It looks like the woes of debt fund investors are far from over. In an unprecedented move, Franklin Templeton Mutual Fund has announced the winding up of six of its debt schemes as it faced severe redemption pressure and illiquidity in the bond markets due to the ongoing Covid-19 crisis. The schemes that Franklin Templeton Mutual Fund has closed are Low Duration Fund, Ultra Short Bond Fund, Short Term Income Plan, Credit Risk Fund, Dynamic Accrual Fund and Income Opportunities Fund. According to data available on the Value Research website, these schemes collectively hold assets of ₹30,853 crore, as of March-end.
With businesses grinding to a halt amid the lockdown, their ability to service debt obligations has become questionable. As a result, many debt fund investors rushed to redeem their investments—debt funds saw one of the highest-ever outflow of ₹1.94 trillion in March. For debt funds, this became difficult to handle as poor liquidity in the debt markets limited their ability to sell the securities. Though the Reserve Bank of India (RBI)took steps, including opening rupee-dollar swap windows and conducting long-term repo operations (LTRO), to improve liquidity in the bond markets, these were too little, too late for Franklin Templeton. So what does this mean for investors in these Franklin Templeton schemes and will it impact investors in other debt funds as well? We try to give the answers.
Investors in the affected schemes
If you have invested in any of the six affected schemes of Franklin Templeton, there’s literally no way out. No investments or redemptions are allowed in these schemes as of now. So you will not be able to redeem, switch out or transfer money from these schemes or start a systematic investment plan (SIP) or invest lump sums in these schemes.
Also, you will receive the proceeds the fund house is able to recover by liquidating the underlying investments in proportion to your holdings. From the investor’s perspective, the fund house will give back whatever money it realizes over a period of time.
How much money you’ll get back will depend on your investment amount as well as the amount the fund house is able to recover. It is uncertain when you will get the money as it will depend on how fast the fund house is able to recover it.
Investors in other debt schemes
The event will also impact schemes of Franklin Templeton Mutual Fund that invested in any of the six schemes, as they will not be able to exit these holdings. For instance, Franklin Templeton India Asset Allocation fund was holding around 46% of its assets in the Short-term Income Fund, as per the March-end portfolio. It will also severely impact the sentiments of investors in other debt schemes of Franklin Templeton, as well as those of other fund houses.
If you are invested in other debt schemes, don’t make this event a turning point for you. Instead, try to assess your fund by doing a portfolio review, asking the right questions and checking your exposure.
A portfolio that predominantly holds securities that are rated AAA and equivalent, and has exposure to lower credit ratings of AA and such in companies with good parentage or names that you recognize as good quality companies should give you comfort. The exposure to unrated papers and lower credit quality should form a very small percentage, say, not exceeding 5%, of the portfolio.
Also, make sure the portfolio does not have concentrated holding. For example, a portfolio that holds a considerable portion in securities issued by banks, financial institutions, NBFCs and HFCs is very vulnerable to a downturn in this segment.
The debt portion is the safe part of an investor’s overall portfolio, so focus on the risk and not the returns. Ask and find answers to how a fund is generating higher returns than its peers and the market, and assess whether you are comfortable with the strategy. Look at your exposure. Unless it is investment in a fund with no credit risk, because of sovereign or quasi-sovereign guarantee in the securities, it is important for a retail investor not to have too large an exposure, say more than 10% of debt allocation, to a single fund.
For most investors, debt funds are a tax-efficient alternative to traditional fixed-income products to provide liquidity and to park funds for different time horizons. Don’t deprive yourself of that advantage by exiting without cause. But at the same time, take only those risks which you understand.
With businesses grinding to a halt amid the lockdown, their ability to service debt obligations has become questionable. As a result, many debt fund investors rushed to redeem their investments—debt funds saw one of the highest-ever outflow of ₹1.94 trillion in March. For debt funds, this became difficult to handle as poor liquidity in the debt markets limited their ability to sell the securities. Though the Reserve Bank of India (RBI)took steps, including opening rupee-dollar swap windows and conducting long-term repo operations (LTRO), to improve liquidity in the bond markets, these were too little, too late for Franklin Templeton. So what does this mean for investors in these Franklin Templeton schemes and will it impact investors in other debt funds as well? We try to give the answers.
