Franklin Templeton fiasco puts MF industry in damage-control mode

Industry executives fear this can exacerbate redemption pressure, and lead to forced sales of relatively good-quality papers or trigger borrowing
The crisis in Franklin Templeton Mutual Fund has put the Rs 22-trillion mutual fund (MF) industry in damage-control mode, with large fund houses trying to allay investor concerns on the risk profile of their schemes and discouraging them from taking hasty decisions to redeem their investments.

Industry executives fear this can exacerbate redemption pressure, and lead to forced sales of relatively good-quality papers or trigger borrowing.

In a surprise move, Franklin, among India’s leading fund houses, on Thursday announced closing six of its schemes with net assets of Rs 25,000 crore. 

The fund house cited illiquid bond markets and heavy redemption as triggers behind the move. Fearing a spillover impact, leading industry players sprang into action to assuage concerns of investors, distributors, and the markets.

“The Franklin Templeton issue can lead to negative perceptions about the risk profile of debt schemes and trigger panic redemptions, which will be difficult to handle in the current environment due to the liquidity squeeze,” said the chief executive of a fund house.

MF players said if the Reserve Bank of India (RBI) could enable committed liquidity lines for them, it would help tide over the current problems. The central bank in 2008 and 2013 had opened a special window to provide banks with funds to support MFs.

 

 
“Banks need to help in making sure that the liquidity through the targeted long-term repo operations percolates down the credit curve, and is not limited to highest-rated debt papers,” said A Balasubramanian, managing director and chief executive officer of Birla Sun Life MF.

 
The current risk-aversion in the system has made it difficult for market participants to do trades in lower-rated papers, with the AAA-rated papers, the highest, absorbing the bulk of the liquidity the Reserve Bank of India and commercial banks are infusing. On several occasions, MFs have run into rough weather on account of their exposure to companies, particularly those highly indebted.

The virtual shutdown of the economy to contain Covid-19 has increased the pain points. 

According to the data from Value Research, credit-risk funds are most vulnerable to lack of liquidity in lower-rated papers, with three-fourths of the assets exposed to AA-plus and below-rated papers.

This also includes some exposure in unrated debt instruments.
“Every fund house has products with their credit and liquidity profile. Retail investors should not panic because this is a one-off incident. We believe most of the industry is well-positioned to deal with the challenges,” said Milind Barve, managing director at HDFC MF, the country’s second-largest fund house.

While the entire product suite is not in trouble, experts say investors need to look at their fund portfolios case by case.

“It is not just credit-risk funds but also some duration funds such as ultra-short-duration and short-duration funds that can have credit risks in lower rated-papers. So, investors need to be wary of this,” said Vidya Bala, co-founder of primeinvestor.in.

“Look at the issuers of AA-rated papers — whether the bond is issued by a well-known company or well-backed business group. A more prominent company or a group name is likely to be a relatively safe investment,” Bala added.

The Value Research data showed that ultra-short-duration funds had close to 30 per cent of their exposure to papers AA-plus and below. Among other duration categories, low duration accounts for 18 per cent exposure to such papers.

In March, net outflows in debt MFs were Rs 1.9 trillion. To honour some of these redemptions, fund houses had to borrow, with several schemes nearing the 20 per cent cap on such borrowing.

Industry players said the borrowing levels had come down.

“We have got feedback from most fund houses and they have confirmed that they have zero borrowing at present,” said Nilesh Shah, managing director of Kotak MF and chairman of the Association of Mutual Funds in India.

Franklin said it had no option but to close down its credit funds because redemptions were forcing it to sell papers at unattractive rates. 

Expert say the industry could be walking a tightrope. 

“If redemptions continue and the liquidity situation doesn’t improve, even the healthier schemes may have to brace for an impact,” said a fund manager, hinting that his outfit would be forced to sell its holdings at high-impact costs.



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