The AMC’s markdown of Vodafone-Idea bonds exposure may have been one of the major contributors for investors heading toward the exit door at Franklin
Franklin Templeton India has been on a roller coaster ride. In an unprecedented decision, on April 23, the asset manager proposed to wind down six debt funds which together managed assets of Rs 26,000 crore. The six debt schemes facing closure are Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund, and Franklin India Income Opportunities Fund.
The wind down decision was unprecedented by any yardstick. Investors could not exit the funds while fresh investments could not be made either. Investors were worried what would happen to their investments. Franklin said they would return “as much as possible” by resorting to secondary sale, prepayments or selling back to bond issuers. The wind down decision is being challenged in courts now by some investors.
Interestingly, no other AMC had to resort to winding down a fund. So why only Franklin had to do this? Would the situation have been different if the AMC had done things differently? Let’s look at a few things in perspective.
Of course, Franklin had taken extra risk with its investments primarily investing in lower, though investment grade securities. It’s also the stated objective of some of the Franklin debt funds to make the alpha by investing in securities that may be in for a rating upgrade, but currently rated lower. But this aggressive, high risk strategy may be alright in a good market, but will surely come and bite you when markets turn like the way it did in March. Now it turns out Franklin’s debt portfolio was not black swan event-proof.
Frankly, we don’t need to tell the debt fund gurus at Franklin how to invest. They probably know the game better. But the fact is Franklin’s debt MFs have many securities which cannot not be easily sold in a tight liquidity market. Also, in hindsight, it seems some of their decisions in the last six months might have caused an investor run on Franklin’s funds. We will talk about it a bit later.
First how their AUM melted like butter on hot plate. For the quarter ended December 2019, the AUM of Franklin Templeton India stood at Rs 1.27 lakh crore. And now, for the quarter ended June 2020, those assets have dwindled to Rs 0.81 lakh crore — a drop of about 40%. If you actually set aside the Rs 26,000 crore of the funds that are being wound up (where they don’t earn a fee now), then Franklin’s net fee-earning AUM would be down to just Rs 55,000 crore, less than half of what they were managing earlier.
Now to the real trigger for Franklin’s AUM meltdown. In our view, the AMC’s treatment of Vodafone-Idea Ltd (VIL) bonds exposure may have been one of the major contributors for investors heading toward the exit door at Franklin. On January 16, 2020, the six debt schemes had marked down the value of their nearly Rs 2,000 crore exposure of VIL to zero. For record, Vodafone-Idea bonds comprise two kinds: one bond was slated for maturity on July 10 and the other one is slated for maturity on September 2, 2023.
Franklin marked down the VIL NCDs (non-convertible debentures) immediately after the Supreme Court dismissed pleas, including those of Bharti Airtel and VIL, to review its earlier judgment that had asked telecom operators to pay more than Rs 1 lakh crore of dues to the government.
Due to the markdown, the six FT debt funds witnessed a sharp decline in Net Asset Value (NAV) on January 16 session, with investors in various funds losing between 4.28% to 6.87% overnight. That is most of the annual returns being wiped out in a day. The next we saw investors started redeeming monies from Franklin – and also a few other debt funds too – who had exposure to not only Vodafone papers but also to other NCDs that did not give much comfort to investors.
Interestingly, Franklin took the call to mark down VIL exposure even before rating agencies had taken the rating decision on the telco following the court decision. The fact was, technically, Vodafone papers were still investment grade, but VIL did not see it that way. While other funds decided to wait for the rating action and recommendation of the valuation agencies, Franklin took a hyper-aggressive step to write down the value to zero on the evening of the court decision only.
Franklin had its justification. Its view was that the valuation adjustment following a rating action only reflected the realisable price of the relevant securities on the date of valuation, and it did not indicate any reduction or write-off of the amount repayable. So Franklin decided – following the court’s decision – VIL was probably headed towards bankruptcy and so it made sense to write down the value to zero.
A day after Franklin Templeton MF’s move to fully write down the Rs 2,000 crore VIL exposure, other fund-houses like UTI AMC, Nippon India AMC, and Aditya Birla Sun Life AMC also took some mark-down steps. But none of them valued it at zero while choosing to go with the recommendations of the valuation agencies.
It took about a week for the first rating decision to come. On January 24, CRISIL downgraded its rating on the Rs 3,500 crore worth VIL NCDs to ‘CRISIL BB’ from ‘CRISIL BBB-. The rating continued to be on ‘Rating Watch with Negative Implications’. But, even CRISIL was not outright pessimistic. The rating action, CRISIL said then, reflected the agency’s expectation of a significant deterioration in VIL’s financial risk profile on account of the potential payout against the adjusted gross revenue (AGR)-related liability.
Immediately after the CRISIL rating action, Franklin made its next move. The board of trustees of the AMC approved the creation of segregated portfolios (side pockets) in the six debt funds. FT maintained that the side-pocketing decision was taken in order to protect value for existing unitholders in these schemes. This, of course, was a good decision for investors as they could exit the FT funds while still retaining the hope that one day they could get their money back from Vodafone. But it did not help the AMC, as the existing investors in the FT debt funds started redeeming their investments.
Interestingly, the other fund-houses announced side-pockets only three weeks after Franklin’s move. Franklin was in a hurry, while others were not. In fact, we had written about why other fund houses had not still announced side pockets even after many days had passed since Franklin announced creation of segregated units for VIL exposure.
Even though it might be be debatable if Franklin’s quick moves on VIL were done in the best interest of investors, what we know is that they did not really help regain the investors’ love. We are not saying investors had no grouse with other funds who also had to finally segregate VIL exposure. But somehow FT took the disproportionate brunt of it as they were in the forefront of the VIL episode. Besides, FT had the largest exposure to the telco’s papers compared to others.
In a major relief to the investors, on June 12, 2020, Franklin announced it received Rs 102.71 crore as annual interest (for the period June 12, 2019 to June 11, 2020) from Vodafone-Idea for its debt papers maturing on July 10. FT immediately distributed this amount to the unitholders. Needless to say, Vodafone’s payment of interest was a major surprise to the investors as the company is still fighting the case in the court on its AGR dues while there has not been any material change in its financial position. Remember, this was the same company whose securities’ valuation was marked down to zero.
Then, on July 10, 2020, Franklin announced it received Rs 1,245 crore as repayment of the principal amount for the bond that matured on that day, and Rs 7.88 crore as interest for the period June 12, 2020 to July 9, 2020. In all, Vodafone-Idea paid about Rs 1,355 crore to Franklin schemes. Franklin finally received all its dues from VIL for its debt papers that matured on July 10, which helped the AMC to extinguish all segregated units and return the monies to the investors.
When you look at it, the Vodafone episode may have started the entire chain of events at Franklin, which finally culminated in the decision to wind down six debt schemes. But VIL honoured its commitment and paid up principal and the interest due on time, while Franklin is yet to recover from the fiasco.
Did Franklin’s swiftness in acting on VIL exposure cost it dear? It may seem so. Even though Franklin claimed it acted fast in order to protect ordinary investors, the moves by FT had, in fact, an adverse effect on the investors, who, in turn, decided to wind down their own exposure to the Franklin funds.
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