There are 61.35 Lacs (no of folios) debt mutual fund investor, Invested in 329 different schemes. Total AUM of debt mutual fund as on March 2020 is 11.47 Lacs crore i.e. about 50% of total mutual fund AUM in India. However-
In last one year, Indian capital market saw some big events, Events like-
PNB Nirav Modi scam
DHFL fixed deposit
PNC co-operative bank
Fixed maturity plan of Kotak and HDFC AMC
Zee group (Essel) and idea Vodafone paper write off
Yes bank moratorium
Yes bank tier 1 bond write off
Franklin debt fund fiasco
These events in short span of 2 years staggered the entire financial system. Retail investor not just lose the trust on the system but also started shifting to traditional asset class like gold, real estate and fixed deposit with public sector banks.
Indeed Franklin Templeton news was top trending in google trends investing in last 30 days. Franklin templeton debt mutual fund was searched more than IRCTC share and SBI cards share.
Why this has happened?
These event happens just because of greed perhaps people forgot the basic-
It is not High risk High return, its Higher the return, higher the risk.
(Since most of the people don’t know what is risky and what is not, it is better to derive the amount of risk from the amount of return)
What is risk free return-?
Warren buffet in recent Berkshire Hathaway annual meeting answered this question-
He says “the yardstick for me is always the U.S. (Govt.) Treasury and when somebody offers you quite a bit more than the U.S. Treasury, there’s usually a reason….There’s much more risk”
Going back to the topic-What is high return in Indian prospects-?
Anything more than government bond carries the risk. Recently RBI has 10 year bond yield at 5.79%, thus this become the benchmark. (Considered as risk free rate of return or Rf)
It means government is taking loan for 10 years at 5.79%, so if anyone be it bank, NBFC or any other person offering you more than say 6% or so on there is a risk - Risk of default
What people do vs what is the reality-
What people think-
They consider google as their best advisor
STAR ratings of mutual funds is the best criteria of investing decisions
Anything against the google opinion advisor hurt them the most.
Here is the reality-
Analyzing debt mutual funds (in fact not just debt but all the mutual funds) are not easy, Regulatory structure of debt mutual fund in India is very complex. Analyzing all the aspects and complexity require lots of time, extensive research and skill set.
Let’s understand how complex is the funds system-
As per the Categorization and Rationalization of Mutual Fund Schemes, a mutual fund schemes are classified into 5 part
Solution Oriented Schemes
As the name indicated these 5 schemes invest majority of their money in respective asset class. Like Equity scheme invest majority in Equity, Debt scheme in debt and so on so forth.
What is debt mutual fund ?
Debt mutual funds invest in various debt instruments of different maturity based on object of the fund. SEBI has categorized debt schemes in 16 parts-
Category of debt funds and where these mutual funds can invest-
Overnight fund – 1 day maturity
Liquid funds – Debt & money market Securities up to 91 days of maturity
Ultra short duration fund – Debt & money market Securities with duration of 3 to 6 months
Low duration fund – Securities with duration of 6 to 12 months
Money Market fund – Money market instrument having maturity up to 1 years
Short duration fund – Debt instrument with duration of 1 to 3 years
Medium duration fund – Debt instrument with duration of 3 to 4 years
Medium to long duration fund- Debt instrument with duration of 4 to 7 years
Long duration fund- Debt instrument with duration more than 7 years
Dynamic bond- Investment across the duration
Corporate bond fund- 80% investment in AA+ rated bonds
Credit risk funds- 65% investment in corporate bonds (Allowed investment in below AAA rated bonds)
Banking and PSU fund- 80% investments in debt instruments of bank, PSU and public sector financial institutions
Gilt Fund- 80% investment in Government securities
Gilt fund 10 year duration- 80% investment in government securities with portfolio duration of 10 years
Floater fund- 65% investment in floating rate instruments
I am sure after reading all 16 category of schemes you must have realized that it’s not that easy to understand. Let me assure you here it is tougher than understanding equity.
Where does debt mutual funds invest ?
There are different kind of money market and debt instruments where these Mutual funds invest (Before November 2019 mutual fund was allowed to invest in unlisted debt instrument as well)-
Money Market (short term)-
Government bonds ( GSecs )
a. T- Bills ( Treasury bills)
b. Cash management bills
Certificate of deposit (Cd’s)
Commercial papers (CP’s)
Call money papers
Repo- Repurchase agreement
Debt Instruments- (Long term)
Mortgaged backed securities
These 16 category of schemes invest across the money and debt market instruments as per the mandate of SEBI and their fund house and schemes investment strategy.