Investors in the affected schemes
If you have invested in any of the six affected schemes of Franklin Templeton, there’s literally no way out. No investments or redemptions are allowed in these schemes as of now. So you will not be able to redeem, switch out or transfer money from these schemes or start a systematic investment plan (SIP) or invest lump sums in these schemes.
Also, you will receive the proceeds the fund house is able to recover by liquidating the underlying investments in proportion to your holdings. From the investor’s perspective, the fund house will give back whatever money it realizes over a period of time.
How much money you’ll get back will depend on your investment amount as well as the amount the fund house is able to recover. It is uncertain when you will get the money as it will depend on how fast the fund house is able to recover it.
Investors in other debt schemes
The event will also impact schemes of Franklin Templeton Mutual Fund that invested in any of the six schemes, as they will not be able to exit these holdings. For instance, Franklin Templeton India Asset Allocation fund was holding around 46% of its assets in the Short-term Income Fund, as per the March-end portfolio. It will also severely impact the sentiments of investors in other debt schemes of Franklin Templeton, as well as those of other fund houses.
If you are invested in other debt schemes, don’t make this event a turning point for you. Instead, try to assess your fund by doing a portfolio review, asking the right questions and checking your exposure.
A portfolio that predominantly holds securities that are rated AAA and equivalent, and has exposure to lower credit ratings of AA and such in companies with good parentage or names that you recognize as good quality companies should give you comfort. The exposure to unrated papers and lower credit quality should form a very small percentage, say, not exceeding 5%, of the portfolio.
Also, make sure the portfolio does not have concentrated holding. For example, a portfolio that holds a considerable portion in securities issued by banks, financial institutions, NBFCs and HFCs is very vulnerable to a downturn in this segment.
The debt portion is the safe part of an investor’s overall portfolio, so focus on the risk and not the returns. Ask and find answers to how a fund is generating higher returns than its peers and the market, and assess whether you are comfortable with the strategy. Look at your exposure. Unless it is investment in a fund with no credit risk, because of sovereign or quasi-sovereign guarantee in the securities, it is important for a retail investor not to have too large an exposure, say more than 10% of debt allocation, to a single fund.
For most investors, debt funds are a tax-efficient alternative to traditional fixed-income products to provide liquidity and to park funds for different time horizons. Don’t deprive yourself of that advantage by exiting without cause. But at the same time, take only those risks which you understand.
The rupee touched a low of 76.83 to the US dollar on 21 April and it is expected to remain weak on the back of the economic consequences of the Covid-19 pandemic. A weakening rupee directly affects certain expenses such an education or healthcare planned abroad or the purchase of gold for a specific event like a wedding. A depreciation in the rupee pushes up the cost, in rupee terms, while an appreciation brings it down. This can affect the value of these goals.
Investors saving for these goals can neither predict the direction of the rupee or the magnitude of the impact. Two mutual fund categories—international and gold funds—can help you hedge manage the impact of currency movements on the cost of these expenses. We tell you what these are and how they help.
International Funds
International funds are either actively managed and invest primarily in securities of foreign companies listed in foreign markets directly, or invest in international indices, such as the Nasdaq or S&P 500.There are some funds that act as feeder funds which invest in an identified mutual fund in the international market and then there are funds of funds that invest in units of international funds.
Since these mutual funds invest in foreign currency-denominated stocks, say, stocks listed on the US stock exchanges, they act as a hedge against currency movement for Indian investors.
If you are saving for the education of your children abroad, you may face a situation where you may need a larger corpus in rupee terms than what was budgeted for because of rupee depreciation. Accumulating the corpus in international funds can help offset this risk. When you need the money, you can redeem from international funds in rupees.
If the rupee has depreciated, the exchange rate will work in your favour as you will get more rupees in exchange of the dollars invested in the fund. The depreciation in the rupee against the US dollar has been to the extent of 3.5-4% per annum on an average over the long term and this augments the returns earned from an international fund in rupee terms. “For dollar-denominated expenses in the future, allocation to India-based US funds would help offset the currency fluctuation risks.
