On April 23, 2020, Franklin Templeton announced it was winding up six of its credit-oriented fixed-income schemes--Franklin India Credit Risk, Franklin India Income Opportunities, Franklin India Short Term Income, Franklin India Ultra Short Bond, Franklin India Low Duration, and Franklin India Dynamic Accrual.
For the uninitiated…
Due to the challenging environment in the fixed-income market last year, these funds faced significant redemption pressure, which intensified in the months of March and April 2020. The Indian bond market is fairly illiquid and even more so in the lower credit-rating space. But what we witnessed last year was unprecedented. Because of the coronavirus pandemic, the country went into a complete lockdown on March 24, 2020, with business activities coming to a standstill. Despite measures taken by RBI, the liquidity in the Indian bond market, especially in the lower credit space, squeezed substantially.
The fund house did take measures to meet redemption pressure by way of getting borrowers to prepay debt, selling bonds to banks, and using the credit line provided by banks. However, with unparalleled high redemptions from these funds, it came to a situation where these were not viable options anymore. Therefore, because of severe market dislocation, illiquidity, and the inability to continue to meet redemptions without impacting the funds' net asset values adversely, the fund house took the extreme decision to wind up the schemes.
Since then, there have been multiple developments on this front.
The decision to wind up was challenged in the court of law. Since this decision was taken via a board approval, the courts opined that it was a grey area and that unitholders’ approval should be taken. The Supreme Court of India directed Franklin Templeton to take approval from unitholders, which it did through e-voting in late December 2020. Almost 97% of the unitholders who participated in e-voting voted in favour of winding up the schemes.
In addition, the Honourable Supreme Court upheld the validity of e-voting process and directed that the disbursal of available funds to unitholders should proceed. As per the latest information that we have from the fund house, a total of Rs 91.2 billion has been disbursed to the respective unitholders in proportion to their holdings in the five cash-positive schemes in the winding up.
Recently, there have been some disconcerting reports related to the findings of the leaked forensic audit report.
The forensic audit was conducted by a third party appointed by the capital markets regulator, Securities Exchange Board of India, or SEBI, to examine the investment rationale of these funds and whether the investments were made in the best interests of investors, among others.
Based on the leaked portion of the forensic audit report findings, it is being alleged that there were lapses by the fund house that led to the winding up of the six schemes. It also highlights certain transactions wherein a few members of the board of directors, trustees, and key managerial persons redeemed their investments prior to the announcement of the windup. These findings are now being investigated by SEBI.
Our View
- At Morningstar, stewardship is one of the key pillars of our research framework. While we are cognizant of the various purported infractions, we think it is important not to draw conclusions with incomplete information. As is our general practice on Parent ratings, we will wait for a settlement or conclusion by the regulator on these matters before arriving at any conclusions.
- We view disclosures of manager investments in their funds as a good disclosure practice. SEBI, through its circular on March 2016, directed asset managers to disclose the details of ‘Investment by Directors of AMC, Fund Manager(s) & Other Key Managerial Personnel in the Scheme’ in the Scheme Information Document, or SID. These disclosures for the six schemes under windup are fairly dated as of Nov. 30, 2019, and precede the windup event. However, it would be prudent for an updated disclosure on the same, particularly since, as per regulations, the SID was originally to be updated annually, and the more recent guidelines as of March 4, 2021, require the SID to be updated half yearly--that is, every March and September.
What about equity?
Franklin Templeton is a large global asset manager with many distinct investment teams across different regions. In India, it has been in active money management for over 25 years and has built a strong track record over time. However, the development on the fixed-income side did impact the fund house’s brand image in India.
That said, we would like to highlight that the equity team at Franklin Templeton has a separate structure from the fixed-income team and they work differently. It is a strong team, headed by seasoned manager Anand Radhakrishnan. The team also comprises experienced managers like R. Janakiraman (who is a mid- and small-cap specialist), Laxmikanth Reddy (who manages fund house’s multi-cap strategies), and Roshi Jain (who has expertise in managing riskier and focused strategies and who complements other managers at the fund house well). These managers make a strong combination. The team has been stable and close-knit.
Further, the analyst team supporting the managers is experienced, well-resourced, and of high caliber. The equity investment team has consistently practiced its brand of research-oriented, valuation-conscious, and long-term investing effectively over the years.
From this perspective, we believe that the issues faced on the fixed-income side will not have any direct bearing on the prospects or the management of the equity funds.
Most of the equity funds from the fund house have positive Morningstar Analyst Ratings, and for now we are retaining the ratings on these funds.
