Franklin wound up six debt schemes and now says they will pay back over five years. It’s not a pleasant situation especially when our hard-earned money is being locked down and there is a prospect of capital loss as well as the opportunity loss.
Here are some of the questions which I am being inundated with.
I have all my savings in mutual funds. I don’t know what happened with Franklin. Everything is a fraud. I hear that big NBFCs cannot raise money. Perpetual Bonds of banks like PNB have been dealt at some crazy 12-14% levels. It is front-page Economic Times news. We should exit debt mutual funds while we can.
So?
I think your reaction will decide what will happen to Debt Mutual funds.
Let’s take a breather, slow down a bit to take stock of the situation.
Thirteen lakh Crores were the overall Assets under management of debt mutual funds end of March 2020. Assets under management mean the money which has been entrusted by you and me to debt mutual funds which in turn have been invested by them in different types of bonds via different schemes.
Out of the above, the percentage of bonds that were lower than AAA will be around 5-6%.
Franklin had a high concentration of lower-rated bonds. When push came to shove Franklin had to surrender. Let’s leave aside Franklin for a minute. It is a problem child and is worse off for it.
If you want to know what happened to Franklin, you can read about Franklin here.
Depending on how many people run to other credit funds and other debt funds to get their money back will decide their fate. They are obliged to pay on redemptions and if there are mass-scale redemptions they will have to manage with the help of the regulator.
Why is this only happening to Debt Mutual funds? No one told me I could lose my Principal in them?
Let’s look at what is happening all around us.
As recent as 5 March 2020, Yes Bank, the fifth-largest private sector bank had to be rescued by the government. When it was rescued it had a deposit of over 2 lakh crores.
In the last couple of years, we had highly rated entities like IL&FS & DHFL, RCom, Zee, Altico, and Vodafone downgraded or have gone bust.
We have to accept the fact that regularly some entities will and can go bankrupt. It can be a business failure, fraud, mismanagement, unpredictable events, or all of the above.
The only issue is that all these losses don’t touch us. These things happen, we grimace but there is no direct effect on our savings. Sometimes they do. Like DHFL bondholders.
When Yes bank had to be saved it had depositors, so did PMC bank.
But the regulator chose to bailout Yes bank depositors.
But chose to let other financial entities perish or sacrifice some creditors.
They cannot protect everyone. So they decide what is systematically important and bail them out. Let us not get into merits or demerits of the regulator’s decisions.
So we have got used to the fact that bank deposits in nationalized banks can never be eroded.
With the same mindset fixed income or debt mutual funds are approached and sold.
If we accept the fact that every bailout is funded by taxpayers, directly or indirectly we will not be so distraught.
Bonds and the Bond market does not exist in a vacuum.
What is happening all around us can happen to bonds as well. As the companies who have issued them can or may get into financial crunch or may also fold up post-Covid.
For eg, Vodafone is almost a bankrupt company, currently, its equity is being traded at the thereabouts of Rs 4. Five years back its price was Rs 100, how can the bondholders or lenders of Vodafone remain unscathed?
The difference is that when banks get saddled with troubled borrowers the losses are not passed on to the deposit holders.
Although the share price of the banks does get impacted with higher troubled loans and bonds in its portfolio.
The shareholders of Yes bank have lost a lot of wealth and have taken it on the chin and moved on.
Yes, But this is not fair.
Why so?
Post the Covid breakout, Sensex has fallen from 41300 to 28000 and now back to 31000. An eye-popping 30% drop from January highs. It has recovered but still trading 25% lower from the top.
Investors are handling with equanimity the equity decline. There is an understanding of how the market functions and there is no liquidity crisis.
Therefore the Indian equity investor is keeping the faith, understands the challenges listed companies are going to face and is in it for the long haul.
Those who cannot bear the heat are getting out of the kitchen.
But no panic.
Last week oil price was negative and many commodity investors went bust.
Shit is hitting the roof all around us.
If we accept that there is risk in life and sometimes, howsoever small, that risk can and may materialize, there will be less angst. If your savings are well-diversified then the stress may be more manageable.
Let me digress a bit.
With the Covid outbreak. We are forced to lockdown and spend our time indoors. There are untold business losses and emotional distress.
Are we blaming epidemiologists, Pharma companies, the Government? (Ok, there is some blame game, WHO is somewhat responsible & so is China & so is Trump).
We can whine that the big pharma and the public health officials should have foreseen the situation, should have prepared for such outbreaks, should have tested vaccines, and should have got a cure by now.
We want it.
But we understand that they are doing the best they can and we accept their contradictory statements and advisories meekly.
Some situations cannot be foreseen. And some losses we have to bear howsoever unsavory.
Which is the case even in bonds or Debt mutual funds.
We have to deal with it.
Or
Given the situation in India for fixed income, invest in either government regulated schemes or government-owned banks.
Be happy with low returns.
There is no free lunch. If you want higher returns, then accept the commensurate risk.
Coming back to Franklin. The jury is out and the fund management team is being hanged out to dry.
While they took the risks and generated the returns, no one complained. Some investors and advisors did not like their aggression and stayed away.
Franklin’s mutual fund’s woes were known way back in May 2016, when they had to distress sale Jindal Power and Steel bonds.
Other fund houses also got into trouble but Franklin was a known yield chaser.
There is mandated reporting of the schemes portfolios by the regulator. There are limits and valuation norms and elaborate rules on maturities and valuations.
The schemes enjoyed high ratings by entities like the Morningstar. Regulatory oversight could have been more proactive. If Franklin was taking undue risk with the monies of investor it was their job to discipline and make them course correct.
Who can blame the regulator though? They are sending out show causes notices now. Which is comical.
Advisors cannot have an understanding of complex structures in debt or have an understanding of the covenants and the liquidity/illiquidity of debt instruments. The charisma of star fund managers and the lure of high commissions blindside smart investors and advisors.
Portfolios are not static they can change every single day. So how can laity investors manage the risk? They have to rely on external and internal agencies who are mandated to protect their interest to do so.
Some of the bonds and structures are meant for extremely savvy investors like AIF’s and hedge funds. Whereas investments have to stay for long periods or there are tax implications.
Franklin was an accident waiting to happen. There will be learning. Maybe toothless industry bodies like AMFI can become more effective in curbing excesses via self-regulation.
Let’s hope so.
So getting back to Debt mutual funds. Banks are sitting on seven lakh Crores of cash. They can buy whatever bonds they want, can fund whichever business as well. Their risk assessment team is in a coma. At the end of the day, they also want to protect their shareholders.
Only the Big Daddy has to come out and rescue. The government via the RBI. I am sure a package is being worked out. Just that the FM could have been a bit for communicative. It would have soothed nerves.
If you are an investor in debt mutual fund, no one can promise you will bear no losses in any scheme. But you can take an informed decision by taking your advisor’s help.
I believe that it is highly unlikely that you will lose all your money if you have invested in a decent fund houses scheme and if you have patience. Take some effort, understand what you have invested in, take a dispassionate assessment of the situation, and then take a call taking a holistic view and not a knee jerk reaction.
Just because Yes Bank got into trouble, it did not mean all banks were unsafe. No one ran to withdraw all their deposits from banks.
There are many different types of debt funds, liquid, short term, medium-term, and dynamic, gilt. All will have to be seen independently and with your risk profile and then decided upon.
I believe that the debt industry should be and will be resilient and survive and will be better for it.
Komal Seth
Excellent insights into the investment world simply told