Gold funds
The domestic price of gold is a function of the prevalent international price and the exchange rate at which it is imported. A depreciation in the rupee pushes up the landed price of gold.
Typically, households buy gold jewellery over time with the intent of gifting them on the marriage of a child or for other purposes. However, changes in designs and preferences will mean that some value is lost when the jewellery is remade. A more efficient option for you is to accumulate units of gold funds or gold exchange-traded funds (ETFs) over time and redeem the units at the prevailing price of gold when it is required. The funds so realized can be used to buy and gift gold in the form preferred, without the issues related to purity, storage, insurance and others that come with holding physical gold.
The price of gold at which the units will be redeemed and the price at which the jewellery or other forms of physical gold will be purchased will both be the prevailing price of gold. So you will not face a price shock from currency movements or other demand and supply factors when you need to meet the expense.
For a rigid need for gold, the best way to accumulate is through paper gold such as gold funds and ETFsThe advantage of using an asset class like equity to meet the need if the goal is well into the future which may give the investor a better corpus and greater flexibility in how they choose to use the accumulated funds.
What you should do
Given the current turmoil in currency movements, gold prices as well as net asset values of international funds will see volatility. Investing periodically into these funds using systematic investment plans (SIPs) can help you take advantage of interim price movements and also bring down the cost of acquisition.
If you are not looking at meeting specific expenses, investing in the two funds will provide diversification benefits to the portfolio, since they have low correlation with traditional investments such as equity and debt. An exposure of around 15% to each asset class can give meaningful diversification benefits.
Investors saving for these goals can neither predict the direction of the rupee or the magnitude of the impact. Two mutual fund categories—international and gold funds—can help you hedge manage the impact of currency movements on the cost of these expenses. We tell you what these are and how they help.
International Funds
International funds are either actively managed and invest primarily in securities of foreign companies listed in foreign markets directly, or invest in international indices, such as the Nasdaq or S&P 500.There are some funds that act as feeder funds which invest in an identified mutual fund in the international market and then there are funds of funds that invest in units of international funds.
Since these mutual funds invest in foreign currency-denominated stocks, say, stocks listed on the US stock exchanges, they act as a hedge against currency movement for Indian investors.
If you are saving for the education of your children abroad, you may face a situation where you may need a larger corpus in rupee terms than what was budgeted for because of rupee depreciation. Accumulating the corpus in international funds can help offset this risk. When you need the money, you can redeem from international funds in rupees.
If the rupee has depreciated, the exchange rate will work in your favour as you will get more rupees in exchange of the dollars invested in the fund. The depreciation in the rupee against the US dollar has been to the extent of 3.5-4% per annum on an average over the long term and this augments the returns earned from an international fund in rupee terms. “For dollar-denominated expenses in the future, allocation to India-based US funds would help offset the currency fluctuation risks.
Gold funds
The domestic price of gold is a function of the prevalent international price and the exchange rate at which it is imported. A depreciation in the rupee pushes up the landed price of gold.
Typically, households buy gold jewellery over time with the intent of gifting them on the marriage of a child or for other purposes. However, changes in designs and preferences will mean that some value is lost when the jewellery is remade. A more efficient option for you is to accumulate units of gold funds or gold exchange-traded funds (ETFs) over time and redeem the units at the prevailing price of gold when it is required. The funds so realized can be used to buy and gift gold in the form preferred, without the issues related to purity, storage, insurance and others that come with holding physical gold.
The price of gold at which the units will be redeemed and the price at which the jewellery or other forms of physical gold will be purchased will both be the prevailing price of gold. So you will not face a price shock from currency movements or other demand and supply factors when you need to meet the expense.
For a rigid need for gold, the best way to accumulate is through paper gold such as gold funds and ETFsThe advantage of using an asset class like equity to meet the need if the goal is well into the future which may give the investor a better corpus and greater flexibility in how they choose to use the accumulated funds.
What you should do
Given the current turmoil in currency movements, gold prices as well as net asset values of international funds will see volatility. Investing periodically into these funds using systematic investment plans (SIPs) can help you take advantage of interim price movements and also bring down the cost of acquisition.
