Franklin Templeton – Winding up of 6 debt schemes – Do investors vote a “Yes” or a “ No” – Does the vote lead to Panic redemptions or an orderly exit?
Background:
What are Debt or Fixed Income Investments?
Debt or Fixed Income investments are an essential part of Asset Allocation for an investor. Traditionally corporates or risk-averse investors prefer debt investments as they provide higher capital protection along with stability of returns. In India, fixed income investment includes the preferred Bank Fixed Deposits (FDs), LIC, PPF, Corporate deposits, debentures, bonds, debt mutual funds, etc.
To put it in perspective – in the world, there are more debt or fixed-income investments than equity investments – even in the listed space. For Eg BlackRock – the world’s largest asset management company -manages more of fixed income assets than equity assets.
Historical Background – Fixed income crisis
In the mid-1990’s we had the CRB scam – a corporate fixed deposit default (a corporate fixed deposit is in fact an unsecured deposit/creditor of the company should the company go into liquidation). This in turn spooked the trust of investors who used to invest in corporate fixed deposits blindly for higher returns as compared to fixed deposits. Later some other well-known companies (well known at that time) too defaulted on repayment to investors.
US (Unit Scheme) 64 scam – Oct 1998 – Unit scheme 1964 (US 64) was a scheme in existence promoted by Unit Trust of India (UTI)and having a government backing. It was in existence since 1964 and regarded as a fixed guaranteed return investment by investors as year on year they paid a fixed rate of return to investors, without fail, in the form of a yearly dividend. But in fact, this scheme was structured more like a Monthly income plan (MIP) and had exposure to equities and some low investment-grade bonds and thus at that point of time had some defaults/losses and was unable to pay the returns/capital back to the investors and had to be closed permanently and investors got some assured bonds as a way of repayment at a much lower rate – the payment being spread over many years -causing a heartache to small investors.
Collective income schemes and plantation schemes: In the 1990’s we also had many plantation companies which collected thousands of crores from investors and promised them lucrative returns, even in the range of 18-24% per annum. These schemes suffered a similar fate of not returning the investors money. We can also add the ongoing turmoil of Sahara India and Pearl Agro investors in this list.
Entry of Debt mutual funds-which seemed a panacea
In all this mayhem in the late 1990’s – a trend emerged which seemed the panacea (remedy) for all the misfortunes of fixed income investors – debt mutual funds which promised investors -Safety of Capital, Steady Returns, Liquidity, and a higher post-tax return as compared to other traditional debt instruments.
For the past 25 years or more this held true as debt mutual funds delivered on this promise year on year and was perceived by investors as a much superior and tax-efficient way of investing in debt or fixed income instruments.
Background – Franklin Templeton :
Franklin Templeton is one of the world’s largest independent, specialized global investment managers with a combined $1.5 trillion in assets under management (AUM). In India, in the year 2002, they successfully acquired Kothari Pioneer Mutual Fund – the first private sector mutual fund established in India in 1993 with successful schemes like Kothari Pioneer Bluechip Fund, Kothari Pioneer Infotech Fund, Kothari Pioneer Prima Fund, etc
In Fixed income investing – Franklin Templeton gave a higher yield or return on investments, had a consistent track record and it was well known that to generate higher returns they had a higher proportion invested in AA or A-rated securities but were able to manage the risk efficiently and for the past 20 years or more this playbook worked wonderfully, without any hitch, for the Fund House and the investors.
Year 2020 – Covid crisis -Watershed year for Debt Mutual Funds
In the run-up to year 2020, we had deteriorating macro conditions and a slowing economy which led to a series of downgrades and defaults of debt paper -for eg like IL&FS, DHFL, etc, and general illiquidity in the debt markets for lower-rated paper.
The onset of Covid triggered a series of unfortunate events in a slowing economy and led to a virtual credit freeze in the last week of March. Investors – spooked by these events – started withdrawing their debt investments – especially from funds which they perceived held less liquid paper.
This in turn led to a run on 6 debt schemes of Franklin Templeton which accentuated the rather unfortunate closing down, post 23rd April 2020, of these 6 schemes and now the investors are at the cross roads of voting Yes or No to the winding-up process in order to get their money back. The voting process is mainly from 9 am on 26th Dec 2020 to 6 pm on 28th Dec 2020 and the voting result will be given in a sealed cover to the Hon’ble Supreme Court.
Factors which need to be considered by the investors before making the crucial voting decision :
- Panic Redemptions if the vote is a “NO”: If investors predominately vote “NO” to the winding-up process – that essentially would open up the schemes for redemptions. As is perceived by a majority of market analysts – this could, in turn, lead to huge redemptions and the securities would in all probability have to be sold at a discount as the market is largely illiquid for such securities at present. This, in turn, could lead to a haircut or losses in the NAV (Net asset value) for which at this point of time no estimation can be made but the fact cannot be denied that in all probability there would be a permanent loss to the unit holders, which goes against the interests of the unit holders or investors.
- Fire sale or distressed sale of assets (debt securities): In case of a “No” vote then the Fire sale or distress sale of debt securities in a COVID economy and general illiquidity in lesser rated securities would not result in a fair price realization for investors and even pose a threat to the overall health of the corporate bond market in general.
