When it rains, it really does pour. Ever since Franklin Templeton’s fateful decision to shut down those six debt fund schemes, things have gone from worse to woreset for the fund house. First, they couldn’t handle the surging redemptions, so they decided to shut down the schemes. Then Jennifer Johnson, Franklin’s global head, decided to blame SEBI’s circular on capping MF exposure in unlisted bonds for its fiasco. Then SEBI was like “don’t you get cute with me, shut up and focus on cleaning up your mess” and the Franklin was like “sorry, sorry, we didn’t mean it, a thousand apologies, please don’t make life difficult for us”.
Then sometime in May, there were reports that Franklin erroneously sold ICICI papers from Franklin Ultra Short Fund. And then Chennai Financial Markets and Accountability (CFMA) filed a Public Interest Litigation (PIL) in the Madras High Court seeking a probe into the conduct of Franklin. The Madras HC issued notices to key personnel, including Santosh Kamath, the CIO of Debt.
As a slight aside, CFMA had issued a press release and had also created a Change.org petition, and one thing stood out for me:
For long the Mutual Fund industry has been running a campaign “Mutual Fund Sahi Hai” in association with AMFI to hypnotize, mesmerize and orient the mind of the common people, who are largely middle class, that the amount invested in Mutual Funds is safe like that of Bank FD. The small disclaimer at the end of offer document, “Investments in Mutual Funds are subject to Market Risk” does not absolve the mutual funds, its trustees, fund managers and KMPs from cheating, fraud, arbitrariness and imprudent investment decisions.
The question of – will investors trust in mutual funds and specifically debt mutual funds be dented post the Franklin episode seems interesting and I’ll pick this up later.
But the bad news for Franklin didn’t quite end there. Last week SEBI finally ordered a probe into the fiasco. And then, it got even worse when the Gujarat High Court passed an order after the promoters of Rasna had filed a suit in Gujarat High Court seeking a stay against winding up of the schemes. Oh, the mention of Rasna brings up so many childhood memories, no summer was complete without Rasna – anyways, a movie will be made on my childhood, laters.
The Rasna guys alleged that Franklin failed to obtain the consent of unit holders before deciding to wind up the schemes. They also asked that their redemption requests be honoured as of the NAV of April 23rd, they had Rs 6.55 crores in Franklin debt schemes. Oh, and Franklin had scheduled a vote of unitholders asking them to choose between the AMC or Deloitte to aid the trustees in disposing of the assets to recoup money and pay back the investors. But the Gujarat HC stayed the voting process. Franklin moved to have the stay lifted saying – hey Gujarat HC, SEBI is the main baap, don’t poke your nose where it doesn’t belong. The case of whether the Gujarat HC’s nose belongs in this smelly matter will be heard on Monday (June 8th)
This brings up several interesting and puzzling questions, let’s undress them one by one slowly.
Was Franklin supposed to obtain the consent of unitholders?
In its notice, Franklin said cited 39(2)(a) of the SEBI (Mutual Funds) Regulations. Here’ what that section says:
39. (1) A close-ended scheme shall be wound up on the expiry of duration fixed in the scheme on the redemption of the units unless it is rolled-over for a further period under sub-regulation (4) of regulation 33.
(2) A scheme of a mutual fund may be wound up, after repaying the amount due to the unitholders, -(a) on the happening of any event which, in the opinion of the trustees, requires the scheme to be wound up; or
(b) if seventy five per cent of the unit holders of a scheme pass a resolution that the scheme be wound up; or
(c) if the Board so directs in the interest of the unitholders.
And then section 41 says:
41. (1) The trustee shall call a meeting of the unit holders to approve by simple majority of the unit holders present and voting at the meeting resolution for authorising the trustees or any other person to take steps for winding up of the scheme.
Should the courts even be getting involved here, do they have jurisdiction? Isn’t SEBI supposed to be the big bad wolf here?
Look, I’m no bloody Lawyer, and I failed my 10th miserably, and I have the IQ of an empty Rasna dabba. But to me, it seems like Franklin really doesn’t need to obtain unitholder consent as long as the trustees approve it. It seems reasonable, doesn’t it? Does it? Investors are for most parts, idiots, which is why they are entrusting their money to a fund house that is supposedly full of qualified and capable professional geniuses with quantum underwear.
Now, the professionals go looking high returns, buy a bunch of bonds which nobody knows about, a stupid virus ravages the planet forcing a total shutdown of economies, liquidity in the bond market dries up like a lake in Bangalore, people queue up to withdraw money from Franklin debt schemes, Franklin calls buyers and says – hey, we have amazingly good bonds with high returns, would you like to buy, the buyer on the phone coughs and sneezes, the Franklin bond trader gets scared of contracting Corona through the phone and hangs up, Franklin tells the trustees, listen – nobody wants to buy our shitty bonds, and we need to shut the schemes down, trustees pretending to know everything say – ok beta, follow your heart and dreams.
Now, if the guidelines do indeed require the consent of unitholders, do you think unitholders are smart enough to understand debt market liquidity in AAA, AA, A papers, widening spreads, etc? Hells NO! Most of these idiots bought these schemes because they had 5 shiny stars and high returns for most parts. Now, imagine for a second that the consent of unitholders was needed. A bunch of Franklin lawyers band together and publish some PDFs detailing the reasons and process using English that would make Shakespeare blush in his grave. Retail investors who don’t have a clue what YTM is, read the PDF, can’t make liver or tail, get confused go and vote “no”. And if the redemptions continue, Franklin would have been forced to sell the bonds at distress prices. The ultimate loser would have been the investors.