If you are not looking at meeting specific expenses, investing in the two funds will provide diversification benefits to the portfolio, since they have low correlation with traditional investments such as equity and debt. An exposure of around 15% to each asset class can give meaningful diversification benefits.
It is an old saying that every cloud has a silver lining. The meltdown in India’s markets on account of the Covid-19 outbreak has cut into the value of people’s mutual fund investments. However, on the positive side, this may have also lowered or even completely wiped out any taxable gains, allowing investors to make changes to their mutual fund portfolios without incurring income tax liability while doing so.
According to experts, there are four such changes you can make in your portfolios in order to optimize your gains from any future recovery in the markets.
Revisit your MF asset allocation
A sharp fall in the equity market would have shifted your asset allocation in favour of funds that invest in other assets like debt or gold. If you think you should carry on with the earlier asset allocation, you can now move some money from debt and gold funds into equity funds to take advantage of more favourable valuations. For instance, if a 50:50 equity-debt portfolio has become 40:60 in favour of debt, you can move it back to 50:50 by redeeming your debt funds and buying equity funds.
Investors should not worry about missing out on gains in the process of shifting to equities. For example, if the switch takes two to three working days and the market moves up by 5-10% in the interim, you may miss out on some gains, but a staggered approach can average it out for you in the long term. Nobody can catch the absolute bottom or the top. In the long term, these will get ironed out. To reduce risk, you can do this in a staggered manner. For example, if you want to shift ₹10 lakh from debt to equity, make redemptions of ₹2.5 lakh each over four weeks, accompanied by fresh purchases into equity as soon as the money hits your account.
However, ensure you have adequate liquidity before committing more money to equities in these uncertain times. Keep in mind your risk profile and financial goals while switching your funds. If you are retired or face unemployment you may need the debt portion to survive. However, if you have emergency funds or have a debt corpus in excess of what you require in the next two to three years, you can still carry out this switch.
Shift to funds that are outperformers
Investors have a tendency to hang on to duds. Some of this stems from an inability to admit and accept mistakes in selecting funds in the past. Continuing with an underperforming fund will mean that your money is not working as hard as it could for you. The present volatility owing to the pandemic gives you a great opportunity to start over with a clean slate.
But be careful when choosing an outperforming fund. It is not just a fund that’s done well over the past year but one that’s done well over multiple market cycles. You should carefully examine how it has contained its downside in slowdowns or recessions. Also, pay attention to the rolling returns rather than trailing returns which can be biased by a single point in time. Rolling returns average out returns using multiple start and end points.
Note, however, that although the correction may have wiped out the tax liability which you may have incurred when switching funds, you may still need to pay an exit load, wherever applicable.
Typically, exit load is imposed in equity funds for up to one year after the purchase. You can also use the correction to switch from dividend to growth plans of mutual funds. Budget 2020 abolished the dividend distribution tax (DDT) on stocks and mutual funds and made dividends taxable at slab rate in the investors’ hands. This significantly increases the burden for investors in the 30% tax bracket. Earlier, dividends were tax-free in the hands of investors although DDT was imposed on equity funds at 11.65% and debt funds at 29.12% (including surcharge and cess).
However, remember that a shift from the dividend to growth option and vice-versa is seen as a redemption and is liable to capital gains tax and exit load.
Pare down your portfolio
Many investors buy mutual funds as if they are stocks and end up with vast portfolios of 20-30 schemes. Since a mutual fund typically holds 30-50 stocks, a portfolio of more than six to eight equity funds will tend to just replicate the market on average and cancel out any outperformance or alpha. It will give returns similar to an index fund without the low costs of an index fund. Since index funds mimic the index they track, there is only a small fund management fee you have to pay. Investors should consolidate their portfolios. Get down to four to eight funds, ideally index funds. This will also help you track your funds better and rebalance your portfolio on a regular basis. Such an exercise can also be used to give the portfolio some intra-asset class diversification. For instance, if you own too many large-cap funds, you can consider switching to the multi-, mid- or small-cap categories, depending on your risk profile. Investors should ideally split their money between market segments as per their risk appetite. Those wanting index-like returns should stay with large-cap funds while those prepared to take on more risk can go into mid- and small-cap funds. A multi-cap fund combines the best of both worlds, some years, such as 2019, favour large-caps, while others favoured mid- and small-caps. I would suggest roughly a 60:40 split between large and mid/small, as a rule of thumb.
