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'Blanket withdrawal is not a good strategy'

April 30, 2020 09:12 IST

'Investors should restrict themselves to a few category schemes with high quality portfolios apart from overnight and liquid funds.'

When Franklin Templeton announced last Thursday, April 23, that it was shutting down six of its credit strategy-oriented debt mutual fund schemes -- Franklin India Credit Risk Fund, Franklin India Ultra Short Bond Fund, Franklin India Low Duration Fund, Franklin India Short Term Income Fund, Franklin India Income Opportunities Fund and Franklin India Dynamic Accrual Fund -- mutual fund investors went into a tizzy fearing for their investments.

While the long-term impact of this sudden closure of six debt mutual funds worth about Rs 28,000 crore will play out in the time to come, for the time being investors in these funds won't be able to redeem their investments.

Omkeshwar Singh, head of RankMF, Samco Securities, explains to Prasanna D Zore/Rediff.com what debt mutual funds are all about, the Franklin Templeton fiasco, the hope for those invested into these funds, the impact this closure will have on investors sentiments and offers advice for mutual funds investors.

What is a debt mutual fund and how does it work? How safe are these debt mutual funds?

Debt mutual funds pool money from investors and then lend money to issuing entities for generating interest income and capital appreciation.

Debt mutual funds are positioned to provide better returns with high liquidity for its investors.

Debt funds are mutual funds that invest in debt instruments like Commercial Papers (CPs), Corporate Bonds, Non-Convertible Debentures (NCDs), money market instruments like treasury bills (or government bonds), repurchase agreements, Certificate of Deposit (CDs), and banker's acceptance.

There are 16 different categories of debt mutual funds in India with various degree of credit risk and duration risk.

The safety of the debt fund is completely dependent upon the quality of debt instruments that it holds in the portfolio.

Investment in mutual funds are subject to market risk. This is not just limited to equity mutual funds, but to all mutual funds schemes across categories including debt funds.

Fund managers have to find optimally trade-off between credit risk and duration risk vis-a-vis yield to maturity (YTM), that is, risk-return trade-off.

What kind of investors usually invest in debt MFs and why?

Investments in debt mutual funds are dominated by corporates and HNIs; institutional investors dominate liquid and money market schemes (84%), debt oriented schemes (56%).

Since current accounts earn no interest, institutional investors invest short term surplus funds in debt mutual funds to generate returns on idle funds available with them including working capital and redeem as per their cash flow requirement.

What are credit strategy-oriented debt MFs and why has Franklin Templeton closed six of its debt MFs belonging to this category?

As the name goes, credit strategy-oriented debt mutual funds are open-ended debt schemes that invest substantial portion of funds in lower-rated debt instruments including unlisted debt instruments.

The returns are superior and so are the risks for these strategies; disproportionate risk has cascading downward spiral as liquidity is very low for such instruments and default risk is higher.

There has been constant redemption pressure in debt funds from March 2020 and post COVID-19 lockdown the situation aggravated as most of the corporates redeemed these debt funds to meet their cash requirements.

The continuous redemption pressure coupled with absence of liquidity of credit risk debt instruments of these six schemes of Franklin Templeton, the AMC was not able to fund these redemptions on a sustainable basis and therefore winded up six schemes under redemption pressure.

Now as and when the money is realised, the same will be credited to unit holders.

Investors have no choice but to wait till liquidity gets back into the lower end of the system as and when the lockdown is over and economic activities begin.

Only then the AMC will be able to pay back the realisable money.

What went wrong with these six debt MFs? Are there any chances that Franklin Templeton AMC will revive these schemes?
Does Franklin Templeton run other such debt MFs and what would be your advice to investors invested in these MFs?

All these six schemes had substantial portion of funds invested in lower-rated debt instruments including unlisted debt instruments.

The liquidity dried up due to COVID-19 lockdown and there were no takers of these lower-rated debt instruments and the continuous redemption pressure on these funds completely dried up any funds for the AMC to pay for redemption.

Therefore, these six schemes were wound up.

The likelihood of revival of these six funds is very bleak; the trust and sentiments of investors have been badly hit as Rs 28,000 crores has got stuck.

Presently, these six schemes have got highlighted, but investors must sanitise their (debt) portfolio and must evaluate the quality and strength of the mutual fund's holdings and act accordingly.

What happens to investors's money who had bought these debt MFs?
Should investors withdraw money from FT debt MFs in particular and debt MF schemes of other AMCs?

Investors cannot redeem the units in these 6 schemes, and they have no choice but to wait so that the liquidity gets back to the lower end of the system as and when the lockdown is over and economic activities starts and returns to normalcy, only then the AMC will pay back the realisable money.

Blanket withdrawal is not a good strategy. Instead, investors must evaluate and review their portfolio and seek professional advice accordingly.

What kind of impact can the closure of these six Franklin Templeton debt MFs have on investors's psyche about investing in mutual funds in general and debt MFs in particular?

There is loss of trust in the short term.

Safety first will take over returns to protect the capital.

There will be flight of funds towards safer investments.

Earlier, only corporates were taking out money for cash management. Now, high networth individuals and retail investors will go for panic redemptions.

It's only when the lockdown is lifted and normalcy comes into debt markets towards the lower end of credit MFs, then only we can see easing of pressure on mutual funds with risky debt holdings.

Your advice to MF investors...

Investors should be prudent while investing in debt funds and always look only for the quality of the portfolio.

They should completely ignore past performance, big names and big brands while making investments decisions.

Investors should restrict themselves to a few category schemes with high quality portfolios apart from overnight and liquid funds, that is:

  • Money market funds for investment up to one year
  • Short-duration funds for investment from 1 to 3 years
  • Corporate bond funds of any duration
  • PSU and banking funds  of any duration
  • Gilt funds: Short to medium term duration

Photograph: Arko Dutta/Reuters. Kindly note the image has been posted only for representational reasons.

PRASANNA D ZORE