How the Franklin disaster came about and what can be learned from it
20-May-2022 •Dhirendra Kumar
The Franklin affair has reached its natural conclusion. Almost all the money has been recovered, and no one has lost anything. Right from the beginning, this was an overwhelmingly likely course of events. Had it not been for the ill-advised actions of a tiny number of investors, this would have happened long ago and a huge number of investors would not have suffered as they did. Moreover, the well-deserved and long-standing reputation of an excellent AMC would not have been besmirched needlessly.
For those who have not yet understood what the entire story really is, let me narrate it in as few sentences as possible.
Franklin Templeton had a set of fixed-income schemes which were designed and sold as 'high-yield' funds. These invested in a set of corporate bonds that carried higher returns and somewhat higher risk. Back in 2020, when China first unleashed its virus, many of these bonds became illiquid. It was no longer possible to sell them readily to meet redemption demands from investors. In the last week of April 2020, Franklin Templeton closed down six of its debt funds, thus freezing over Rs 25,000 crore of investor money. This is unprecedented in the history of open-end funds in India. The AMC took this action because it found that the bond markets had practically frozen and it was unable to sell off enough of the bonds held by these funds to meet redemption requests.
The fund house's plan was that it would stop the on-demand redemptions that open-end funds normally have but keep redeeming the money as and when it was able to either sell the bonds, or when their maturity ended, redeem them with the company issuing the bonds. The interest payments on the bonds would also be disbursed as and when they came in. SEBI ruled that this process would be approved by e-voting from investors. However, the process was interrupted by court cases filed by some investors who suspected that there had been some sort of irregularity in the running of these funds and wanted an investigation.
At that time, it was clear that this outrage was being actively promoted by some fund distributors. They had probably encouraged their customers to invest in these funds by not explaining the risks that came with high returns and tried to pass the blame by telling investors that there must have been some mala fide. The reality - clearly proven by subsequent events - was that these funds took higher risks and earned higher returns. Intermediaries found the higher returns an easier sell. Investors liked the higher returns. When the bond markets froze in response to the virus, various parties tried to look for scapegoats.
It's an unfortunate fact that most Indian fund sellers and their investors do not appreciate what it means to be investing in market-backed securities. Some kind of smaller debt fund blow-ups had been happening since 2018. However, in each case, investors and others blamed the particular funds involved. You can always try to pick some scapegoat or the other, but if you are a sensible investor, look at the underlying principles. Match your risk level to the kind of fund you invest in. Go for a liquid fund if you want the safest kind of fund. There is enough real information available about risk levels, including on Value Research.
By and large, most intermediaries will be focused on selling. When there is only a small differentiation between products and intermediary services - as is the case of debt funds - then shortcuts are often taken in terms of promises made and risks explained. It's your money and it's your responsibility ultimately.
In the Franklin case, the interests of a huge number of investors were damaged by the foolishness of a few who could afford to hire expensive lawyers and sustain the legal process. Unfortunately, that's the flip side of the word 'mutual'. Your fate is attached to your fellow investors.
This editorial appeared in Mutual Fund Insight June 2022 issue. To read the cover story and other insightful analyses, columns and articles