In the aftermath of Franklin Templeton Mutual Fund winding up its six debt schemes, industry experts believe credit risk funds are going to face redemption pressure from investors, worried about the safety of their money.
The experts also advised investors to be prudent while investing in debt funds. Smaller fund houses too can face issues as smaller fund size means more liquidity stress in case of redemptions, they added.
“We believe stress even in a small segment of the credit market can turn highly contagious in bad times due to lack of liquidity and extreme risk aversion,” said Pankaj Pathak, Fund Manager – Fixed Income, Quantum Mutual Fund.
Catching investors off guard, Franklin Templeton Mutual Fund late on Thursday announced winding up of six debt schemes, citing redemption pressure and lack of liquidity in bond markets due to the coronavirus pandemic.
“The negative sentiment…coupled with the pessimism emanating from the COVID-19 pandemic, created a situation where a large number of investors started redeeming from fixed income funds, of which Franklin Templeton MF saw amongst the highest outflows,” according to Morningstar.
Meanwhile, industry body Amfi has called the incident an isolated event and assured investors that their money in debt schemes is safe. It said that majority of fixed income mutual funds assets are invested in superior credit quality securities and such schemes have appropriate liquidity to ensure normal operations.
Omkeshwar Singh, Head- RankMF at Samco Securities, said in crisis situations any portfolio with exposure to credit risk debt instruments have risk of liquidity and will be adversely impacted. Making a similar point, Sanjiv Singhal, founder of online investment provider Scripbox said credit risk funds are going to see redemptions by investors worried about the safety of their money.
Credit risk funds take additional risk to generate additional return and the current economic environment has led to defaults, he added.
Further, the debt funds are dominated by corporates and HNIs from investment side and most of the corporates due to coronavirus lockdown have liquidity issues and are therefore aggressively redeeming debt mutual funds to meet cash requirements.
According to Singh, Franklin Templeton Mutual Fund was not able to fund such redemptions and therefore winded up the six schemes. As and when the money is realized, the same will be credited to the unitholders.
“This means investors (of Franklin Templeton MF) have no choice, but to wait so that the liquidity gets back to the lower end of the system as and when the lockdown is over and economic activities start, only then the AMC will pay back the realisable money,” he added.
He further said investors should be prudent while investing in debt funds. They should always look only for quality of the portfolio and completely ignore past performance, big names and big brands while making investments, he said.
Pathak added, “We have been for long cautioning investors against taking credit risk in their debt funds.”
He further said a segment of the corporate debt market (lower-rated credit) in India had been under pressure even before the coronavirus crisis.
The fallout of IL&FS collapse first put the credit market euphoria to sudden end in September 2018 and it could never recover from there despite series of support measures taken by the government and the RBI. Since then, various sectors of the economy — NBFCs, airlines, infrastructure, telecom and even banking jolted the credit market.
In the overall corporate bond market, there are approximate 40-45 per cent papers that are rated below AAA, out of which 20 per cent are not even rated.
With possible further extension of lockdown, these unrated papers might face difficulties in liquidity.
Also, any papers below AAA grade may also be at risk selectively, depending on the industry and cash flow of individual companies, said Amit Jain, co-founder and CEO at Ashika Wealth Advisors.