Who Is to Blame for the Franklin Templeton Fiasco?

May 11, 2020

Playing the blame game instead of focusing on solving problems is a common human tendency when faced with a crisis. The world is debating about who to point the finger at for the coronavirus crisis; in India some people are arguing over whom to blame for the (mis)handling of lockdown implementations.

Meanwhile, Franklin Templeton MF has found someone to affix blame for the debacle of its six debt schemes.

The backdrop story is, FTMF wound up six of its debt scheme on April 23 citing COVID-19 related market dislocation. Franklin's global chief, Jennifer Johnson, during a recent conference call with analysts partly blamed the winding up of six of its debt scheme on SEBI's October 2019 rule.

In October 2019, SEBI had asked mutual funds to cap their exposure to unlisted non-convertible debentures (NCDs) at 10% of the schemes' corpus. According to Johnson, the rule 'orphaned' one-third of their funds as these unlisted NCDs could not be traded after the circular.

However, the fund later clarified that Johnson's quote had been taken out of context by media outlets and issued an apology to SEBI for any unintentional slight this may have caused.

In my opinion, SEBI's rule cannot be blamed for the debacle of six schemes. In fact, the rule introduced in October was expected to bring in more transparency, liquidity, and accountability.

After the IL&FS default came to light in September 2018, which put the corporate bond market under pressure, SEBI reviewed the regulatory framework and took necessary steps to safeguard investors' interest.

SEBI found that unlisted securities lacked transparency in terms of structure and true nature of risk on the one hand and lack of ongoing disclosure in respect of financials of the issuer on the other. Therefore, SEBI decided to cap investment in unlisted NCDs.

Furthermore, SEBI had provided adequate timeline to comply with the investment limits. Exposure to unlisted NCDs had to be brought down to 15% by March 31, 2020 and 10% by June 2020. Additionally, it permitted mutual funds to grandfather the existing investments in unlisted debt instruments (as on the date of the circular) till maturity of such instruments, so as to not disrupt the market.

Image Source: photo created by pressfoto - www.freepik.com

In view of COVID-19 related disruptions these timeline were extended to Sept 30, 2020 and Dec 31, 2020, respectively.

The market regulator had taken the decision in the best interest of investors, but some fund houses took investors for granted. 'Despite the regulations being clear, some mutual fund schemes seem to have chosen to have high concentrations of high risk, unlisted, opaque, bespoke, structured debt securities with low credit ratings and seem to have chosen not to rebalance their portfolios even during the almost 12 months available to them so far', it said.

SEBI responded to FT's claims saying it should focus on returning the money of investors as soon as possible.

Who is to blame?

Though SEBI lays down the broader guideline for mutual funds, it does not micromanage. The final responsibility of risk management lies with the fund manager and the fund house.

The high-risk high-return strategy that benefitted the fund so far finally collapsed under the weight of COVID-19. FTMF had high exposure to lower rated securities in the six schemes that were wound up. Heightened redemptions amid virus outbreak brought in liquidity challenges for schemes with higher exposure to low rated instruments, thus crippling them.

Table: FTMF's high risk exposure in the wound-up schemes

Data as on April 23, 2020
(Source: FTMF, PersonalFN Research)

According to a media report, FT was the sole lender to 26 out of the 88 entities in its debt schemes' portfolio, some of which were lesser known companies.

Clearly, the fund manager went too far in search of higher yield without considering the negative implications it could have had. Hence, the blame for the collapse of schemes falls on the poor investment decisions of the fund.

The good news is that FTMF has started receiving repayments/prepayments from some of the companies. Sooner the fund repays its bank liabilities, the more quickly it will be able to start making payout to its investors.

[Read: Franklin Templeton Fiasco: Here Is When You Can Expect to Get the Money Back]

What should investors do?

AMFI has yet again assured investors that despite unprecedented redemption pressures mutual funds have carried out business as usual. It further stated that all mutual funds, barring one, have been able to manage day-to-day redemptions through orderly liquidation of portfolios because of acceptability of underlying securities in secondary market and measures taken by SEBI to deepen the debt market.

While SEBI has time and again stepped up to tighten measures, in this market environment, it would be preferable to invest in instruments issued by government and public sector enterprises, and stay away from those having high exposure to private issuers.

Before investing in debt funds understand the various risks involved and invest in schemes where the portfolio risk aligns with your own risk appetite and financial objective.

[Read: Make Mindful Choices of Mutual Fund investments in Current times]

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Warm Regards,
Divya Grover
Research Analyst

 

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