Franklin Debt Fund Issues – What to do now?

It was shocking news yesterday from Franklin Templeton Mutual Fund that it is winding up 6 of its debt mutual fund schemes. The following schemes are closed now.

1. Franklin Low Duration Fund
2. Franklin Dynamic Accrual Fund
3. Franklin Credit Risk Fund
4. Franklin Short Term Income
5. Franklin Ultra Short Bond Fund
6. Franklin Income Opportunities Fund

Some of them are very popular schemes which enjoy high star ratings from rating agencies.  The combined assets under these schemes are around 25000 crores.

What does this mean for investors?

1. You cannot invest in any of these schemes now.
2. You cannot withdraw your investments from any of the above funds.

In simple words, your money is stuck with the fund house now.

What about other funds of Franklin?

There are many other funds (both equity and debt) from Franklin.  They are not affected. The issue is limited only to 6 of these debt funds.

Is my money lost?

No, your money is NOT lost. You will get it back.

It is just stuck. You cannot withdraw it whenever you want – like you were doing earlier.

As and when the fund house realizes the money from these investments, it will be paid to the investors.

Why Franklin took this decision?

This fund house used to invest in low rated securities to generate higher return. If you look at the performance of these funds in the past, it is better than other funds in the respective categories. Higher return is always accompanied by exposure to higher risk, which the fund house was managing nicely for many years.

COVID 19 created lot of liquidity issues in the bond market even for high rated bonds.  The impact on low rated securities was even bad.  Fund managers find it difficult to meet the redemption pressure.

Franklin schemes saw huge redemption in the recent past.  Fund size of a fund reduced from 20,000 Crores to around 10,000 Crores in few months due to huge redemption.

When the fund is selling good quality bonds to meet the redemption pressure, the quality of the existing portfolio will have high exposure to low rated securities. This is not in the interest of the remaining investors. So, the fund house has decided to wind up the scheme in order to protect the interest of remaining investors.

When can I expect my money back?

Your money is invested by the fund house in many debt securities. In the case of Franklin Ultra Short term debt fund, 10,000 plus Crore asset is invested across 88 securities. The trustees have control on the securities of the fund house.  All unit holders of the fund are the part owners of this money.  You will get your money back as and when the AMC realizes the interest payment or principal repayment on maturity of these securities.

Different securities have different maturity dates. In the case of ultra short term debt funds, the average maturity period of such securities is 180 days.

In case of an extreme bad economic situation after COVID 19 some bonds may go wrong. They can default on interest payment or principal repayment. This can impact the investors. So, don’t expect the entire amount back in the case of these funds. There can be some loss. It is very unfortunate.

Will there be an impact on other debt mutual funds in general?

This is the first time our generation is witnessing a situation like this due to a pandemic. The impact of this is beyond the guess of anybody. Foreign Institutional Investors (FII) who invested heavily in India is selling aggressively due to many local and global reasons.  If the economy goes for a recession type situation, it can have minor impact in all debt funds for some time. Nobody knows how the situation is panning out after COVID 19.

My suggestion on debt funds

I used to suggest only liquid funds and ultra short term debt funds. Such funds are relatively safe compared to other debt fund categories. Most of these funds invest the assets across 100 plus securities to reduce the risk of concentration. They usually invest major portfolio in top rated securities only.

Debt funds are attractive to FD in terms of taxation only that too if your investment horizon is 3 years or more. If you need the amount within 3 years, debt funds cannot give higher return than FD.

Your debt fund portfolio – what to do now?

If you are investing in liquid funds or ultra short term debt funds for long term goals (as part of the debt component in the portfolio), there is nothing to worry. Please continue with SIPs in those debt funds. Minor impact (if any) in the short term can be ignored.

But, if you need the amount (invested now in debt funds) in the next 3 years for some short term goals, sell it now and reinvest in bank fixed deposits.  Please note that the short term capital gain (if you are selling units within 3 years) will be added to your income for this year and taxed as per your tax slab. If you are selling it after 3 years, Long term Capital Gain will be taxed at 20% after indexation.

Please feel free to email (melvin@finvin.in) me in case of any specific queries regarding your debt funds.