Breaking Trust – The Franklin Experience

When it comes to Trust, there is only one quote that is evergreen and that of course comes from the Sage of Omaha

 “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Debt funds in recent times have been in the news for all the wrong reasons. While the reason for investors choosing Debt funds were due to tax arbitrage, they have been in recent times been more surprised on the negative side than the positive.

One of the best performing funds in recent times has been from the Franklin Stable. The Franklin India Ultra Short Bond Fund – Super Institutional Plan recently had a one year return of 10% – something that was unmatched among its peers.

But like the Taleb quote of Turkey and 1001 days, the whole advantage offered by the fund came crashing down on 16th of January 2020.

Writing off the whole Vodafone exposure may seem prudent even though there is no default for it ensures that investors who are aware of the risks don’t scoot away with the return forcing the fund to sell other good quality assets which would raise the weight of the Vodafone exposure. But by preempting, it also avoids side-pocketing which means that those who have taken the hit don’t have exclusive benefits if Vodafone returns the money it has borrowed.

Since the incidents of defaults started impacting debt mutual funds started, I started to think about whether it made sense to even look at Alpha in funds. Based on my own risk profile, I decided to henceforth move funds more into Liquid of PPFAS or Quantum, the only two liquid funds that don’t have credit risks and at the same time moved a bit more of the assets into Equity.

Afterall, if I am to take risks of a nature that came with Equity funds, I better have the upside of Equity as well. The one year return for UTI Credit Risk fund for example is -15%. Losing 15% in Equity is acceptable, in Debt, it’s a death knell. 

While my own debt investments are fairly diversified (10% approximately per fund), one fund that I gave the benefit of the doubt regardless of my view of the portfolio was the Franklin India Ultra Short Bond Fund – Super Institutional Plan. It was a leap of faith in the ability of the fund manager to extract himself from very sticky investments he loves to invest.

That leap of faith unfortunately has been shattered, not because he has taken a writeoff on the Vodafone but the way it has been taken. Vodafone for all its current misery isn’t dead, at least for now. The write off of the debt is based on the view that its unlikely to repay a cent. 

My own belief in the fund came from their own past. In 2016, Franklin Funds were holding debt papers of Jindal Steel and Power Ltd. On 15 February 2016, Crisil downgraded JSPL’s debt rating to BB+/A4+, from BBB+/A3+. On 29th February 2016, the funds exited the whole investment with fund investors taking a 32.5% hair-cut. The buyer of the troubled bonds was none other than  Franklin Templeton AMC.

Of course, even then there was a controversy whether fund investors should have taken a 25% haircut or 32.5% cut since the buyer and the seller were basically the same. But that was any day better than writing off the investment by 100%.

As an adviser, I had a clear view of most fund houses when it came to debt funds. One fund where I did not have was Franklin and that has been now set to rest. The King is Dead, Long Live the King