Update: We did a follow-up video to this article to clarify a few questions. Please watch it here.
Many of our customers have written to us asking whether they should continue with the Franklin Templeton funds that they hold. People are worried not just about debt funds, but about the future of their equity funds as well. These worries are not misplaced given recent developments at the fund house.
As readers of this space know, we have been tracking the performance of this fund house from a time well before the crisis relating to the decision to wind up six debt schemes unfolded. So, for us here at PrimeInvestor, this question of what to do with your holdings is not tough to answer.
Our MF Review tool has already been providing you with calls on most of the Franklin funds (equity, hybrid, and debt) based on their performances. Actually, for the debt funds where the credit risks were high, we had long ago issued, performance notwithstanding, a ‘reduce’ call in November 2019 and January 2021 before the 6-fund lockdown happened.
At this time, after taking into account unfolding news and events and after weighing risks against performance, we feel that we must take a decisive, across-the-board call on all the funds from this AMC.
Our extensive coverage on the Franklin issue and related topic of identifying risks is given below:
- Cut exposure ahead of the Vodafone issue, in November 2019
- The Actual Vodafone Impact in January 2020
- The announcement of winding up and what it means
- How PrimeInvestor identifies risks in debt funds
- Similar risks in debt funds from other AMCs
- Evaluating risks in debt funds
- Will demat of your FT units help
- Neither the regulator nor regulated entity to your rescue
As of December 2020, of the 34 open-ended Franklin funds, 16 did not have an opinion in our MF Review Tool as these funds did not meet our criteria to rate or review (either because they were thematic like international or too small).
11 funds featured a ‘sell’ call, 2 funds had ‘reduce exposure’ and 5 were ‘holds’ in our review system. On the 6 debt schemes that were closed for redemption since April 2020, you can view what our calls were just before they were shut.
Now, we have decided to issue a ‘sell’ call on all the open-ended funds you hold in Franklin Templeton India.
We understand that this is a sweeping decision. But it is one based on objective analysis of the situation rather than subjective opinions. We want to assure you that we did not take this lightly or in haste.
#1 Equity under-performance
Franklin Templeton’s equity funds have not been doing well for a few years now. Refer to the table below, which lists the rated equity funds. Most of these funds have low Prime Ratings and also slipped over the course of the past year. Most were either ‘Sell’ or ‘Reduce’ in our MF Review Tool or at best a ‘Hold’. These calls have been substantiated in our various quarterly reviews of 2020.
Franklin’s equity funds have steadily lost to peers for multiple reasons. Some of them lost out on being too value-conscious and missing out on substantial rallies in a narrow universe of stocks (like Reliance Industries that peers like Axis Bluechip rode on). A few others (like Franklin India Focused Equity) lost out on top concentrated calls (Bharti Airtel call a couple of years ago) not working for a good while.
We are not providing a substantiation for each review call here as we have done that earlier. Suffice to say that we had gradually moved our calls in some of them to a ‘reduce’ where the margin of underperformance (with benchmark) gave some leeway to catch up and issued ‘sell’ calls where the underperformance margin was too high to make a bounce back.
For example, the current market has seen many underperforming funds or those with value strategies bounce back in their 1-year charts with high returns. Franklin India Bluechip for example, is one of them. But so were many of its peers like SBI Bluechip or ABSL Frontline Equity. Still, despite this frenetic market move, Franklin India Bluechip lags the Nifty 100 TRI by 1.4 percentage points over a 3-year period. A simple Nifty index fund like the UTI Nifty index would have delivered 13.3% annually over these 3 years as opposed to 11.1% from Franklin India Bluechip.
In other words, even a massive rally is yet to close the longer-term underperformance. So is the case with Franklin India Focused Equity. Its 1-year outperformance notwithstanding, the proportion of outperformance against category remains 23% when you look at the 3-year returns rolled for last 3 years! This has been the case with other funds from the house.
The table below will show the poor consistency in performance across key equity funds from the AMC.
We did not have any of the Franklin equity funds in our recommended list barring Franklin India Prima for a quarter up to March 2020. We had changed the call on this fund to a ‘hold’ when it became clear that it had a long way to go to catch up with category leaders. To us, the current rally offers a good exit point for those of you who haven’t.
#2 AUM slide and loss of confidence
In the open-end fund structure, when an AMC shakes up investor confidence in some of its schemes through unexpected actions, others don’t escape unscathed. In deciding to abruptly wind up six of its debt schemes which were very popular with retail investors and were indeed flagships in their category, we believe Franklin Templeton undermined the confidence that investors placed in the fact that this fund house was conservatively managed in their best interests.
