Franklin Templeton’s decision to wind up six of its debt mutual funds has left investors puzzled: weren’t debt funds supposed to be safer than equity funds?
Franklin Templeton’s decision to wind up six of its debt mutual funds has left investors puzzled: weren’t debt funds supposed to be safer than equity funds? Debt funds invest in, as the name suggests, debt instruments, expecting to give stable returns. On the other hand, equity mutual funds invest in shares; their objective is to generate higher returns, which happens only when the underlying stocks perform well. However, the current situation is unprecedented with the economy coming to standstill and non-essential businesses being asked to deliver services from home. With this, debt funds have seen unparalleled redemptions in the past few weeks.
The six funds closed by Franklin Templeton invested in high-risk and high-yield category papers, an option that is risky under the current situation when there is heightened risk aversion. “In normal circumstances, just to outperform, they put some portion of money in the high-risk category, high yield debt instruments. In a general scenario, liquidity is available for the lower categories as well and they are able to service debt,” Omkeshwar Singh, Head – RankMF, Samco Securities told Financial Express Online. With lenders already trying to clear non-performing assets (NPA) from the books, the risk aversion is such that liquidity is not easy to come by, making it difficult for the lower categories to secure funds from banks or non-banking finance companies (NBFC).
Funds can not be stopped from investing in papers rated lower than others, that is their way of trying to generate more returns. “Fund houses may invest in papers rated lower than the safest paper in the market. Some schemes may invest in low-rated papers to generate better returns. However, if things go wrong for the issuer, the credit ratings can drop sharply, causing the debt paper and the fund to lose value,” Ravi Singh, VP- Head of Research, Karvy Stock Broking, told Financial Express Online.
Where is the money?
The problem of securing liquidity has not gone unnoticed in the markets and to tackle the same the Reserve Bank of India decided to undertake targeted long-term repo operations (TLTRO) 2.0. Under this RBI made available, Rs 50,000 crore for banks to lend, of which Rs 25,000 crore was earmarked for small and mid-size NBFCs. However, of the Rs 25,000 crore, only Rs 12,000 crore has been subscribed so far, standing testament to the risk aversion. “All the funds that Franklin Templeton decided to close are corporate debt-oriented funds. Due to the COVID-19 issue, the credit profile has been impacted and the trading hours have also changed. So with the truncated trading hours, generating liquidity in the secondary market has become difficult,” Alok Singh, Chief Investment Officer, BOI AXA Investment Managers Ltd, told Financial Express Online.
“Debt funds are dominated by corporates and HNIs from the investment side,” added Omkeshwar Singh. “With the lockdown in place, these corporate entities, which invested in debt mutual funds, are facing liquidity issues due to the coronavirus and the subsequent lockdown. Hence, they are red redeeming debt schemes to meet their cash requirements,” he said.
The issue of liquidity crunch came up in Franklin Templeton’s Friday morning conference call as well. “Markets need clarity on what’s ahead and needs liquidity. Till there is no clarity the risk appetite is low, if you sell your paper in this situation it will go very low price. LTRO by RBI, most of it went to AAA papers, which is understandable. With the TLTRO 2.0, this was clear that banks were not ready to take the risk. We need to fund the redemptions, which becomes harmful,” said Santosh Kamath, managing director and chief investment officer at Franklin Templeton.