According to experts, there are four such changes you can make in your portfolios in order to optimize your gains from any future recovery in the markets.
Revisit your MF asset allocation
A sharp fall in the equity market would have shifted your asset allocation in favour of funds that invest in other assets like debt or gold. If you think you should carry on with the earlier asset allocation, you can now move some money from debt and gold funds into equity funds to take advantage of more favourable valuations. For instance, if a 50:50 equity-debt portfolio has become 40:60 in favour of debt, you can move it back to 50:50 by redeeming your debt funds and buying equity funds.
Investors should not worry about missing out on gains in the process of shifting to equities. For example, if the switch takes two to three working days and the market moves up by 5-10% in the interim, you may miss out on some gains, but a staggered approach can average it out for you in the long term. Nobody can catch the absolute bottom or the top. In the long term, these will get ironed out. To reduce risk, you can do this in a staggered manner. For example, if you want to shift ₹10 lakh from debt to equity, make redemptions of ₹2.5 lakh each over four weeks, accompanied by fresh purchases into equity as soon as the money hits your account.
However, ensure you have adequate liquidity before committing more money to equities in these uncertain times. Keep in mind your risk profile and financial goals while switching your funds. If you are retired or face unemployment you may need the debt portion to survive. However, if you have emergency funds or have a debt corpus in excess of what you require in the next two to three years, you can still carry out this switch.
Shift to funds that are outperformers
Investors have a tendency to hang on to duds. Some of this stems from an inability to admit and accept mistakes in selecting funds in the past. Continuing with an underperforming fund will mean that your money is not working as hard as it could for you. The present volatility owing to the pandemic gives you a great opportunity to start over with a clean slate.
But be careful when choosing an outperforming fund. It is not just a fund that’s done well over the past year but one that’s done well over multiple market cycles. You should carefully examine how it has contained its downside in slowdowns or recessions. Also, pay attention to the rolling returns rather than trailing returns which can be biased by a single point in time. Rolling returns average out returns using multiple start and end points.
Note, however, that although the correction may have wiped out the tax liability which you may have incurred when switching funds, you may still need to pay an exit load, wherever applicable.
Typically, exit load is imposed in equity funds for up to one year after the purchase. You can also use the correction to switch from dividend to growth plans of mutual funds. Budget 2020 abolished the dividend distribution tax (DDT) on stocks and mutual funds and made dividends taxable at slab rate in the investors’ hands. This significantly increases the burden for investors in the 30% tax bracket. Earlier, dividends were tax-free in the hands of investors although DDT was imposed on equity funds at 11.65% and debt funds at 29.12% (including surcharge and cess).
However, remember that a shift from the dividend to growth option and vice-versa is seen as a redemption and is liable to capital gains tax and exit load.
Pare down your portfolio
Many investors buy mutual funds as if they are stocks and end up with vast portfolios of 20-30 schemes. Since a mutual fund typically holds 30-50 stocks, a portfolio of more than six to eight equity funds will tend to just replicate the market on average and cancel out any outperformance or alpha. It will give returns similar to an index fund without the low costs of an index fund. Since index funds mimic the index they track, there is only a small fund management fee you have to pay. Investors should consolidate their portfolios. Get down to four to eight funds, ideally index funds. This will also help you track your funds better and rebalance your portfolio on a regular basis. Such an exercise can also be used to give the portfolio some intra-asset class diversification. For instance, if you own too many large-cap funds, you can consider switching to the multi-, mid- or small-cap categories, depending on your risk profile. Investors should ideally split their money between market segments as per their risk appetite. Those wanting index-like returns should stay with large-cap funds while those prepared to take on more risk can go into mid- and small-cap funds. A multi-cap fund combines the best of both worlds, some years, such as 2019, favour large-caps, while others favoured mid- and small-caps. I would suggest roughly a 60:40 split between large and mid/small, as a rule of thumb.
