Why did Santosh Kamath, Managing Director and CIO, India fixed income, Franklin Templeton Mutual Fund, invest in long-term papers when some of funds are meant for very short-term horizon of a few months to a year? Why did he lend large sums to a few companies?
These are two question most Franklin investors have been asking themselves or the mutual fund participants ever since the fund house announced its decision to shut down six debt schemes in April 23. Finally, we have the answer to them. That too, from the man himself. A podcast with Santosh Kamath throws light on the thought process behind his investment decisions. Edited transcript of the podcast:
Contrary to beliefs and expectations, the six funds under winding-up have invested in long term papers, despite certain funds meant for very short-term investment horizon, say, three months to a year.
It is a standard practice to create a portfolio with diversified and staggered maturity profiles – some shorter than average, and some longer. This strategy allows a fund manager to take benefit of pricing anomalies across a broader yield curve.
Most of the funds are classified not based on maturity but based on Macaulay Duration which measures the interest rate sensitivity of the portfolio. This is derived from the Macaulay duration of individual securities which in turn is calculated for the industry at large by two independent valuation agencies as appointed by AMFI. Fund Managers can use floating rate bonds and/ or interest rate reset papers to reduce the interest rate sensitivity of the portfolio. So, while maturity of some of the securities may be longer, the Macaulay duration is low because of the interest rate being floating and not fixed. However, while disclosing the maturity profiles of these schemes we have used final maturity dates for some securities while calculating projected cash flows. Hence the repayments look elongated to some extent.
In a normal market scenario, many issuers might prepay rather than pay higher market interest rates and therefore while maturity of some of the holdings appear long, they may get extinguished earlier depending on market conditions.
Why is there a higher concentration of lending to a few companies? Also, why have you invested in the same companies across the different schemes, for example holding of Vodafone across all 6 funds under winding-up? There are over 20 companies where Franklin Templeton was the only subscriber to the full bond issue. What is your thought process when being the sole lender from capital markets to a borrower?
I am aware that this is a question that has been asked extensively in a lot of forums by investors and distributors alike. Let me break the answer into a few important points.
All the 6 funds have been following a philosophy over the last 10 to 15 years of investment across the rating curve. As a fund management team, we have targeted that all our investment decisions are in line with the stated investment objective and asset allocation. Yes, I agree that there are some common issuers across these funds. But these have been included basis the availability of cashflow and suitability of the security for the fund.
Let me now move to the second part of your question about why Franklin Templeton was the sole investor in some securities. The ownership pattern of an issuance is unlikely to have any impact on the credit risk. I know distribution partners and investors have developed concerns regarding these investment decisions. I want to assure you that all investment decisions were made after appropriate due diligence by the investment management team.
We must keep in mind that there are two sides to every coin….Let me give you some examples…. In the past, there have been instances where widely held papers across AMC’s have defaulted. In 2018 and early 2019, we heard about large ‘AAA’ companies widely held among investors going into stressed mode. Some companies which have had large Public bonds issuances also faced stress and but on the other hand some companies with very few investors have done quite well. Let me share some examples with you ….There is a company called Vastu Housing Finance where we are the predominant holder and the same was upgraded last month in a difficult market environment. It shows the strength of this company. If we go back I remember when we invested in AU Finance or Equitas Finance or Tata Sky or Mahindra World City, we were among the only investor in those companies then and it turned out quite well for the schemes. AU Finance – a small NBFC turned into itself into a bank. Equitas –same story, a small NBFC turned into itself into a bank. Tata Sky got upgraded and many investors started buying those paper and therefore spreads came down and that’s true for Mahindra City and many such names.
The reason I am giving these examples is to highlight that this has been a part of our investment philosophy in the past too and the same has played out well with meaningful outcomes for our investors . The 6 funds have successfully delivered on this philosophy over more than a decade. Therefore, to build doubts and get impacted by rumors is a bit unfortunate.
Finally…any message to our investors and distribution partners?
I acknowledge that it’s been a very tough time for investors and distributors. On behalf of the entire fixed income fund management team, we understand the disappointment and worry you may be feeling with the current situation. The decision to wind up the funds was an extremely difficult one and not a situation we wanted to find ourselves in.
However, I believe this decision was the only viable way to preserve value for our unitholders, despite the immediate challenges this may bring.
We are committed to wind up the portfolio in an orderly manner and expedite remitting the money back. We have 2 funds - Franklin India Ultra Short Bond Fund and Franklin India Dynamic Accrual Fund - which have paid up all their borrowings and are cash positive.
In fact, Franklin India Ultra Short Bond Fund has 13% of its AUM in cash as of June 30th.
In two more scheme, Franklin India Credit Risk Fund and Franklin India Low Duration Fund, the borrowing level has come down to sub 10% from their original levels on April 24,2020. This is without resorting to secondary market sale.
I understand that the delay due to various legal cases have added to your disappointment and inconvenience. We are doing our best to have these resolved at the earliest so that the schemes can start to efficiently monetize assets and return money to you.
We are also working towards listing these schemes on the stock exchanges for those investors who need urgent liquidity.
The market is slowly normalizing and hopefully the economy and the market normalizing process will gain speed and that will further help us in the process of unwinding.
Franklin Templeton has more than 25 years of history in India, and we remain committed to the Indian market, our investors and our distribution partners. I am very thankful to our investors and distribution partners for their patience with us. I am sure with this winding up decision which may have caused disappointment, once the legal cases are resolved it will be our endeavour to monetise these assets at the earliest at the most appropriate value and remit back monies to our investors. I will sincerely thank investors and distribution partners for their patience during this difficult time.
