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Franklin Templeton to Conduct a Vote on Winding Up Debt Schemes

Dec 9, 2020 10:46 AM 4 min read

Following the Supreme Court’s (SC) direction, Franklin Templeton (FT) issued a notice to its unitholders wherein they would vote to decide on whether to wind up the six debt schemes that were frozen on April 23rd earlier this year.


In April, FT decided to shut six of its open-ended debt funds. As reasons for this move, it cited lack of liquidity in the debt market and unprecedented redemptions in these yield-oriented schemes in the wake of the coronavirus outbreak and the subsequent slump in the Indian economy.

These schemes together managed assets worth ₹26,000cr ($3,453m). And they had direct exposure to higher-yielding, lower-rated credit securities, which were particularly affected by the pandemic-induced market volatility in March-April.

Furthermore, a later audit by SEBI opened a can of worms. It found several wrongdoings by key management personnel at the fund house. More on that here

To read more about the FT funds that were shut and why they were shut, read this article or this Twitter thread.


Court Intervention

FT’s decision invariably riled up investors, who challenged the same in various High Courts (HC). All cases across the country were clubbed by the SC and directed to be heard by the Karnataka HC.

In October, the Karnataka HC ruled that FT should give its unitholders a say on whether the schemes should be wound up or not. FT appealed this decision, but the apex court took the same stance.

And now, as per the Courts’ decision, the fund house is organising a vote that will determine the fate of the six debt schemes.


How Will the Vote Be Conducted?

Franklin Templeton's e-voting process will begin at 9 am on December 26th and end at 6 pm on December 28th. The verdict will be determined by a simple majority.

A video conference between unitholders will follow the vote on December 29th in addition to separate meetings for each scheme. More details on login credentials and mechanisms here.

FYI: Together, the six FT schemes in question have c. 300,000 unitholders. 190,000 of these have investments below ₹2L ($2,712).


The Two Choices

On December 26th, investors will be faced with two options:

  1. Vote in favour of winding down the funds. This would lead to distribution of the cash flow the funds have been receiving since April 23rd. (All in all, they received ₹11,576cr ($1.57bn) from maturities, prepayments and coupon payments since April.)
  2. Vote against winding down the funds. If unitholders opt for this route, the schemes will have to be reopened for investments and redemption.


The Ramifications

FT has urged unitholders to give consent to winding up the six funds. The fund house argues that if the schemes are opened again (Option 2), it could lead to large-scale redemption and distress sale of assets, causing the funds’ Net Asset Value (NAV) to fall further.

Basically, opening the schemes would make their liabilities to unitholders become “callable”, which if actioned upon through redemptions implies FT may have to force-sell its assets (i.e. Its investments in high yield debts) as per market demand for cashing-out. FT argues this could lead to assets being sold at a discount causing potential losses to unitholders.

On the other hand, should unitholders decide to wind up the schemes, the fund house assures it would be able to distribute the cash already available and “make further payments at regular intervals as the schemes receive cash flows from monetisation of assets”. Translation: It gives FT more time to plan asset sales and thereby protect unitholders instead of selling under redemption pressure.

The truth is somewhere in between. Bond markets are at a much better position today than they were six months ago. In fact, four out of the six schemes are already cash positive. Individually, Franklin India Low Duration Fund, Franklin India Ultra Short Bond Fund, Franklin India Dynamic Accrual Fund and Franklin India Credit Risk Fund have approximately 48%, 46%, 33% and 14% of their respective assets in cash as on November 27th.

Moreover, the key risk in taking Option 1 is the future possibility of defaults from the corporates issuing the underlying bonds, which haven’t defaulted yet. Particularly so given that the six debt funds have high exposure to low-rated bonds and the credit risk involved could hurt investors.

But it is a chicken and egg story. Would redemptions from FT unitholders cause a default within the corporate underlying or would defaults of underlying corporates lead to FT unitholders losing their principal? And if it is the latter, shouldn’t the unitholders already be aware of those risks? Or should FT have done a better job marketing these schemes in the first place rather than mis-selling them to folks who are unaware of the risks they entail?

Any which way, we digress. The outcome of the vote will be known in a couple of weeks’ time, following which a distressing episode in the mutual fund sector may finally draw to a close.


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