Kamath, chief investment officer (CIO) for Franklin's debt schemes, was once considered somebody whose unique calls gave regular rewards. But the awe eroded in no time when his bets of investing in little-known but highly risky papers soured.
An engineer by qualification, Kamath joined Franklin Templeton as the head of their fixed income business in 2006, before the financial crisis and when the global fund house was reviving its debt mutual fund business in India. He had previously worked with ING Vysya AMC, Zurich Asset Management, SBI Mutual Fund, CRISIL and Jardine Fleming Asset Management.
Since then Kamath has been instrumental in setting up Franklin's entire research team in India, overseeing the entire debt schemes and setting up the strategy of investing in sub-AA papers or structured debt. These papers, though risky, generate higher yields and are typically favoured for generating superior returns.
The portfolio of these schemes with Assets Under Management (AUM) of ₹25,658 crore is made up of many unknown names. In fact, Franklin Templeton is the sole mutual fund lender to 26 of the 88 papers in their debt portfolio.
"While for many years, these managed credit funds have carefully invested in and supported growing businesses in India, unfortunately the extreme drop in liquidity in the bond markets, coinciding with very large redemptions following the covid-19 outbreak has compelled us to make difficult decisions in order to protect the interests of the funds’ unit holders," said Kamath in a press statement issued on 23 April.
26 years of research experience, 19 years of portfolio management experience and appetite for lower rated bonds gave Kamath the tittle of one of India's best known investors. It quickly gave him the ranking of a star fund manager and the cult around him only grew.
"In a bull market it is easy to generate returns but the real test of a fund manager is to weather the bear market. A task that majority of so-called star fund managers have failed in," said a CEO of a leading wealth management firm.
Franklin's decision to shutting down its suite of 6 credit heavy funds can be directly linked to Kamath's strategy of investing in lower rated paper and the fund house's inability to manage covid-19 related redemption pressures.
When the going was good, Franklin Templeton debt schemes outperformed rivals handily. Mutual fund distributors trying to lure India’s risk averse middle class into mutual fund investments found these funds an easy sell compared to the bank fixed deposits.
This pitch looked compelling after fixed deposit rates dropped in November 2016 as the demonetisation money flooded the banking system. From 1st November 2016 to 1st November 2019, Franklin India Short Term Income Fund--the most popular product among the 6 schemes--delivered a CAGR 7.81%.
This is only marginally higher than the SBI 3-year FD rate of 7% in November 2016, but the scales tilt strongly towards the fund when tax is considered. Capital gains in debt mutual funds held for longer than 3 years are taxed at 20% and have the benefit of inflation indexation. Interest income from fixed deposits, on the other hand, are taxed at the marginal rate, which is 30% for many urban middle class investors.
Morningstar India, a mutual ratings and research agency had rated 5 of the six schemes as ‘silver’ and one of them as ‘gold’ till the very end. Silver is the agency’s second highest rating and gold is its highest. Morningstar only suspended ratings the day after the winding up was announced.
Dhirendra Kumar, chief executive at Value Research Ltd, a mutual fund advisory firm says the fund was always transparent and Kamath's strategy was not hidden. "This strategy made returns for investors of Franklin funds," said Kumar.
This is where the cult builds up. "You blindly begin to follow the returns and the man, without once pausing to think of what if the tide turns," said senior debt fund manager who did not wish to be named.
Franklin did have some blips in its journey which it weathered without any serious questions from stakeholders. For instance, the exposure to Jindal Steel and Power (JSPL) had gone bad in early 2016, but the fund house simply took the paper on its own books and contained the problem.
The strategy of sticking with lower-rated papers backfired in January 2020. An unfavourable Supreme Court decision in January 2020 on Vodafone Idea led Franklin Templeton to completely write off its exposure to the telecom provider. The collapse of Yes Bank in March 2020 and the consequent write down of its debt caused the Franklin story to hit another massive speed bump.
In March when the cover-19 pandemic took hold of the world, equity markets dropped by 25-30% and debt markets yields shot up even temporarily hurting ultra-conservative liquid funds. In the ‘credit risk’ segment, the market simply froze. There were Net Asset Value (NAV) drops because bonds weren’t simply being traded. Faced with a flood of redemptions, Franklin Templeton simply borrowed money to honour them, because it was unable to sell its high risk bonds in the market meet the redemption pressures.
All this while the AMC kept on putting up a brave public face. An April 2020 ‘Market Insights’ note from Kamath said that shorter end products like Franklin Ultra Short Bond Fund, ‘provide a great investment opportunity.’ This is among the 6 schemes being wound up.
