will explore all possible ways to liquidate the underlying assets in the portfolio, without falling back on any distress sales. It will take all possible measures to return the investors’ money at the earliest possible time. The schemes aspire to return those monies in much advance of the maturity dates of the underlying assets.”
This incident forced investors to rethink further investing in mutual funds, which are mainly hyped because of their stability and low risk. But again, we should not forget the statutory disclaimer “mutual funds are subject to market risks. Please read the offer document carefully before investing.”
What happened with Franklin Templeton?
As reported by Bloomberg, all six schemes that were wound up was managed by Mr Santosh Kamath. He is a star fund manager (does an incredible job of raising assets and are the most effective single marketing tool used to draw in investors) and also the chief investment officer for fixed income in Franklin Templeton. He is well known for helping in creating a market for buying debt instruments that are ranked below the AAA rating, the most secure rating for any private debt. Thus Kamath’s funds would invest money into companies that did not possess as good of a rating for their debt as the top Indian companies. Consequently, they had to pay much greater interest rates to retrieve credit. These higher interest rates converted into greater returns for the investors who are willing to hold these instruments, even though they are at higher risk if the companies fail to pay in time.
In the past Kamath’s strategy had earlier paid off well, helping him defeat his competitors. Franklin Templeton’s Ultra-Short Bond Fund had delivered a 7.7 per cent annual return over 5 years, a masterstroke that helped him beat 80% of his peers. But this time, Mr Kamath’s strategy backfired spectacularly. Some of these investments were extremely risky (Mr Kamath loves embracing risky investments) and Mint reported that Franklin Templeton was the sole lender to 26 out of 88 market entities in its’ debt fund portfolio. This simply meant that, if they faced difficulties, the whole mutual fund house would consequently share the failure.
Bloomberg pointed out how Franklin Templeton held all the zero-coupon bonds of Yes Capital (run by Yes Bank co-founder Rana Kapoor), and how Yes Bank has fallen apart since then (was put together by the State Bank of India).
What exactly happened with the asset management company was that the investors started dissolving their money from these funds. This surge in withdrawing money was because they needed cash due to the havoc economic hit India has taken due to the abrupt nationwide lockdown and also because some of the investors were concerned about how the schemes would perform while the market was crashing. Franklin Templeton initially decided to pay back the investors’ money by borrowing funds. But the pressure to return was excessively high, making it impossible for the fund house to return the money. On top of that, the underlying assets of these schemes fell in the risky category, hence it was unlikely that there would be other takers for these assets. As a result, the company decided to wind up the six schemes, in the hope that those assets would gain back the value either by selling them or waiting for them to attain maturity.
Many analysts believe that this incident will not be limited to just Franklin Templeton. Investors have been retrieving money from various credit-risk funds. This move to wind up the schemes, has since 2020 prompted many others to withdraw their money out. Other fund houses have been trying to convince their customers that their debt schemes do not invest in risky assets like Franklin Templeton, but this has not helped in stopping investors from withdrawing their money.
Edited by Aishwarya Ingle