Franklin Templeton Mutual Fund has announced, in April, the closure of six debt funds, effectively locking up more than Rs 30,800 crore in assets. The funds that have been closed are-

1. Franklin India Low Duration Fund
2. Franklin India Dynamic Accrual Fund
3. Franklin India Credit Risk Fund
4. Franklin India Short Term Income Plan
5. Franklin India Ultra Short Bond Fund and
6. Franklin India Income Opportunities Fund

What forced Franklin Templeton to announce the premature closure of the above six debt funds was the redemption pressure. Investors wanted their money back because they fear that due to the nationwide lockdown, companies will not be able to meet their debt obligations to whom the fund house has lent money.

Due to the closure, investors cannot take their money out of these funds or switch them out to other schemes or even begin to put money into them again. “The decision has been taken in order to protect value for investors via a managed sale of the portfolio,” the fund said in a statement.

Franklin Templeton has invested in the debt securities of many small or privately held companies for seeking higher returns, compared to the regular debt funds. Credit risk funds generally invest in low-rated papers for higher returns. But the selection of companies, Franklin Templeton chose to invest has come under question after the fund house had to ultimately shut down the six debt schemes. It was shocking for entire mutual fund industry.

India’s debt fund market has been roiled by the failures of two big non-banking finance companies – Infrastructure Leasing & Financial Services Ltd (IL&FS) and Dewan Housing Finance Corporation collapsed in 2018 and 2019 respectively. Several debt funds that had exposure to these NBFCs had to write-off their investments partly or fully. Now coronavirus pandemic, has added to the woes of debt funds. Due to the pandemic, the corporate bond market has been suffering, which prompted Reserve Bank of India (RBI) to inject special liquidity for the debt funds.

Some investors who enrolled for systematic transfer plans (STP), got badly caught in the Franklin Templeton. This facility works just like the systematic investment plan, but if you have a lump sum amount already that is waiting to be invested in equities, then STP allows you to park it in a debt fund and carry out a monthly or weekly transfer to an equity scheme, within the same house. With Franklin Templeton winding up six schemes, even STPs have come to a grinding halt. This means investors who had planned to go to equity funds, via a short halt in Templeton’s debt funds, are now stuck in these schemes badly. Now, their money will not get invested in equity funds through STP and their equity investing plans would also go for a toss.

Investors should understand that debt funds are not risk-free. Just like equity funds, there are different categories of debt funds that carry different risks and are meant for investors with the varied risk profile.

Risk spectrum in debt funds varies from funds investing in money market instruments with the lowest risk to investment in credit risk fund that carries higher risk. The pandemic has created a lot of volatility in both equity and debt market. Franklin Templeton’s misfortune threaten to accelerate the mutual fund outflows. Investors in the current situation should avoid panic selling as Franklin Templeton episode seems to be a one-off case representing a small portion of debt mutual fund AUM. Highly conservative investors could park their money in Gilt funds.