2. Is there a systemic flaw? Yes, if you ask me, and, no, if you ask the mutual fund ecosystem, comprising fund companies, fund managers, distributors, advisors, and the regulator. The popular narrative of this group — broadcast by the media — is that the problem is mainly external (the havoc wrought by Covid-19) and partly internal (extra risk taken by Franklin). I am sure the fund does not accept the second. These arguments are specious. I argue that the problem is both with the fund industry and the product categories.
The fixed-income division, not just of Franklin but various mutual funds, has been trying to swing for the fences. MFs have been involved in all the major scandals over the past 18 months — Infrastructure Leasing & Financial Services, Zee/Essel, Dewan Housing Finance Ltd (DHFL), and YES Bank.
Some time ago, Franklin wrote off 100 per cent of its investment in a Vodafone paper. It had the highest exposure to the telco, at Rs 2,074 crore out of a total Rs 4,500 crore, which Vodafone owed the fund industry as a whole.
I had first exposed in Moneylife
how Wadhawan Global Capital (WGCL), the personal holding company of DHFL
promoters, raised Rs 2,125 crore through zero-coupon bonds from Aditya Birla MF and Franklin. Franklin had also lent to Rana Kapoor’s holding company YES Capital, which held 3.27 per cent of Kapoor’s YES Bank
stake, again through zero-coupon bonds. IDBI Mutual Fund put this highly risky product in its liquid fund, while Franklin India Debt Fund has put 8.27 per cent of its assets in these bonds. In all these cases, MFs acted as reckless lenders and not as prudent investors. Clearly, how debt funds
are being run is a systemic issue.
3. Is there a role for the regulator here? Yes. It can do two things. One, it needs to fix the accountability of credit-rating companies and fund companies by enforcing clauses that claw back the fees of all cases that blow up. Funds abdicate their responsibility to raters who have no accountability to them! This is perverse. Raters must be made accountable for ratings that blow up without warning.
Secondly, if Franklin is asked to put back into the fund the fees it has extracted from these six schemes, it (and all other fund houses) will certainly straighten up and take a close look at the rackets that its debt guys (supposed to be risk-averse people) are up to. It will regulate itself well. Two, the regulator needs to redo debt fund classification. While equity has 10 categories, debt has 16. We don’t need so many. Several, such as credit-risk funds and long-term debt funds, should not be sold to retail investors at all, but only to institutions.
4. Can this happen again? Yes, of course, it can, because the regulator has never touched the heart of the problem: The fund industry’s income is a percentage of funds it collects. This incentive makes asset-gathering its main objective, not its fiduciary role as a trustee of other people’s money. If their fees were somehow linked to returns and/or certain outcomes, there would be a change in their behaviour. But the Securities and Exchange Board of India (Sebi) is not even thinking of this.
5. What should investors do to avoid such accidents? Take a look at the funds named in the first para. I can bet even finance professionals can’t tell where such funds invest and their related risks. Debt investment is the specialised domain of a small group of finance professionals. Many investors I know don’t even understand that debt schemes are mislabelled as fixed-income schemes, which give investors the impression that they are similar to fixed deposits. In reality, many debt schemes have huge hidden risks.
The principle here is simple: Capital protection is paramount. Take your chances in equity, never in debt. So, say no to fixed-maturity plans, credit risk, and dynamic debt. You need only liquid schemes as a substitute for a savings account to park your money and, maybe short-term schemes. Of course, there is one more important step. You need to figure out which liquid and short-term debt scheme is okay. This is impossible for the average investor. Option two is to find an advisor you can trust. As you can see, even my bare-bones solution is not simple. That’s how hard Sebi and the fund ecosystem have made it for you.
The writer is the editor of www.moneylife.in