Fund Ratings — what do they even mean for investors?
April 23, 2020 — again, one of the dates that would go down in the history books for the capital markets in India. Franklin Templeton, one of the oldest Asset managers in India took the decision to wind up six of its schemes in the debt space. This comes as a shock for investors, who have looked at debt funds as a principal-protected structure — however, when liquidity dries up, and redemptions hit, an open-ended fund is left with no choice.
How are debt funds sold?
Over the last 5 years, the debt funds in India have grown by a 6x volume from an AUM perspective (Source: https://www.amfiindia.com/research-information/amfi-monthly). This has also been accompanied in a period of falling rates. While debt mutual funds as an asset class, are an important part of an investor’s asset allocation, its imperative that each fund needs to get measured against its liquidity and risk parameters. For eg: Franklins debt funds, were one of the best performing funds in 2013–15 which resulted in significant inflows between 16–18 (it would make sense if investors were to follow returns). However, when the size of the fund exceeds capacity, not so happy things usually happen to investor risk.
Who was the fund manager and is he responsible?
Franklin was headed on the debt side, by Santosh Kamat — who was rated as one of the best fund managers for a long time. The difficult aspect of a fund management job, apart from managing money, is to decide when to say no to new money. I personally believe the fund house, did a poor job of managing this aspect ( To be honest, most funds do). There comes a time in a fund manager’s role, where he/she needs to take an honest look at the liquidity of the fund and manage it with respect to the inflows. Saying no to new money is hard, but is a fiduciary responsibility of the fund manager/house. The default cycle in India started with DHFL and IL&FS, towards late 2017 where Franklin’s debt funds saw inflows. Investing in credit opportunities through the midst of the cycle was certainly not prudent, especially for the size of the fund.
The Decision to close the 6 funds
The fund house had no choice to close the fund, due to the redemption pressure over the last 6 months ( yes, you heard me right !!) redemptions did not just come all at once in March, the trend started in October 2019. Covid, and the lockdown just accelerated this. The funds had to be closed to protect the remaining investors, to ensure the last set of investors are not left picking up the slack.
The role of Rating Agencies — are they fiduciaries
The rating agencies have always had a principal-agent problem. They get paid by the issuers they are rating. In India, MorningStar has been one of the well-established brands that rate mutual funds, which is looked upon by wealth managers, investors, and advisors. The issue, however, has been, their rating methodology being staid. It was shocking to see an article by MorningStar suspending ratings on Franklin Templeton funds (post them getting shut down — talk about being ahead of the curve). (Source: https://www.morningstar.in/posts/57735/five-debt-funds-franklin-templeton-placed-review.aspx)
Their latest article shows the outflows from each of the Franklin Funds starting from October 2019. It was not very hard for them to have downgraded the funds earlier. Was it a question of not acting on time, or lack of focus will be a separate debate in itself.
The future — does quality research and ratings have a space
Mutual funds as an asset class, allows retail investors to access capital markets in an efficient way. However, there clearly is a need to build a research focussed wealth management firm that democratizes this to ensure investors’ money is protected. The closure of the 6 debt funds of Franklin, could not be a more opportune signal for this to happen.