Should you remain invested in FT schemes? | Economic Times

The Franklin Templeton (FT) saga continues to develop new twists. What began as a liquidity squeeze forcing the fund house to wind up six debt funds about a year ago has now spilled into the realm of foreign policy. Last month, Economic Times reported that the asset manager’s US-based parent has engaged diplomatic channels to rein in Indian authorities from taking a harsh stance on the matter. The asset manager even dropped a subtle hint of a walkout in case of adverse regulatory actions. A few days later, FT’s Indian management reiterated its commitment to the domestic business. Yet, the spectre of a pullout by the fund house now hangs over nervous investors.This new development has implications for investors beyond the six troubled funds. One of the earliest players in the business, FT had established a reputation for bringing in foreign best practices to wealth management in India. It was considered the gold standard in fiduciary responsibilities. But the handling of its debt schemes has eroded the trust of many investors. Investors who have nearly Rs 78,000 crore in its schemes face an anxious wait to see how this story plays out. Should you wait for events to take their own course or should you withdraw your money right away? If the fund house soldiers on, should investors repose faith in its ability to create wealth like it has done for so many years?What if Franklin shuts shop?If you are worried about your money lying with the fund house, do not fret. Your money is safe and held in a trust in the name of individual investors. The AMC only manages the money in exchange for a fee. If a fund house shuts shop and closes down all its schemes, it must offer an exit to investors at the prevailing NAV.Even so, a forced exit for investors would entail certain risks. First is the likely incidence of tax on any capital gains realised on the investment proceeds. The extent of your tax liability would depend on when you had invested in the schemes. Another negative of a forced exit is the prospect of reinvestment risk. The money investors get back will have to be redeployed somewhere. But with prevailing low-interest rates environment and lofty equity valuations, the opportunities are scarce.Other more likely possibility is that another fund house buys out the troubled entity and absorbs its existing schemes. There have been several instances of such takeovers in the past. The most notable takeover over the past decade was L&T Mutual Fund’s acquisition of Fidelity’s schemes in 2012. Morgan Stanley, Daiwa, Pinebridge, ING, Goldman Sachs and JP Morgan are among other foreign fund houses that left Indian shores.Several foreign asset managers have quit in recent pastIndian AMCs have acquired the assets, either merging with own existing schemes or running separately. 82002171However, with strict new rules permitting asset managers to run only one scheme per category, an acquisition by an established large player can be tricky. FT runs a full suite of funds, each sporting a sizeable asset base that cannot simply be absorbed into existing funds. As such, only a new entrant with deep pockets and running empty shelves will be in a position to take command of FT’s product suite. Whichever fund house takes over FT, investors will be given a month’s window to pull out their money if they wish to do so.Should you wait or exit?Unlike most other foreign fund houses who have had short stints in India, FT boasts a 25-year track record with a solid foundation. Yet, experts reckon it will be a long road back for the beleaguered fund house to regaining investors’ faith. Vidya Bala, Head – Research, Primeinvestor.in, argues, “Though FT has remained entrenched in the Indian markets, a blip in its asset growth or adverse findings or penalties could well prompt a rethink.”Many believe it is time for investors to move on. Ankur Maheshwari, CEO, Wealth Management, Equirus Capital, feels recent developments have added a degree of uncertainty in the minds of both investors and advisers. Bala says, “For the debt funds where the credit risks were high, we had long ago issued a ‘reduce’ call even before the funds were closed down. Now, we have issued a ‘sell’ call on all the open-ended funds of FT.”FT lost big chunk of fixed income AUM, but equity funds largely unaffectedThe sudden winding up of six debt funds put off investors from FT’s fixed income offerings. However, investors have retained faith in its equity funds. 