23 April 2020 – it was a remarkable date in the history of debt funds in India. For the first time in history, a mutual fund house shut not one but six debt schemes. They proposed to return the money gradually as interest and maturity proceeds flow in and they sell instruments when market sentiments improve. Lots of heartburn, frustration and court cases. To cut the long story short, the Supreme Court of India appointed SBI Mutual Fund as the administrator. The job of SBI MF was to liquidate the assets in the portfolio of the six funds and return the money to investors. Though the Supreme Court instructed SBI MF to do it expeditiously, there was no deadline as such. That is, fire sale of instruments was avoided, which is what Franklin Templeton wanted to do in the first place. A distress sale of assets in an illiquid bond market would have led to lower price realizations.
Two years down the line, where do we stand?
SBI MF, on behalf of Franklin Templeton, has paid back 103.5% of the amount due to investors. The calculation is like this: as on 23 April 2020, the total amount in the six shut schemes was Rs 25,215 crore. Till date, they have paid back Rs 26,098 crore, which is the 103.5% mentioned earlier. Moreover, (a) the cash component in those six funds as on date is around Rs 538 crore and (b) the remaining value in the portfolio is around Rs 763 crore, which is at valuation prices given by the agencies i.e. Crisil and Icra, subject to realization in the market. If we add up all this, we get ~ Rs.27,400 crore, which is approximately 109% of the initial amount of Rs 25,215 crore. Notably, the distribution commission in the regular plans of the six schemes till March 2021 was accrued by FT and as per SEBI instruction, is now part of the NAVs of the funds. The cash component of Rs 538 crore mentioned earlier includes the distribution commission of approximately Rs 79 crore. However, this was contested in the Supreme Court by a distributor association and the distribution of the balance cash has been kept on hold till further orders of the apex court.
Now that the dust has settled, it is pertinent to discuss the takeaways from one of the most standout episodes in the history of debt funds in India.
Risk: we discuss the usual risks like interest rate / volatility risk, credit / default risk, etc. Apart from the known risks, there may be liquidity risk or event risk, as anything can happen in the market at any point of time. In the portfolios of FT schemes, some default issues did happen. But for that matter, there are funds from certain other MF houses that suffered a higher extent of default. The fact that money distributed in the six shut funds so far and cash available as on April 13, 2022 is 106% of initial, shows that the shut-down was not due to credit defaults. The issue was that in March and April of 2020, when sentiments in the debt market were negative in the initial phase of the pandemic, FT faced huge redemption pressure. The portfolio composition being a mix of AAA to A rated securities and liquidity in the system having dried up, the bond market could not absorb the supply without impacting the prices.
What is the takeaway from this? Keep your portfolio diversified, not only across fund categories, but also across AMCs.
Regulation: for shutting down of a MF scheme, the SEBI Act did have provisions, but there was vagueness. Subsequent to the judgments of Karnataka High Court and Supreme Court of India, it is now clear. It requires approval of investors (i.e. unit-holders) for shutting down a fund. Hence the probability of recurrence of a similar event i.e. an MF shutting down a fund(s), is remote. What you have to be careful about is a significant run of redemptions in a fund. To be noted, purchase / redemptions happen every day from any fund. It is not required for you to keep track of everything. Moreover, redemptions can happen for reasons that are not logical, just due to prevailing sentiments. As an example, in April and May 2020, subsequent to the FT fallout, there was redemption pressure on other MFs, even from Liquid Funds. When investors realized that MFs are honouring redemptions and “not all MFs are shut down” (!) it gradually abated.
Conclusion: Mutual Fund as an investment vehicle is robust, and there is a solid framework from SEBI. There has not been, and will not be, any default from a MF. Market issues may happen e.g. default by a bond issuer (e.g. IL&FS, DHFL) or liquidity issue like the one discussed above. That risk will be there, even if you execute investments on your own, without any investment vehicle.