On January 17, 2020, many debt mutual fund investors with Franklin AMC woke up to a nasty surprise. NAVs of many popular debt mutual fund schemes from Franklin had gone down by 4-7%.
Why did this happen?
Many of Franklin debt mutual fund schemes held debt issued by Vodafone-Idea.
What about Vodafone-Idea?
On January 16, 2020, The Supreme Court of India dismissed the review petition of telecom companies over AGR dues payable to the Government of India. Without going deep into the issue, the telecom companies would have to cough up tens of crores towards payments to the Government. Vodafone-Idea’s liabilities to the Government would have stood at around ~50,000 crores. And this amount had to be paid by January 23, 2020. Given Vodafone-Idea’s precarious financial position, it was unlikely the company would be able to meet make payments.
When a company does have money to make statutory payments to the Government, it is unlikely that other financial commitments will be honoured.
In the light of these developments, Franklin chose to write down the exposure to Vodafone-Idea debt in many of its schemes to zero. And this resulted in a sharp fall in NAV.
Why didn’t Franklin side-pocket the troubled asset?
Side-pocketing is possible if there is default or the company’s debt has been downgraded below investment grade. Nothing of this sort happened with Vodafone-Idea. Hence, side-pocketing was not possible.
Franklin took the next best option.
Franklin’s concern (as they stated) was that, as the implications of SC judgement became clear to smarter investors, they might have pulled out money from the fund. This would have affected the existing bondholders. Rs 900 crores is 4.5% of Rs 20,000 crore fund. If Rs 5,000 crores flow out, the fund size becomes Rs 15,000 crores. Rs 900 crores is 6% of a Rs 15,000 crore fund.
If Franklin didn’t write down the value on that day and the outflows happened the next day, the investors who stayed back would 1have suffered. Instead of losing 4.5%, they would have lost 6%.
So, a smart move in that sense. Here is the official communication from Franklin in this matter.
Do note that fall in NAV does not mean that the money is lost forever. If Vodafone-Idea makes the payment to various schemes, such amounts will be written back. Franklin, in its conference call, mentioned that they will keep revisiting the developments in this space on a daily basis. As I understand, they can write back some portion if prospects improve. However, in my opinion, it is prudent to write back the money only once it is received.
Another perspective that Franklin would not acknowledge can be: Writing down the Vodafone-Idea exposure helps them keep the AUM intact. Now, nobody would want to run away since their losses will become permanent. Therefore, this move helps Franklin keep the AUM intact and keep earning fees on it. Side-pocketing wouldn’t have prevented fund outflows. So, it was better to write down exposure even before side-pocketing could become possible.
A win-win for both.
By the way, Franklin has limited to Rs 2 lacs per investor per day. Therefore, any new investor coming in becomes a holder of Vodafone-Idea debt at no cost (at the cost of new investors). I hope this does not become a new selling point. In my opinion, Franklin should have restricted all investments in the scheme.
I am an investor in one of these funds. What should I do?
Had side-pocketing been done, there would have been a bad fund (that contained Vodafone exposure) and a good fund (that contained all the other assets). You could have sold your units in the good fund and still retain the holding in the bad fund. As and when the money was recovered from Vodafone, you would have got that money back too. Essentially, if Vodafone Idea paid back, your losses (due to fall in NAV) would have been recovered.
Since there is no side-pocketing, there is no bad fund that contains Vodafone-Idea exposure. Therefore, if you sell now, you are letting go of your claim on money recovered from Vodafone Idea. If you sell now, your loss becomes permanent. Therefore, if you are comfortable with the rest of the scheme portfolio (let’s say the portfolio of Franklin Ultra Short Bond Fund), you must stay put.
You also need to see when the exposure is maturing. For instance, in the case of Franklin Ultra Bond Fund, the exposure to Vodafone Idea will mature in July 2020. Personally, I would be comfortable if the exposure to a troubled asset is maturing sooner than later.
As an investor, you can wait until the maturity of the bond. If the company makes the payment on time, you are good. If it does not, NAV already accounts for the losses. However, in both cases, you must revisit your decision of investing in this fund and your comfort with the risk involved.
Update (January 27, 2020): The exposure to Vodafone-Idea has now been segregated by various Franklin funds i.e. side-pockets have been created now. The existing investors will get units in the segregated fund that will only contain exposure to Vodafone-Idea. Therefore, existing investors, who are uncomfortable with current portfolios of various Franklin funds and their investment strategy, can exit the main fund now. Despite exiting the main fund, they will retain the units in the Segregated scheme (Sideopocket). As and when money is received from Vodafone-Idea, it will be passed on to the investors.
Franklin wasn’t the only one
Franklin wasn’t the only AMC with Vodafone Idea debt in their schemes. There were other AMCs too. All such schemes took the hits, perhaps a day later.
By the way, not all the AMCs have written down their entire exposure to Vodafone-Idea.
What is the learning?
As investors, you need to appreciate the risks involved in debt mutual fund investments. Many of these funds were darlings of retail investors. Though the loss is nothing compared to an equity fund, the sudden fall has shocked many investors who thought of debt funds as a replacement for bank fixed deposits.
This is not the first time such a thing has happened. We witnessed such sharp falls (and perhaps even bigger falls) when issues with IL&FS and DHFL popped up.
