COVID-19 has created a first big impact in the Debt mutual funds space. Franklin Templeton had announced a closure of 6 of its debt funds. The closed funds are below:
Franklin India Low Duration Fund
Franklin India Ultra Short Bond Fund
Franklin India Short Term Income Plan
Franklin India Credit Risk Fund
Franklin India Dynamic Accrual Fund
Franklin India Income Opportunities Fund
An investor cannot redeem any of the units from the date of closure. The official notification from the AMC is here. Franklin is one of the top 5 AMCs in India. The funds which are closed had a combined AUM of over 30,000 Crores. This closure will lock investments which were expected to be liquid and available for immediate requirements. Whether is a moratorium of banks or closure of mutual funds, it is the small investor who is left to fend for himself/herself.
What is the reason for the AMC to close these funds?
These funds have been holding securities which are not the best rated. The funds have had a history of chasing higher yields at the cost of quality. Thus far there have been a few down grades and defaults which have hit them in the past. The most notable one being Vodafone Idea limited securities which were downgraded by credit rating agencies in January. There has been no recent default or downgrade event. The funds have been losing the confidence of investors over the past few months. This is clearly visible in the declining AUM of the funds. Below table and chart show this decline
When redemption pressure hits a fund, the securities need to be liquidated. However, several of the securities held by these funds were poor credit quality and not readily trade able. If the AMC had gone ahead with a distress sale, the NAV of the funds would have got hit drastically.
The March 2020 factsheet shows that funds had negative cash holding which are basically overdraft. The negative position was between -4% and -17%. As per SEBI rules, Mutual funds can have borrowings upto 20%. It seems these rules were either breached or likely to be breached due to constant redemption by investors. So, it appears that the Fund managements had no choice but to approach the fund Trustees and they have decided to close the funds for investors on the end of day of 23rd April 2020.
When can I get back my money?
The official communication from the AMC says ” The Trustee or the person(s) authorised by it will continue to realise and / or dispose-off the assets of the Schemes in the best interest of the Unit holder(s). The sale proceeds after discharge of all liabilities and expenses will be paid to the Unit holder(s) in proportion to their respective interests in the assets of Schemes. “
Some of the holdings which mature this year could be paid out to investors as and when the money is received by the AMC. However since some of the securities will be maturing in the next few years, one needs to wait and watch.
The factsheet of March can be found here here. The securities holdings and the percentage is available as well.
Moral of the Story
Debt funds which take on credit risk are to be avoided by investors. It is better to invest safely in Fixed deposits of safe banks and safe debt fund categories such as Overnight and liquid.