View: Just Unlucky! Why the Franklin fiasco should not be allowed to affect India Inc credit flow

This is probably going to the biggest negative fallout of the Franklin fiasco. Inflows into credit funds and duration funds are going to dry up, funds may not have it in them to support low-rated corporates till liquidity and semblance of normalcy...

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As if the Covid-19-induced disruption was not enough, Indian debt market investors were dealt a stunning blow last Thursday when savvy investor and marquee fund house Franklin Templeton suspended operations of six of its debt funds. Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund will shut doors and investors will not be able to withdraw, invest or redeem their funds. SIPs will be stopped while money under the systematic transfer plan will be stuck.

This is an unprecedented development in Indian capital markets. No major fund house has shut its funds so abruptly and so dramatically. The decision has sent shockwaves and fears that other debt funds would also have to do something similar have rattled investors. The regulators have swung into action and it is anybody’s guess as to how things will pan out from here. It is possible that Franklin will be an isolated case and it is also possible that the Reserve Bank of India will step in and ask banks to provide liquidity to mutual funds.

Quite naturally, the implosion at Franklin has focused much attention on the investing methods of its savvy debt fund manager Santosh Kamath. He drove much of Franklin’s investment into attractive high yielding debt securities thereby creating a market for low-rated companies to raise money. Debt investors, unwilling to keep their money in the bank and desirous of earning a higher return flocked to his funds unmindful of the risk of double A and single A papers as long as they earned more. It is said that Kamath’s risk appetite drives the funds into the quagmire that they are in. It is also said that his chase for yield made him ignore risks and that he became reckless investing in papers of poor quality.


The fund manager’s risk appetite is not under dispute here. A quick glance at the portfolios of all six debt funds that were suspended would show that there is not a single investment in a triple A security. Most securities are either double A+ or lower. Most are just double A. Kamath didn't just chase yield. He embraced it and made it a part of his investing life.

But what should be disputed and questioned certainly is whether such a risk appetite was unnatural, irregular, unhealthy and plain reckless. A debt fund investor is not just there to protect and safeguard your money. His primary job is to grow it, multiply it and give you, the investor, higher returns. Obviously, you can't do enough of that by just investing in government bonds or triple A paper so you chase something extra.

In this case, the extra was all about a Shriram Transport Finance security maturing in 2024 and yielding 10.25%, a Tata Motors debenture maturing in 2023 and yielding 9.31% and single A debenture of India Shelter Finance Corporation maturing in 2026 and yielding 11.25%. All these are among the top five holdings of the Rs 3,119 crore Franklin India Dynamic Accrual Fund which was shut down last week. The portfolio of the other five funds are also broadly similar.
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It must be remembered that Franklin’s problems did not stem from default or collapse of any of its investments. None of its investee companies have failed to pay. Rather, a health pandemic of epic proportions and unimaginable ferocity which has shut down much of the civilized world’s economic and social life has caused this problem.

Lakshmi Iyer of Kotak Mahindra Asset Management made an important point the other day. She told BloombergQuint that the most important issue facing corporate bonds right now is liquidity and not credit risk. She added that a company without a high rating and suffering due to liquidity issues may still have a sound business. A drying up of liquidity certainly appears to have forced the issue for Franklin. Flight to safety in debt markets obviously means triple A bonds or G-secs and a fund which has sufficient stock of these in its portfolio would have been able to ride out the storm. But Franklin, as we saw above, did not have that luxury.

Redemptions are not new in mutual fund business and can be handled through new infusions or sale of securities. The former was not possible in today’s market circumstances and the latter became unviable due to volatility and jump in prices. A stray sale of the paper of a troubled housing finance firm in October 2018 by DSP led to one of the biggest market crashes in recent history but Franklin decided it would not venture down that road in these troubled times. Shutting down not one but six major funds is an unimaginably brave decision. It will cost Franklin no doubt and a brand that has taken years to build has been dented severely. But debt investors are a forgiving lot. They may come back once the storm has passed and the clouds of risk-aversion are driven away to reveal sunny climes and a blue horizon.

Franklin has much to fight for and much to feel good about. A strong equity business and the rest of the debt business will perhaps not be affected too much by the debt funds debacle. It certainly made an impact in the market for high-yield, low-rated corporate paper, in the process, helping several companies shut out of the banking system for various reasons, raising money.
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This is probably going to the biggest negative fallout of the Franklin fiasco. Inflows into credit funds and duration funds are going to dry up, funds may not have it in them to support low-rated corporates till liquidity and semblance of normalcy returns. Faith, confidence, trust are the bedrock of the financial system. Once eroded they are difficult to reacquire. With banks unable or unwilling to lend below triple A, mutual funds scarred by Franklin, India Inc’s second and third tier corporates may once again feel the chill winds of a credit freeze.

These are independent views of the author

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