Franklin Templeton Mutual Fund Crisis Explained!
“Crisis and deadlocks when they occur have at least this advantage, that they force us to think” - Jawaharlal Nehru
Rightly quoted by Jawarharlal Nehru, the crisis does let us stop and pushes us to think. Well, the entire COVID-19 pandemic is having a similar effect on all our lives.
No business, no economic sector, no individual, has been spared from the effects of COVID-19. Akin is the situation of the mutual fund arena! As a result on April 23, 2020, Franklin Templeton Mutual Fund voluntarily announced to shut down 6 of its debt mutual funds.
But, why did it do so? How severe is the issue? What is the controversy all about? Let’s dive right in to understand all of it.
WHAT REALLY HAPPENED?
As mentioned above, on April 23 Franklin Templeton, one of the reputed names in the mutual fund business, announced to close 6 of its debt mutual fund schemes! You must know that Franklin Templeton has been an ace performer in Debt mutual funds but the step it took came as a surprise, rather a shock for everyone, especially the people who had invested in it.
The six of the debt mutual funds that it shut down included- Franklin India Ultra Short Term Fund, Franklin India Short Term Income Plan, Franklin India Credit Risk, Franklin India Dynamic Accrual Fund, Franklin India Low Duration Fund, Franklin India Income Opportunities Fund. The total corpus of these funds as on 20 April 2020 was around ₹2,450 crores.
While shutting down these credit funds, Franklin Templeton issued an official statement and laid out the rationale behind their decision. There were 2 reasons quoted by them, first the massive dip in the liquidity of the bond market and second the surging redemption amid the COVID-19 pandemic.
Although Franklin Templeton did issue an official statement while taking this step, many of us were clueless of what the actual issue was! How such a reputed mutual fund house ended up in this mess. No worries! We will decode this from scratch and will try to arrive at a more crisp and clear explanation of this fuss.
How Franklin Templeton and other fund houses operate-
To start with let us understand how fund houses really work in short. The mutual fund houses simply pool money from a handful of investors like you and me, then go on to invest that capital in certain stocks which offer a decent return. The stocks come in the scene if the pooled money gets invested in the Equity fund.
This is a common and known fact that markets are volatile and one can never really predict the recurring ups and downs. Thus, many investors opt for a safer path in order to skip the volatility of the stock market.
They knock the door of another type of mutual fund i.e. Debt mutual funds. Now, debt funds come with a perk that they are not subject to the market risks. The fund managers simply lend the pooled money to the government or corporates and in return, they agree to pay a certain amount of principal within a specified frame of time.
This deal is termed as a bond in the finance world. The specified frame of time is Maturity Period. And, finally, the return one incurs is termed as yield.
The agreement or the bond is mostly honoured by both the parties as there are legal consequences of not doing so. In any mutual fund house mainly two kinds of activities take place. On one hand, there are investors who redeem their funds once a bond has completed the maturity date and on the other hand, there are a fresh set of people looking to invest/pool their money with the mutual fund house. This helps the fund house to maintain a balance helping them to have some spare cash. And, this spare cash is put to use for completing the redeem requests of existing investors.
Apart from this, in order to skip any kind of unprecedented situation that might occur in future, the fund houses also separate a certain amount of investments made from people, in cash. But a point worth mentioning here is that this small portion set aside is not fixed. It is a speculative figure that is decided by the fund managers based on their estimations and experience.
Fund houses need to ensure a continuous supply of cash for smooth operations. This is why they tend to invest in bonds that have a range of maturity dates like 1 month, 2 months, so on and so forth. This enables cash inflow in every few days and they can use this as per their wish.
But, the crisis comes with no alarm!!
A crisis like COVID-19 made people question not only their investments but their decisions were clouded too. Soon after redemption requests started to build up with Franklin Templeton and it handled the situation calmly in the starting. At first, it turned its focus on its cash reserves and the bonds that were to mature in March and April. It used all this money to pay out the investors their fund. It also tried its hand in the open market hoping to sell certain bonds. Unfortunately due to cash crunch investors were not willing to invest in the highly risky bonds.
Franklin Templeton was stuck and nothing seemed to work. So, they stopped selling the bonds and started borrowing money. In short, they did it all to honour the flooding redeem requests of the investors. And with this, the fund house started to sink in debt.
Franklin Templeton holds a good reputation in managing risks. But how? It does this by lending the money to those institutions where the deal is risky but the yields are higher. But, the pandemic magnified all the risks in multi-folds. Remember, as mentioned above, the redemption requests were building in like a tornado! The balance of inflow and outflow of cash got disturbed. But, the deal was to be honoured and so were the redemption requests.
But, all the extreme measures got exhausted!
At last, it had to resort to the most drastic step! We all know what that was, closure of 6 debt funds, that means no inflow and no outflow!
The fund house has not yet given a clear statement as to when it will liquidate all its investment and pay back the investors their funds.
The investors might have to wait for long
If the fund house decides to wait for the debt securities of the closed debt funds to mature then it won’t certainly be a good idea, because most of the securities belonging to that 6 debt funds have a maturity period of 5 years and above. And, it will take months for the market to become normal. Although, the fund house has assured the investors that it will safeguard their invested funds.
Reserve Bank of India Stepped In
The mutual fund industry had been suffering since the onset of COVID-19 pandemic, more so after the case of Franklin Templeton. The problem was expanding like a balloon so the Reserve Bank of India had to jump in and look into the Mutual Fund crisis!
During the last week of April, it rolled out a credit line worth ₹50,000 crores and offered it to the mutual fund industry in India. The RBI realised that the uncertainty surrounding the mutual fund world would lead to extreme pressure on the good mutual funds. Thus, it had to take some measure to put a cork to the redemption pressure.
But, the entire Franklin Templeton case has been a sort of lesson for other fund houses teaching them not to always run after the higher returns, thus risking the hard-earned money of the investors!
To sum up, do not lose your faith in investment and mutual funds as they are beneficial! You just need to be attentive and be sure of your portfolio before putting in the money.