- Track record of Franklin Templeton to recover part of the money :
When the 6 schemes closed down on 23rd April 2020 the amount outstanding in the schemes was close to 28500 crs with short-term borrowings -which needed to be repaid -over Rs 3500 crs . So in net around 25000 crs were owed to the investors of the scheme. A very short period of 8 months has elapsed since then and Franklin Templeton has not been able to try to effectively monetize all the assets, with the intervening situation of a COVID economy and pending the investor winding up vote. But still, an amount of Rs 11907 crs has been recovered from repayments and coupon (interest) payment since 24th April 2020. This recovery of 11907 crs consists majorly from lower-rated A or AA paper which in itself is a major positive in the current market environment. After repayment cash available for distribution stands at Rs 7488 crs for 4 of the cash positive schemes.
4. Borrowing levels of schemes: Around 3500 crs of borrowings have been repaid and 4 schemes are cash positive . 2 of the schemes holding longer-dated paper - Franklin India Short Term which had a borrowing level of nearly 30% in April is now down to only 1% borrowing levels and Franklin India Income Opportunities Fund which had close to 35
% borrowing level is now down to around 16% of the current AUM.
5. Cash positive schemes: The 4 cash positive schemes have 7488 crs .The Fund House has indicated that post a “Yes” vote they can immediately return the said cash to unitholders of the schemes – namely Franklin India Low Duration- 49% of the NAV or net assets, Franklin India Ultra Short Bond Fund -48% of the NAV, Franklin India Dynamic Accrual Fund- 34% of NAV and Franklin India Credit Risk Fund -16% of the NAV.
6. Vodafone Idea segregated asset recovery – June,July & September 2020: Vodafone Idea debt paper July 2020 and September 2021 was held by many of the closed debt schemes of FT. This asset was segregated on 24th Jan 2020 and units were allotted to unitholders on that date and even unit holders who exited between 24th Jan -23rd April 2020 had a proportionate claim for any recovery. Close to 1500 crs was recovered by FT in June, July 2020, and September 2020 for principal and interest recovery from Vodafone Idea and paid to all unitholders of segregated assets including unitholders of the closed debt schemes which has not been accounted for in the amount recovered. Secondly, schemes like Franklin Ultra Short Bond Fund recovered nearly 5% of the NAV which is not included in Fund % Returns or repayments. Thirdly and lastly – if Vodafone Idea survives then in Sept 2021 unitholders – especially in Franklin India Short Term Income and Franklin India Income Opportunities Fund can recover up to 3-4% of the NAV.
7. Future Retail recovery: The exposure to group companies of Future Retail has been written down to zero as the said securities defaulted or were downgraded to D rating . The exposure to Future Retail companies is more than 10% of NAV in Franklin India Income Opportunities Fund, 8-9% in Franklin India Short Term Fund, around 5-6% in Franklin Credit risk fund, and Franklin India Dynamic Accrual Fund. Reliance Ind has closed a deal to acquire the Future Group and in all probability recovery of this asset could happen, subject to the ongoing dispute resolution by Amazon or order by the courts. In case of a “Yes” vote, in due course, if this asset,which is not a segregated asset is recovered the unitholders will receive the proceeds and in case of a “No” vote recovery of this asset could be ambiguous if the unitholders have exited.
8. Fund performance(current) and YTM (yield to maturity) :
Note: As given in the preceding paragraphs the Vodafone Idea recovery has not been added to the returns and the hit on account of Future Retail downgrade/default has been taken into account.
Procedure for E-Voting and Unit Holders meeting :
As the Voting dates closer, here is the “How To” video on E-Voting and Unitholders meeting.
Click here to watch the video - https://youtu.be/MSaNVsofJbQ
For queries related to the User ID and Password for the e-voting and unitholders meet please call 18003454001.
A word of caution on the E-Voting process: The unitholders can vote from 9.00 am on 26th Dec 2020 to 6 pm on 28th Dec 2020 and during the Video conference hour on 29th Dec 2020. But please note that the Video Conference hour will have a limited number of participants capability and it is in the best interests of unitholders to vote in advance and not wait for the Video Conference to cast their valid vote.
Conclusion – Whether to vote “Yes” or “No” during the E-voting process: This is the choice of each individual investor – whether he wishes to vote “YES” or “NO” to the winding-up process. Post a “Yes” vote a further voting to appoint the authority for realization of assets in an orderly and efficient manner to best realize the fair valuation of assets would be undertaken. A “No” vote could have the potential to open the schemes for redemptions and it is perceived by many learned market analysts that this could lead to a situation of Panic redemptions which will result in a fire sale of the assets at distressed valuations – thus causing a loss to the investors.
Still, the above article cannot be construed as advice to the investors – investors are well-advised to read all the matter and facts before making any decision and also consult their advisors or distributors for any further course of action.
Disclaimer: No responsibility is taken for any error or any inadvertent mistake in the data by the author or the website. The above article does not constitute a solicitation for investment and is for knowledge purpose only, based on information available in the public domain and from the Fund house itself.
Mutual Fund investments are subject to market risks and past performance is not an indicator of future returns.