The sudden redemption pressure due to the following factors forced them to take the decision. So it was more of a liquidity issue rather than a credit risk problem.
- Post lock down in the month of March, debt markets turned extremely volatile and illiquid
- One day to 3-month rates spiked to astronomical highs
- There were only sellers and no buyers
- FPI pulling out from Debt and Equity markets aggravated the situation
- Advance tax outflows and year end redemptions created further pressures
- Retail borrowers have been given moratorium of 3 months on their dues but NBFCs from whom they have borrowed have not received the same consideration
- This stretched some of the weaker NBFCs, Manufacturing Companies, and many more post lifting of the Lock Down by the Government
- Economic activities were at a stand still
- Rating Agencies hands were tied behind their back in as much as they are not allowed to change their ratings for some of these weaker companies during this lock down period
- Post opening up, there was no certainty of how many companies will be downgraded or will delay or default on their borrowings
- All this had only put further pressure on Credit space going forward
- Most Fund Houses do not had as much exposure to Credit as FT , 10% redemption pressure in Rs 5,000 crore scheme v/s 10% redemption pressure on Rs.28,000 crores which can be as high as Rs 2,800-Rs 3,000 crores impact.
Post March 2020, RBI announced aggressive rate cuts and liquidity announcement measures and nudged banks to borrow in REPO at 4.40% and invest in 1-3 year-securities (under LTRO). Due to lack of risk appetite, transmission of rate cuts had not materialized. Nevertheless, the FT continued to get redemption pressures in all their Credit space schemes. Fund House had to resort to borrowing to meet redemptions or sell liquid assets due to mispricing of securities and illiquidity attached to the same due to Debt market situations.
Hence, FT had two choices going forward:
1) sell securities at any price and erode value for the Investors or
2) bide time by winding up these schemes and safeguard value at the cost of liquidity to the Investors.
FT has chosen the latter to safeguard interests of the Investors at the cost of delayed liquidity.
The Ministry of Finance engaged with SEBI and RBI to resolve the issue and avoid any further damage or creating a ripple effect to other AMC. Finally on 28th April RBI announced a special liquidity window of Rs.50000 Crore, which saved the day. Question remains whether a timely decision by RBI might have avoided the event.
How our investors were spared:
I don’t think any advisor/mutual fund distributor ever doubted Franklin’s intention on closure of the scheme, it was undoubtedly in the best interest of investors.
But the lock down, worsening situation due to covid and flow of negative news diluted the intention and resulted in disappointment and anger of investors.
As an advisor we were amongst lucky few to get our investors timely exit from 2 of the closed funds namely ultra-short and low duration funds. Decisions were purely driven by short term needs of the investor only. As both the funds were meant for short term needs, Uncertainty looming around, loss of salary or job due to lockdown or sudden medical requirement due to pandemic helped us to make timely decisions to exit the schemes. That is why it is in the benefit of investors to always link all investment to goals.
Another important aspect for us is that we have always shared the risk fund carries against the return it makes with investors upfront, not only once but repeatedly during personal meetings. So our investors were never doubtful despite of all the negative news flow of last year about getting back their money might be with some haircut. For us to not take exit call on this long term fund was on the premise that the situation would be much better at least in the next 1 year or maybe 2 years. Anyways funds were meant for a period of more than 3 years. Secondly if the credit situation worsens there might be defaults but on the risk reward scale it was prudent to remain invested as against FD considering YTM, taxation and exit loads of the fund.
Was Franklin responsible?
Undoubtedly Franklin is responsible for denying liquidity to investors when they were in need. But they compromised their credibility of 27 years of their existence in India just to safeguard investor’s interest.
Were advisors, MFD and investor’s not aware about the credit risk in the portfolio before investing? Portfolio was declared on a monthly basis and was clearly showing credit quality of funds.
I understand that investors do not read portfolios. But they must be aware of investing common sense that “Every extra point of return comes with extra risk”, which was evident from the yield of the fund providing 100-150 basis points higher than the peer group. But at that time everyone was ignoring risk and riding on returns.
Even timely liquidity by RBI might have helped avoiding the situation
Aggrieved investors knocked the door of the High court against the decision taken by Franklin, after the high court decision went to the Supreme Court. Luckily the case was fast tracked and the decision came finally in February. After taking investor consent for winding of the scheme, they started receiving funds. Almost 70% of funds received in ultra short and low duration fund, 36% credit Risk, 48% in Dynamic accrual, 21% in short term income and 7% income opportunities fund.
We are hopeful that by the end of this year majority of funds would be received by investors as they have not yet started active monetisation of schemes. Best part is the majority of prepayment received. till date are from lower or unrated papers and NAV’s are much higher than winding up date and returns better than any of the bank fds.
Investors tend to forget the basic rule of investing “Every Extra point of return comes with extra risk”, so whenever some of the fund or product is promising you some extra return, check for the risk involved. Invest only after understanding the risk, it will help you to cope up the risk when it actually comes.
Everyone wants to have little extra return in the present low interest and high inflation scenario. But try to diversify in different instruments and even within the same category in different cos., which will help to optimise returns.
In investment by adopting above steps we can minimise risk but can’t nullify it. Future is always going to be uncertain and keep throwing new surprises the way it did last year “there was no such history of winding up in Indian context and no one ever anticipated it.”
Is credit risk fund become a history? I don’t think so. We are lacking a robust debt market. It is undoubtedly one of the best categories for getting extra return in a fixed income space. After stricter due diligence in place this category has started seeing fresh inflows.
So luckily “All’s well that ends well” but lessons are for lifetime.
(The writer is a financial planner and co-founder of ABM Investment, Vadodara)