Many people in the populace may be looking at starting systematic investment plans (SIPs) in mutual funds to benefit from the steep correction in equities. Some may also be thinking of buying or enhancing the life insurance cover as the world grapples with the Covid-19 pandemic which has emerged as one of the biggest threat to human life and health in recent history.
But many do not know some mutual fund houses offer life insurance for those investing in their SIPs. Mutual fund houses have varying names for such products. These are basically group insurance policies which are provided free of cost to SIP investors by the fund houses.
The idea is that it acts as a bundled product with no additional cost allowing a retail investor to save systematically for long term financial goals in a disciplined manner and at the same time, if there were an unfavourable event with the unit-holder, the nominee becomes recipient of the life cover proceeds.
THE OFFER
It is a free insurance cover for which one can opt for while starting an SIP. It is mostly provided on all equity and hybrid schemes of the fund house. Most fund houses offer SIP insurance to people in the 18-51 age bracket investing in eligible schemes. No health checkups are required as these are group policies. The insurance cover is valid till 55 years of age. So, if an investor starts a 10-year SIP at the age of 51, the insurance cover will be available till 55 years of age.
THE COVER
The insurance cover is only available in case a person takes an SIP with a minimum tenure of three years. If the SIP is stopped in between, the cover will cease to exist. Insurance coverage will also stop in case of part redemption or switches from the scheme. However, if the SIP is stopped after 3 years, then the cover will continue till the maximum eligible age for coverage. So, if the monthly SIP is ₹1,000 then the insurance cover for the first year will be 10 times higher at ₹10,000, for second year it will be equal to ₹50,000 and in the third year the coverage will go up to ₹1 lakh.
THE PROCESS
While filling up the form one simply needs to go for the insurance option. While in case of claim, the nominee will have to approach the insurance company directly.
SHOULD YOU OPT FOR IT?
The life insurance cover comes free so, if you are planning to invest in the scheme of the fund house you can opt for it.
However, this shouldn’t be the basis of you investing in the fund. Investors should choose a fund basis its past performance and their own risk appetite, investment horizon, life goal etc. While it’s a good feature to have on your investments, investors should not get swayed by it and must not base their choice of fund on this feature alone. Also, you shouldn’t depend on this life insurance cover.
But many do not know some mutual fund houses offer life insurance for those investing in their SIPs. Mutual fund houses have varying names for such products. These are basically group insurance policies which are provided free of cost to SIP investors by the fund houses.
The idea is that it acts as a bundled product with no additional cost allowing a retail investor to save systematically for long term financial goals in a disciplined manner and at the same time, if there were an unfavourable event with the unit-holder, the nominee becomes recipient of the life cover proceeds.
THE OFFER
It is a free insurance cover for which one can opt for while starting an SIP. It is mostly provided on all equity and hybrid schemes of the fund house. Most fund houses offer SIP insurance to people in the 18-51 age bracket investing in eligible schemes. No health checkups are required as these are group policies. The insurance cover is valid till 55 years of age. So, if an investor starts a 10-year SIP at the age of 51, the insurance cover will be available till 55 years of age.
THE COVER
The insurance cover is only available in case a person takes an SIP with a minimum tenure of three years. If the SIP is stopped in between, the cover will cease to exist. Insurance coverage will also stop in case of part redemption or switches from the scheme. However, if the SIP is stopped after 3 years, then the cover will continue till the maximum eligible age for coverage. So, if the monthly SIP is ₹1,000 then the insurance cover for the first year will be 10 times higher at ₹10,000, for second year it will be equal to ₹50,000 and in the third year the coverage will go up to ₹1 lakh.
THE PROCESS
While filling up the form one simply needs to go for the insurance option. While in case of claim, the nominee will have to approach the insurance company directly.
SHOULD YOU OPT FOR IT?
The life insurance cover comes free so, if you are planning to invest in the scheme of the fund house you can opt for it.
However, this shouldn’t be the basis of you investing in the fund. Investors should choose a fund basis its past performance and their own risk appetite, investment horizon, life goal etc. While it’s a good feature to have on your investments, investors should not get swayed by it and must not base their choice of fund on this feature alone. Also, you shouldn’t depend on this life insurance cover.