Debt mutual funds can provide you better tax-efficient returns as compared to bank fixed deposits. However, this excess return comes with risk attached. Appreciate those risks. Select the right debt mutual fund for your portfolio. Get your allocation right.
If you can’t do that, seek professional assistance from a SEBI Registered Investment Adviser.
Disclosure: A few of my clients have invested in Franklin Ultra Short Bond Fund. Some of it was legacy money while a few invested based on my recommendation. Most of them were aware of Vodafone-Idea exposure too and the associated risk. This fund, despite being an ultra-short fund was chosen as a Credit Risk Fund in the portfolio. However, the exposures as a percentage of the overall portfolio were quite measured. Therefore, the net impact was small. I do not deny that the sudden fall in NAV took us by surprise.
13 thoughts on “Loss in Franklin Debt Mutual Funds: What should you do?”
Informative article.
Thanks Andrew!!!
Sir
Few points which I never understood. Mutual Funds are expected to be managed by professionals and people who are on the field (so to speak). They are paid to have knowledge and to handle public money. Without this supreme court judgement, the question that need to be asked is was VodaIdea a great company by its own merits for MF to invest in their papers?. I do not think so. Voda was having cashflow problem. Since September 2018 (data available in money control) they were making continuous loses. How come Franklin India and other MF invested in these papers. With regard to IL&FS, we can console by saying transaction was fraudulent and rating agency did not do their job. The financials of Vodaidea is there for every one to see. Why did Franklin Ultra short term fund or liquid fund invest in these companies. This I fail to understand and nobody seems to be questioning the AMC for this. I saw an interview with Mr.Birla who openly said that he will let the company close but will not inject money (kind of open black mail – It is as if Government did something wrong and not his inefficiency in running his business). Even then MF did not take corrective action (not sure if they could do anything)
Franklin needs to answer a lot of questions to small time retail investors.
Not a single soul is asking AMC who invested in these papers as to why they did it. Voda was never a great company in the first place.
The story remains the same, its retail investors who lose out their valuable savings due to negligence or not sure if I can call it fraudulent methods used by MF. Need to know how many of the decision makers in Franklin is going to lose their job for this. I am sure it will be none.
For Gods sake a illiterate like me knew Vodaidea was not a great company to put money in but the professionals did not see it?
As it says “Whose life is it anyways”. AMC must be saying “Whose money is it anyways”……
The never ending story continues, Bank FD are treated as step motherly product, scare people with inflation, retirement and make them invest in MF, take commission and be happy. The trick of the trade of AMC is do it with retail investors who invest small portion but millions so that no one will file a case against them.
Now that people are more educated by burning their fingers, AMC have started ETFs. Everywhere I see new ETFs, Intelligent ETFs being packaged.
Ninan
Hi Ninan,
I understand the frustration that investors face when such things happen.
Not denying that the fund managers could have done a better job. The industry does not smell of roses.
At the same time, the things are not always so black and white.
Perhaps, they wanted to sell earlier but could not sell. Perhaps, they never thought that the situation would come to this point.
We must also understand that most Franklin debt funds are low on credit quality.
Expecting to earn better returns because of low credit quality and yet also expecting that nothing will ever go wrong with the portfolio is also not right. There was risk all along. The risk materialized in Vodafone Idea case.
On Point! Predatory tactics like these are ingrained in the very fabric of such investment schemes (especially Mutual Funds). Big players deal in smaller volumes, but higher value, while people like you and me rely on the opposite. What happened to Vodaidea is a tragedy, but it shows the side of investment bankers we fear the most – that they might be as oblivious as we are. In the end, The situation is rarely ever so cut and dry. One thing that can be ascertained though, is that a lot of times, being your own personal banker is the best thing to do.
Agree Sanjeev!!!
It is our money after all.
Well explained as you do in all articles.
In order to avoid default jerks, it would be better or best in investing in govt securities say Quantum liquid fund or ppfas liquid fund but low return but safe. Because we can’t keep monitoring complete portfolio and their performance etc.
Thanks Sunil!!!
Sticking with liquid funds that invest in treasury bills is an option. However, with the new MTM rules, the return profile of liquid funds have gone down.
If you have to stick with gilt, short term gilt funds would have been a good option. There will be interest rate risk but credit risk will be eliminated. Unfortunately, SEBI classification rules do not specify such category.
I understand the counterargument could be that, for taking risk we have equity funds and we should completely eliminate risk in debt funds.
To each his own.
Therefore, any new investor coming in becomes a holder of Vodafone-Idea debt at no cost (at the cost of new investors)
Deepesh, Did you meant to say old investors?
Hi Deepeshji.
Thanks for the explanation.
If i am not wrong, does it mean that new investors will get benifit of sudden rise in NAV if Vodafone pays it on time.
As, its not the the matter of Side pocketing.
Hi Parminder,
Sidepocket has now been created. Therefore, no such opportunity now.
I could find FMPs having objective as investing in Govt Securities only. The challenge is we could not find such one easily. These FMPs are great w.r.to stable debt investment but to whom does not need liquidity.
FMPs are not available all the time. Plus, most carry aggressive debt with higher yields. Helps in sales.
FMPs in gilt would be a fine option if liquidity is not an issue.