Mistake investors usually made-
The biggest mistake one can do is by investing in debt mutual fund based on past return history.
No alignment in scheme goal (fund type) and your time horizon viz.
a. Investing retirement money in credit risk fund
b. Investment in short duration fund to park liquid money etc.
Over reliance on AMC, relationship managers and credit ratings-
a. Usually people go by AMC like HDFC, ICICI, Kotak etc. but this is not the right approach. Franklin is also a big fund house but results is before us.
b. Remember Companies pay for the instruments rating to credit agencies (there is conflict of interest) One should not over rely on ratings
What should investor look for-?
Considering the amount of complexity in the overall debt mutual fund, it’s not easy to analyse debt mutual funds for the laymen while
There are good alternatives to debt mutual fund, Investor should explore such alternatives. Some of the alternatives are –
Fixed deposits with leading banks
Fixed deposits with NBFC’s with good anchor (parent group)
NCD’s of good business house like TATA, Bajaj, Mahindra
Government bond (held to maturity)
Things to avoid-
Avoid instruments of companies with high leverage e.g. Vodafone idea
Corporate governance issue (DHFL, Indiabulls)
Poor sector (Power, Infrastructure, real estate, aviation etc.)
It is really important to align your time horizon with instrument you are investing in. Like there is no sense of investing in equity for 1 years’ time. Likewise investment of emergency fund into 1 year NCD or bond is not apt.
It is strongly advisable to have a good financial advisor (not the broker or distributor/agent)
Now coming to the Franklin fiasco-
Why Franklin Templeton has to close some debt scheme-
Recently Franklin has announced closure of 6 mutual funds schemes, these schemes has AUM of more than 25000 crore.
What does mutual fund scheme closure mean?
Closing of mutual fund scheme mean now Franklin will not accept the new investment in these schemes and exiting investor cannot redeem their investments, they cannot withdraw money.
What went wrong?
As we saw debt mutual funds invest in various debt instruments with different maturity. These instruments may or may not be listed (SEBI has mandated debt funds to invest in listed instruments only in Nov 2019 but they can carry their existing investments)
So Schemes used to redeem units out of new inflow in the schemes but now due to the bad events and coronavirus, the inflow has reduced and as per rule they can borrow up to a certain extent for redemption, but that limit was also over.
Since investment that they have made is not so liquid, they left with one option i.e. closure of scheme.
What are the option with Franklin-
Now Franklin will start liquidating its assets (bond, debenture etc.) as and when they matures or they found buyer or liquidity coming in the debt paper they have invested in
Once liquidated, they will pay off the investor. Investor can have loss in these investments forgot about the return. And there is high chance of haircut of 5-10%
People are saying it's because of COVID-19 but it is not so, the problem is even big .
The problem statement- (Not just with Franklin but with some other AMCs also)-
In simple language debt mutual funds are into lending business
Unlike banks lending by mutual funds are not much regulated
While many banks went slow on corporate funding, corporate find debt mutual funds as a lender
Many of the mutual funds lended money to corporate with poor credit worthiness
Credit rating business we all knows how it works. (Conflict of Interest and lagging indicator)
Fund manager, fund houses got fees on money inflow. For sales manager of fund house incentive is on AUM & not on safety of clients money.
Do you feel even your advisor understand all these complications?
Despite of being such a big global franchise, experienced fund manager, they have invested in Vodafone paper, Yes bank and promoter entity, essel, Dewan housing (DHFL) etc. thus when the going gets tough the consequences are harsh.
It simply tell us one basic thing- Higher the return mean higher the risk.
We earlier highlighted issues with Franklin mutual funds back in Feb 2020, even before corona virus- Here is the abstract-
15 Feb 2020
Firstly we do not recommend debt mutual funds, there are better options available in the market.
There are good fixed deposits, High yield government bond and NCD’s. Still if you are investing in debt mutual fund for extra 50 bps a year or for diversification, invest through some advisor, an advisor who knows about-
All 16 schemes
All about money market and debt instruments
You risk profile, time horizon etc. and fund you are investing in
Most importantly underlying companies in your funds
Closely tracking the macro economic scenario
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