On April 23rd American Investment firm, Franklin Templeton, announced the voluntary winding up of its six credit risk funds and other related funds. Before we get into the details let us get to know what are credit risk funds
Debt funds with higher yield
Debt securities are rated by credit rating agencies based upon their risk of default. This rating ranges from ‘AAA’ to ‘D’ where ‘AAA’ accredited to securities having a very low risk of default whereas ‘D’ accredited to securities with a risk of default being imminent. Credit risk funds are debt funds in which nearly 65% of the portfolio consists of bonds that are rated below ‘AA’ (next to ‘AAA’). Corporate raising funds through these debt securities have a higher probability of defaulting on their payment obligation.
Then the reason for such investments is because of the higher yields these securities offer. Another way investors make money through these securities is when these securities are upgraded from a lower rating to higher and lose money when they are downgraded. This is because of the underlying risk these securities posses.
All credit risk funds are open-ended funds which means investors have the right to enter and exit the fund at their will. But these securities have a fixed return (coupon rate) and maturity period before which redemption might not be possible. Hence mutual funds to honor their obligation towards fund holders either sell some of the securities in secondary markets where these bond papers are actively traded or raise funds from banks or other institutions at a rate which is lesser than that what the holding debt security offers (Coupon rate offered on bond > Intrest rate of debt).
Outflow of funds from riskier securities to safe havens
The ongoing pandemic has also caused investors to move towards safer assets due to the uncertainties across the economy. Companies that have higher amounts of debt in their balance sheet and uncertainties towards its ability to raise cash will not be appreciated by the investors. This exactly started happening in these credit risk funds where the risk of default by the bond issuer is very high and thus investors started to redeem their assets in such categories. Association of mutual funds in India (AMFI) showed a fall in assets under management for credit risk funds from Rs.61,611.44 crores to Rs.55,380 crores between January and March.
Franklin Templeton winds up its credit funds
The credit risk fund of Franklin Templeton faced similar challenges arising from the redemption requests of the investors. The Franklin Templeton fund house was not able to sell the securities on the secondary market since there were no buyers for these high-risk bond papers. No bank/financial institution was ready to lend them for these securities since their probability of default was very high.
The stress was visible in the fact sheet provided by Franklin Templeton in which their cash and current assets declined from Rs.15,971 crores in January to Rs.-46,665 in March for their credit risk fund. This made the firm wind up six credit risk funds which are Low Duration Fund, Dynamic Accrual Fund, Credit Risk Fund, Short Term Income Plan, Ultra Short Bond Fund, and Income Opportunities Fund. These six funds managed assets worth Rs.26000 crores. Fund of funds (FOF) is a fund which comprises of other mutual funds in its portfolio. FOF’s which comprised these credit risk funds in their portfolio were also winded up.
What’s left for existing fund holders?
Winding up of the fund means it restricts to add any new investor to invest or allow any existing holder to redeem their units. The fund house in its statement mentioned that investors can redeem their stake as soon as either when the securities mature or when there are buyers in the secondary market at a reasonable price. If in the meanwhile there is any corporate whose bond the fund holds defaults investors then have to take the brunt.
After Franklin Templeton winding up its six funds due to redemption pressure, the RBI announced a special liquidity facility of Rs.50,000 crores fro Mutual funds to borrow from commercial banks. The commercial banks can use this facility only to lend it to entities who are involved in mutual fund businesses. But it is up to the banks to come forward, use these facilities, and provide liquidity to mutual funds. This liquidity facility is also expected to bring back investor confidence and prevent panic selling.
The credit risk funds which franklin Templeton closed have exposure towards Vodafone, Essel infra etc. Franklin Templeton recently received an interest payment of Rs. 102.7crores from Vodafone Idea’s Bond held in its bond schemes. The unitholders will be able to realize a small quantity of their position from this.
SEBI on its meeting scheduled on June 25 is expected to discuss the legal and audit issue pertaining to the fund house. The extent of redemption and ways through investors will be able to redeem their funds.
Supreme court on June 2020 ordered to transfer all pending cases in High courts across the country to Karnataka high court. The supreme court noted that the closure of funds during pandemic was not right,on the other hand, Franklin Templeton said all the investors will get back their money.
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