And no, Franklin isn’t making stuff up about bad liquidity in the lower rung of the credit spectrum. FIIs sold debt like there was no tomorrow in March, credit risk funds are seeing their AUM fall off a cliff. In March, even the US bond market – a $40 trillion market experienced liquidity issues. Due to a variety of factors, even US treasuries saw severe dislocations, now remember, US treasuries are the most held and liquid bonds in the milky way galaxy.
But you can say, if Franklin doesn’t need to get unitholder consent, then they can do anything with impunity tomorrow, fuck it up, like cooking Thai Crab Curry for the first time, say oh we fucked up and shut down the schemes again, right? Fair enough, but I think SEBI, no matter what you think is one of the best financial regulators on the planet and has put in enough checks and balances to stop AMCs and fund managers from engaging in adventurous shenanigans.
What happens to your money?
If you hadn’t gone to ValueResearch, picked these Franklin funds looking at those shiny stars, you wouldn’t be reading this post right now. Instead, you’d be getting drunk and watching Aap Kaa Surroor: The Moviee – The Real Luv Story. Anyways, the way I understand it, Franklin can’t do much without a vote on how to dispose of the assets. So, it looks like investors might have to wait longer, or if there’s a run of good luck, the court orders might just force FT, SEBI, etc to hasten things up. Who knows, there’s a lot of ambiguity right now.
And now to the:
Will people stop trusting debt mutual funds and become all-wise and all sensible?
This is a particularly interesting question – I’m split between this being a useful question and a pointless one. Look, a vast chunk of investors will always be idiots. Will the Franklin episode put the fear of god in investors and force investors to be sensible when allocating to debt? Yes, 8 investors will, but in 4-5 months, people won’t even remember the Franklin episode. The irony is, outside social media, most investors haven’t even heard of this epic disaster.
Investors will be back to looking at stars and sorting debt funds based on past 1 year returns in no time. As for the industry, although at the outset it seems like everything is fine, they are busy throwing Franklin under the bus and distancing themselves from the sordid saga.
In this episode, Rajiv talked about how the promise of same-day liquidity in debt mutual funds is an issue and one that AMCs can fix. But nobody has an incentive to because, why fix what’s broken and waiting to blow up right? 臘
Who’s to blame?
It’s been a while since this whole thing imploded, a lot of blame has been passed around, but still, who’s to blame, really? We may never know, but here’s how I think about this.
Fund managers/CIOs: Obvious candidates to blame. Did Santosh Kamath really have to go looking for yield in places nobody dared? Look, I get hunting for yield in credit risk, fund, as the very name implies that’s what it’s supposed to do. But stuffing risky papers in an Ultra Short Bond Fund, that’s legendary stupidity if you ask me. This is a category people were using to park money for the short term. You can extend the same line of thinking for other funds except for the Franklin Credit Risk fund. What really get’s me, and I didn’t write this previously, is that Franklin labeled these 6 schemes as “Yield-Oriented Fixed Income Schemes”. What in the holy hell & heaven is that! Previously, nowhere had Franklin labeled these as yield-oriented schemes, they pulled this term out of the wazoo when shit got real. That’s a smart way to color the whole situation to subtly say – We told you so and we aren’t to blame here!
Trustees: The role of trustees is to ensure that the AMC doesn’t screw over investors by being reckless. By that count, they have partially failed. But this saga does raise the question of if trustees in AMCs are just rubber stamps or if they are actually equipped and capable of having a spine and being decisive to curtail the adventurism and shenanigans of the AMC.
Take this piece with a pinch of salt since a lot of exposes tend to come out once the ship has sunk:
But there apparently was a lot of churn among the trustees.
ET Prime
Corporate records show none of these independent directors of the trustee company had any prior experience with the mutual-funds industry. It is not clear how well-equipped they were to fight for unitholders’ interests. Were they too dependent on Franklin to make their decisions in a crisis that hit less than six months of their taking charge? Did this work against investors’ interest?
But expecting trustees to be independent and do the right things, even if t means friction with the AMC is a bit of a stretch. It is what they are supposed to but I don’t this is possible at all. Could the Franklin trustees have done more? CLEARLY! But the question is, were they equipped to and or allowed to?
Investors: I wanted to get a sense of what people think about this whole saga now that some time has elapsed. Unsurprisingly, investors think that they aren’t to blame.
Mind you, this is not a proper poll but just gives you a faint idea. Look, Franklin surely is to blame, but so are the investors. But I’m not sure how to think about this clearly. Before the blame falls to investors, there were two layers of supposedly smart and professional people with all the resources in the world – namely the fund managers and the trustees. On the other hand, the high YTMs and equity-like returns were there for all investors to see, are investors blameless?
But the very reason why investors hand their money to a fund manager is that they are incapable of investing their money. But I think the bottom line is – AMCs are for-profit entities. A lot of people refer to AMCs as fiduciaries which I think is incorrect. Their job is to make money, end of story! Regardless of whether a fund is managed by a professional or not, it’s your money on the line, and you better not be stupid.
Where does this leave advisors and distributors? Will talk about this in the next post. These guys deserve a special edition.
Another particularity interesting thing to me was the Rasna folks demand that their redemption request be honored as of April 23rd’s NAV. This is really juicy still we’ll talk about this in the next piece in a series of articles I’m writing to help me think and in the process learn about some important and interesting things about the debt markets. Join me or spit at me, if you think this is garbage.