When the winding up notice was issued, we had recommendations on some of the other funds that were not shut – Franklin India Corporate Debt Fund, Franklin India Liquid Fund and Franklin India Savings Fund. Though these funds did not suffer from any credit event and did not see any performance dip (and so our ratings remained high on them) they saw sharp withdrawals by investors that reduced their AUMs. The table below captures the AUM loss on the debt schemes, after the winding up announcement.
In open end debt funds, redemption pressures can trigger a dilution in portfolio quality and force a fund to hold more cash equivalents to meet redemptions, which is negative for performance. AUM fall can also quickly lead to concentrated exposure and enhance a debt scheme’s risk profile even if the holdings are top-rated. This was a key reason we removed Franklin Savings from our recommendations in our June quarter review. We removed Franklin Liquid too as we saw AUMs fall steadily.
Redemptions were managed well by the AMC without borrowing in these cases. But in some funds such as Franklin India Corporate Debt, a good part of the portfolio remained undeployed, which could hurt returns, even though the AUM was stable after the initial fall.
We are therefore changing our Hold ratings to Sell in these remaining debt funds. At this juncture, this call is not on current performance but on possible sub-optimal performance going forward due to redemptions. Hence, with the few debt funds that are a hold, AUM declines and portfolio potential are reasons for our exit call now.
#3 Botched handling of events
What ailed the six debt schemes of Franklin India a year ago was that they had taken on high credit risks to deliver high returns assuming that market conditions would always be favorable in the bond markets, without budgeting for either market uncertainties or paying enough heed to risk and liquidity management that is essential in open-end funds.
Having been caught between a rock and a hard place when bond market liquidity tightened and redemptions threatened, the fund house should have come clean with its problems to its investors. It ought to have stuck to SEBI-specified borrowing limits (without getting back-door waivers) and convinced the regulator that gating flows, at least partly, was the best way forward.
If it felt that the problems were too entrenched to resolve and winding up was the only way forward, it should have sought unitholder approval before winding up after putting all the facts before them. What happened instead was a sudden ‘fund lock down’ (much like the lockdown that the country was placed in). Being able to pull out your money at any time is the fundamental promise that an open-end mutual fund gives its investors, and we feel that violating this promise is the worst thing a fund can do.
Having signed up for a market-linked vehicle, investors wouldn’t even mind poor performance as long as they have the ability to exit at a transparent price. But Franklin India’s actions denied investors this opportunity. That its debt schemes were favoured by many small investors seeking regular income, retirees and those investing emergency money, didn’t seem to weigh with it when it made this decision.
The AMC also failed to convey adequately why it was compelled to act, as it did, to investors. Instead of an unconditional apology for failing to protect one’s money, it seemed to take a moral high ground stance of ‘we preserved value for investors and didn’t have a choice’.
The non-disclosure of the forensic audit findings, and allegations doing the rounds from this report on the AMC’s top personnel/relatives redeeming their units just ahead of the scheme closures, only add further layers of complexity to this case, confusing investors about the quality of governance at the fund house. Recent reports of the group exerting diplomatic pressure for a ‘fair trial’ does nothing to shore up this lost confidence.
All these present investors with additional uncertainties to contend with, should they continue with their investments:
- There could be a flight of AUM from Franklin funds, which presents a particularly acute risk for debt funds.
- There could be flight of talent. The Indian asset management industry is a competitive field and the experienced managers could make for acquisition targets from the other leading AMCs.
- One cannot rule out a change in the sponsor itself. Many foreign money managers have thrown in the towel on their India operations citing a nascent market and high compliance costs. Though Franklin has remained entrenched in the Indian markets over the years as other foreign sponsors have retreated, a blip in Franklin India’s asset growth or regulatory risks in the form of adverse findings or penalties may very well prompt a rethink. While your assets will be safe in this situation, you may still have to deal with a period of uncertainty and a change in management/ownership.
Taking into account these new risk factors, besides performance, we think that our subscribers should move on to better funds from other fund houses. Hopefully, other fund houses have learnt lessons from Franklin India’s missteps.
Taking credit when it’s not due
We see some curious statements and claims being made in social media. One proclaimed with a measure of pride that the closed debt funds of Franklin India have turned cash positive fully now. The other stated that the NAV of those funds have reclaimed their value as of the date of closing (“Only investor interest matters, Baat Khatam!”)
Such claims and assertions are hardly anything to boast about, in our view. There is little to crow about in turning cash positive and that too after a year (in the case one of the funds Franklin India Income Opportunities)! As an investor, would you rejoice that the funds lost close to Rs 4,500 crore of your money in paying loans that should have been avoided in the first place?
And for those who posted that the NAV is higher than April 2020 – how else will any fund that is invested in interest-earning instruments behave? If the NAV did not grow, it calls for suspicion! That’s lesson 1 in income accrual, isn’t it?