Franklin Templeton | Portfolio Yoga

Franklin, Archegos and the power of Narrative

Franklin Templeton has made more news in the last one year or so than the rest of the Mutual Fund industry combined. Then again, I cannot remember the last time such a high profile asset management company decided to shut down and lock out investors in one of the premier funds.

Even before they shut down the funds, I felt they broke the trust of the investors in the way they handled their exposure to Vodafone. (Breaking Trust – The Franklin Experience). In a way, I recognized the problem but decided not to act as I stuck with my investments in Franklin both on the debt side and equity. (our family’s first and a major investment for those days was with Kothari Pioneer Prima Plus Fund).

While the locking out decision was painful, it did not impact me for I have always believed in diversification when it comes to debt and the percentage of funds stuck with Franklin was something I could live with. For now, the decision hasn’t been proven to be wrong though we shall have a real answer once the fund has been closed.

The selection criteria for investing in mutual funds for me basically falls into two buckets. Invest based on past performance or invest based on philosophy. Regardless of the narratives that are sold around by advisors, most just depend on the past returns marrying then with the philosophy when it suits and divorcing them when it doesn’t.

For most fund houses, Philosophies don’t change based on market trends. This maybe a weakness when it comes to the fund house for very few investors want to stick when the returns are sub-par even if the reason for being sub-par is because of the divergence we see in terms of the market vs the philosophy, but as investors I think one should see that the fund house has a strong conviction from which it will not budge much.

The following statement is of Quantum Mutual Fund with respect to their philosophy

That is by following the tenets of Value Investing as a concept for the Quantum Long Term Equity Value Fund since its inception in 2006. Value Investing is defined as “An investment strategy where stocks are selected that trade for less than their intrinsic values. Value investors actively seek stocks they believe the market has undervalued

This from Mirae

The investment process at Mirae has strict investment guidelines ensuring that we contain portfolio risk within the specified levels. We are of belief that the company fundamentals are the primary factors of stock performance.

The difference is stark. Miare is more of a growth oriented fund house while Quantum seems to believe in Value. Both are worthwhile philosophies but when comparing funds, there is no point in comparing the returns of Mirae with that of Quantum. But who has the time for all that research and hence Value funds generally tend to lose out to growth oriented funds.

Interestingly I couldn’t find any such statement by Franklin. But when you have funds that try to cater to everyone, it’s not possible to have such a mission statement in the first place. On their US site, they showcase the breadth of their investment capabilities (Value, Deep Value, Core Value, Blend, GARP, Growth, Convertibles, Sector, Shariah, Smart Beta, Thematic) just on the equity front not to mention Debt and Alternatives to boot.

Franklin talks about Risk Management being one of its most important pillars when it comes to investing client funds but today we know that it ain’t true. But then should one even be surprised. It’s only when shit hits the fan does one realize that something wasn’t right all along.

Nifty Alpha 50 is a Momentum Index that tries to replicate the academic version of Momentum Investing. It’s top two weighted stocks are Tanla Platforms and Adani Green Energy which combined have a weight of nearly 13% in the Index. I have ignored both stocks when it comes to my Momentum Portfolio because of the intrinsic risk I feel exists in both these stocks. If I were to under-perform because of the omission, the question is – am I a good fund or a bad fund.

Most investors tend to barely look at the portfolios of the funds they hold and this means that funds can claim one thing while doing exactly the opposite. A value fund holding growth stocks for example would be an example of such inconsistency and one that makes it tough to analyze the fund in relation to its competition.

It’s for this reason and the fact that finally its returns that the investor is focussed on that we see advisors choosing the best fund of the season. Currently if your advisor is advising fund houses like Axis and PPFAS, you know which data point is driving his decision making.

A couple of days back after Bill Hwang basically blew through his fortune, the Chief Risk and Compliance Officer of Credit Suisse was forced out after the bank took an enormous loss. Here is an interesting thing – Morgan Stanley took an even bigger risk with but I am pretty sure their Chief Risk and Compliance Officer will get a hefty bonus this year.

The risk for all the major players were the same and yet when the final numbers were counted, Goldman and Morgan came out smelling good while Nomura and Credit Suisse sucked. But what if they too had been able to get out (dumping the stocks to their clients before shit hit the fan as Morgan did), would there be any controversy or even news? I doubt so.