82002394With investors’ faith shaken, experts suggest monitoring individual fund portfolios and AUM in the coming months. Arun Kumar, Head – Research, FundsIndia, cautions, “Keep tabs on the AUM of individual funds. If there are sudden outflows due to panic selling, it is a red flag.” Flight of assets could particularly pose acute problems for the fund house’s other open-ended debt funds. “A fall in AUM can lead to concentrated exposure and enhance a debt scheme’s risk profile even if the holdings are top-rated,” Bala observes. Further, check for erosion in liquidity in the fund portfolios, even on the equity side. While large-cap and flexi-cap funds will not face much problems, mid and small-cap funds are vulnerable to a dip in liquidity.Other debt funds also face pressureAUM fall can lead to concentrated exposure and enhance a fund’s risk profile. 82002408Fixed income troublesThe sudden closure of six debt schemes in April 2020 led to widespread anger among investors. “Being able to pull out your money at any time is the fundamental promise that an open-ended mutual fund gives its investors, and we feel that violating this promise is the worst thing a fund house can do,” asserts Bala. FT in defence of its actions has regularly cited ‘severe market dislocations’ induced by the pandemic. It argues that the inability of the schemes to meet daily redemptions was a direct result of the then prevailing market situation.Timeline of the Franklin Templeton fiasco202023 APR: Franklin Templeton Mutual Fund announces winding up of six schemes.28 MAY: Various investors file petitions in High Courts in different states and in Supreme Court against FT’s decision.3 JUN: Sebi orders special audit and hires a forensic audit firm to inspect the dealings of the six schemes.10 SEP: FT assures investors that barring issues in payment by some issuers like Future Group, Essel and ADAG group, all other companies have made payments as scheduled since the six schemes were closed.6 OCT: Forensic audit reveals several lapses in dealings of six schemes. Report highlights that key personnel redeemed their investments right before closure was announced. Also, the AMC favoured certain companies by not exercising the put option even though suggested by the risk management committee. The report also indicated heavy investments in unlisted securities, which were mainly illiquid and some of them newly incorporated.24 OCT: Karnataka High Court rules that FT should have sought unitholders’ consent before winding up. Court restrains trustees from taking further action till unitholders give consent.3 DEC: Responding to a petition by Franklin Templeton challenging Karnataka High Court’s verdict, Supreme Court allows trustees to hold unitholders meeting for approval in the winding up process. 26-29 Dec: Trustees conduct e-voting followed by a unitholder meet.202118 JAN: E-voting results announced. Over 96% of unitholders vote in favour of orderly winding-up across six schemes.2 FEB: Supreme Court directs the cash available with the six schemes to be distributed amongst the unitholders in proportion to their holdings. SBI Mutual Fund assigned to carry out this exercise.12 FEB: Supreme Court upholds validity of e-voting process and directs that the recovered money can be distributed to unitholders in tranches without waiting for liquidation of all the securities.15 FEB: SBI Mutual Fund pays out Rs 9,122 crore from cash available for distribution. FT tells investors that NAVs of all the six schemes are higher than on the date of winding up.4 MAR: Enforcement Directorate registers a money laundering case against FT based on an FIR filed against the AMC at the Chennai Police Economic Offences Wing in September. Separately, Sebi summons few key personnel at Franklin based on the findings of the forensic audit report.2 APR: FT responds to media reports suggesting that the AMC is engaging with Indian authorities seeking just hearing in Sebi’s investigation into the six wound-up schemes. AMC refutes suggestions that it threatened to exit India business if not given a fair hearing.Experts point out that other fund houses were not hit by these external forces to this extent. The disproportionate impact in the six FT schemes was purely owing to the nature of bets. Maheshwari remarks, “Playing high risk, yield maximising strategies in fund categories not associated with taking such risks was not appropriate in the first place.” Further, it is evident that FT placed these bets assuming that market conditions would always be favourable in the bond markets, without budgeting for drying up in liquidity.The subsequent decision to shutter the six funds has put investors in a tight spot. “We recognise this has impacted liquidity for our investors but was necessary in order to preserve value for our unitholders,” asserts Sanjay Sapre, President, Franklin Templeton Asset Management (India). Since closure, FT has tried to monetise the value of assets in the six funds. Till 31 March, the schemes had generated Rs 15,776 crore in cash flows and repaid Rs 9,122 crore to investors as per directions from the Supreme Court.The six shut funds are steadily recovering outstandingsThe six schemes received cash flows from maturities, coupon payments and prepayments by issuers 