The closure of six fixed income mutual fund schemes by Franklin Templeton Mutual Fund has a lot of retail investors worried. Existing investors are wondering whether they will get their money back, and those who have invested in other debt mutual fund schemes are probably considering a flight to safety.
BloombergQuint spoke to two financial planners—Suresh Sadagopan, founder of Ladder7 Investment Advisories and Arvind Rao, founder of Arvind Rao & Associates— about the key questions that have emerged after Franklin Templeton’s decision.
Edited excerpts below:
What does the winding down of the six funds mean for investors?
Sadagopan: The asset management company has said that it has taken this decision to protect the value of the investments for the existing investors. It was unable to meet the redemption pressure and did not want to sell off the investments at sub-normal prices. The AMC has indicated that it will stay invested and will distribute money to unit holders as and when accruals take place. Investors will have to wait it out for now. But, in a positive scenario, if the Covid-19 issue is resolved and the bond market goes back to normal, then there’s a possibility that the fund house will be able to sell some of the debt even before maturity. But when that will happen and whether that will happen is uncertain at this point. We have to hope that the companies, whose debt they have invested in, continue to remain in a position to honour their obligations.
Should you be worried about your investments in debt mutual fund schemes of other fund houses?
Rao: There is no doubt that other fund houses will also see redemption pressure. Ideally, now is not the time to press the panic button. However, every investor will have to review their portfolio and judge the exposure to high-risk schemes, like credit risk funds. If most of their debt investments are in such high-risk schemes, then they should probably take a call to de-risk at this point.
If their portfolio is well diversified, as it should be, then should they stay invested?
Sadagopan: Don’t get worried as of now. As far as Franklin Templeton is concerned, they have a very clearly articulated strategy, which is a credit risk strategy. They’ve done it very well for a long period. Now, at this point of time, due to huge amount of redemption pressure and the crisis we are facing, there is a liquidity issue, certainly for lower-rated corporates. That is not true for all mutual funds. If you look at most corporates, they have a strategy of only having very high-quality papers.
Investors often think of debt mutual fund investments as safe. What are the risks associated with such investments?
Sadagopan: All mutual fund schemes are subject to interest rate risk. The Reserve Bank of India sets the policy rate and that determines the interest rates in the system. When yields spike, the value of bonds in the secondary market falls and this affects the NAVs of bond funds.
Then there is the fund manager risk. Actively managed debt funds are managed by fund managers who are specialists, who may have strategies that may positively or negatively impact the returns that the fund brings in.
And finally, there is a credit risk, which is the problem we are having with Franklin Templeton. If the papers that a fund is investing in are lower-rated, then they will yield a higher return, but they also carry a higher level of risk. There is the higher possibility of a default. In a situation where there is risk aversion, such debt doesn’t find many takers.
Rao: There is also the economic risk that affects everything, but is also dramatically affecting mutual fund investments. In a situation where there is an economic shock, there will be large redemption pressure. In this case, we don’t know how long the crisis will last and how many defaults we can expect over the next few months. This risk of defaults is faced by banks as lenders to such companies, and by mutual funds as investors in their debt.
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