The latest decision by Franklin Templeton Mutual Fund to wind up 6 yield-oriented credit mutual fund schemes could've created a ripple effect on India's corporate debt market, with the managers of fixed-income instruments fearing liquidity risk and higher yields on all top-rated bonds.
On 23 April 2020, Franklin Templeton informed investors that it would be winding-up six of its debt schemes due to large redemption pressure at a time when liquidity in the Indian bond markets has dried up. The combined assets of the six schemes according to Value Research is around Rs. 30,850 crores as of March 31, 2020.
AA-rated Bond Yields witness a sharp Rise
Franklin Templeton's decision impact may be first felt on bonds rated AA and below. Yields on AA-rated bonds had spiked even before the announcement. Data from Bloomberg shows a jump in spreads, or the additional interest sought by investors over government bonds of comparable tenor, ahead of the announcement by Franklin Templeton. On Friday, spreads remained stable at those elevated levels.
As of 24 April 2020, AA-rated corporate bonds for a three-year duration were trading at 240 basis points over the comparable government bond yields. Shorter dated one-year bonds saw an even wider spread of 263 basis points.
Credit Risk vs Liquidity Risk
The main debate among market participants is whether the troubles faced by Franklin Templeton are a consequence of credit and liquidity risk in its own portfolio or a market-wide phenomenon. A report by B&K Securities showed that Franklin Templeton was the sole lender to 26 of the 88 securities in its portfolio. Forty-three securities had 50 percent or more of their borrowings from the fund house.
In the case of such securities, Franklin Templeton may bear a larger share of the risk than other funds in the industry. The large share of securities held by one fund house would also make these securities less liquid.
In the case of such securities, Franklin Templeton may bear a larger share of the risk than other funds in the industry. The large share of securities held by one fund house would also make these securities less liquid. [Source and Copyright © BloombergQuint]
RBI steps in to save Mutual Funds
In a yet another financial headache for India, The Reserve Bank of India again steps in to the rescue and has announced a special relief scheme to help and save mutual funds. Under this Rs. 50,000 crore scheme, banks can borrow funds from RBI at 4.4% repo-rate to lend to mutual funds, or buy bonds held by them thus minimizing the liquidity risk in the dried out sector due to COVID-19 pandemic. The scheme is operational from April 27 to May 11, 2020.
RBI took this decision in order to protect mutual funds from a possible liquidity squeeze as the redemption pressure may create a ripple effect and investors may also shun debt mutual funds in short to medium term.
The scheme was launched to reassure investors and to prevent panicked exits and redemptions thus stopping the domino or ripple effect created by Franklin Templeton's announcement. This has also boosted the liquidity in this market to help AMCs in case of redemptions if needed.
The only obstacles in this scheme are that banks may hesitate in lending to MF AMCs over the fear of default or they might not be interested in buying corporate bonds over quality issues of the asset. On the investors' end, they may not be very pleased by this decision and could look out to exit their schemes in the short to medium term.
RBI also added that this liquidity stress is largely confined to the high-risk debt mutual funds segment at this stage; the larger industry remains liquid.