82002472All six schemes are now cash positive with no outstanding borrowing. What’s more, the cash flows received so far have come ahead of the timeline suggested by the funds’ maturity profile at the time of winding up. The fund house points out that the NAVs of all six schemes are higher than what they were on 23 April 2020, when the funds were closed down.Some insist that if the fund gates had not been shuttered, the outcome could have been very different. The deluge of redemptions would have forced the fund house into distress sale of bonds, which would have eroded the NAVs. But with the funds now sitting on higher NAVs, the fund house has been able to preserve value so far. “Leaving aside the legal aspect of it, taking the extreme step was right at that time. It has been a tough ride for the investors but the situation could have gotten much worse,” asserts Maheshwari. Feroze Azeez, Deputy CEO, Anand Rathi Wealth Management, concurs, “The decision to wind up the funds turned out to be the best course of action in hindsight.”Yet, it is also felt that these positives don’t absolve the fund house from its mistakes. There is little to crow about in turning cash positive, insists Bala. “Would you rejoice that the funds lost close to Rs 4,500 crore of your money in paying loans that should have been avoided in the first place?” Further, funds’ NAV going above the April 2020 NAV is not exactly an achievement. Steady growth in a debt fund’s NAV is to be expected with regular coupon payments and maturity proceeds coming through.When to expect the balanceFT has to still pay roughly Rs 17,720 crore to investors in the six schemes. As per the stated maturity profile of the holdings, Franklin India Ultra Short Term Bond Fund and Franklin India Low Duration Fund are to get back 60% and 69% of the value by 30 April. The Supreme Court has directed SBI Mutual Fund to monetise the assets and distribute the proceeds.A few issuers in some of the funds have defaulted in payment of coupons or maturity. Due to the defaults, these securities have been valued at zero. While this does not indicate any reduction or write off in amount receivable, recovery entirely depends on issuer ability to repay. Further, recovery of value in segregated portfolios in some of the funds will be subject to repayments by issuers in due course. Unless the funds get back these dues, full recovery of investor money is not certain.Are equity funds at risk too?Investors in FT’s equity funds are also watching on nervously. But experts insist blemishes on its fixed income segment have no bearing on the equity division. The AMC runs both verticals independently of each other, with separate risk teams for both. Besides, the AMC’s investing philosophy for the two segments is in stark contrast to each other. It follows a conservative investing style in equities but pursues aggressive strategies on the debt side.Unlike AMCs that rely extensively on individual fund managers to build their brand, FT places strict emphasis on established processes and team culture to drive performance. This has ensured consistency and discipline in investing.However, FT’s equity schemes have struggled in the past 4-5 years. Until a few years ago, many FT equity funds ranked among the top two quartiles in respective peer groups over 5 and 10 year time periods. These are now languishing in the bottom two quartiles. Experts reckon the fund house’s contrarian stance has hurt returns in recent years. “The fund house has consciously taken a contrarian stand paying heed to valuations, refraining from coughing up hefty premium for quality stocks. This has not worked in its favour but the fund managers have stuck to their conviction,” asserts Kumar.Franklin’s equity funds have given poor returns in recent yearsFT’s contrarian stance has hurt funds’ returns in recent times even as they enjoy a healthy long-term track record. 82002499Not able to consistently outperform peersBarring Franklin India Prima, other equity funds have struggled to outperform peers. 82002516With the equity portfolios leaning towards economy-sensitive bets, the pace of economic recovery will determine how the performance plays out. Already, the past 6-12 months have proved rewarding for FT’s equity funds. Franklin Taxshield, Franklin Bluechip, Franklin Focused Equity and Templeton India Value have emerged among the top performers in their categories. Even so, performance needs to improve meaningfully to reflect in the funds’ long-term return profile. The funds have a lot of catch-up still to go given the wide margin of underperformance that still persists relative to their benchmarks. Investors with a limited time horizon or approaching goals may move out if there is no sustained improvement in performance in the coming months. Investors with longer time frames may stay if there is no further deterioration in the return profile.