What is interesting for me about the entire Franklin episode is the way narratives have been built as if they were the only bad guys around. That kind of statement can be only made if every asset manager is subject to a forensic audit and the results published. But as the case of Archegos shows, it’s not the risk that you take that can bring you down as much as not getting out in time.

This is not to say there is nothing wrong with the way Franklin has gone about its business, it has a lot of wrongs that need to be answered, but if you are getting swayed by the public frenzy of opinion makers, it’s important to step back and reanalyze.

When the Fund Stops – A Book Review

“You are as good as your last trade” is something that is often said to traders. Investors generally have it more easy. Fund Managers when they are generating returns are seen as the Gods of Men and yet as soon as they hit a rough patch, they are thrown to the wolfs and the search for the next Fund Manager with a Midas touch begins once again.

Don’t look at performance alone says everyone and yet its fund performance is the only real signalling mechanism as to whether a fund is doing good or not. What this also means is that when funds are managed using vehicles such as Mutual Funds where investors can withdraw at ease, straying outside the zone of what is seen as acceptable can have very huge consequences.

A book I just finished reading is David Ricketts – When the Fund Stops . The book looks into the downfall of Neil Woodford who was once Britain’s most successful fund manager. It’s a pretty slim book and one that seems written to throw the fund manager under the bus for his omissions and commissions.

From the Indian perspective though there are certain interesting differences in how funds are managed in India vs UK. For instance, its surprising to learn that most funds don’t disclose the total portfolio holdings (Neil tried to do it differently and was more transparent than the law required by disclosing the portfolio fully). Also surprising to learn that there seems to be no limit on the percentage of equity of a company that a fund manager can own.

In many ways, it seems that if someone tomorrow wrote a story about Santosh Kamath and the demise of Franklin Templeton (at least on the Debt side of the table), the story would be similar in many ways. The only difference though is that Santhosh blew up when at Franklin while Neil blew up after leaving Invesco and starting on his own.

It’s easy to blame Neil’s blow up to his decision to own a larger portion of the portfolio in low liquid stocks / small cap stocks which in hindsight seemed to be risky with many losing tons of money. But we get no details about the contribution of similar small stocks in his long career when he generated strong returns for the investors. If he was doing something similar earlier and had succeeded, did he really change gears as the Author seems to suggest I wonder.

The similarity with Franklin is also about how the fund was shut down to allow for an orderly sell off though unlike Franklin, this decision was taken by the Custodian of the fund. On the other hand, the Custodian’s decision to sell the portfolio slam dunk seems to have made matters worse for the investors. For now, Franklin seems to be able to redeem without having to for a firesale and one that would regardless of the quality of assets hurt the investor.

Fund management is tough but so are the rewards. Neil and his co-partner Newman had paid themselves 111.5 Million Pounds since they had launched the fund till their exit. Most investors on the other hand would have suffered.

One of the smartest moves in hindsight that Warren Buffett did was to build a moat around himself by ensuring that his investment vehicle was one with permanent capital and hence not subject to the vagaries of customer’s wishes and wills. Doing different from the crowd doesn’t mean it shall work out all the time or even in time but doing different requires a different type of capital than one that could be called back any day. That seems to be the greatest mistake of both Neil Woodford and Santosh Kamath. They tried to be different while investing money that they knew could be called back any single day.

All in all, the book is a easy read. Not much to learn from it though. I rate it 3/5

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

Analyzing a few Mutual Funds

Mutual funds are one of the ideal vehicles to invest in the markets. But with a plethora of funds, its tough to identify what fund to go with. Should one invest in the top rated (by rating agencies such as ICRA) or should one invest in funds managed by star managers.

Among the large cap funds, HDFC Top 200 fund rules the roost. With Asset under Management of 14,285 Crores, its one of the biggest (if not the biggest) funds that you can find in India. Launched in 1996, the fund has a very impressive track record with compounded growth of 22.37% since launch. The expense ratio for the fund is 2.33% for the regular plan and 1.65% for the Direct plan.

Two funds that have a similar history (in terms of being launched around the same time) come from the Templeon stable.

First off was the Kothari Templeton Prima Fund (as it was called in those days). Launched in 1993, it has been one of the top performing funds with it having a return since launch of 21.80%. But despite such stellar returns, its Asset under Management is just around 3400 Crores. Expense ratio for the fund is 2.32% for the regular plan and 1.14% for the Direct (among the lowest you shall come across).

A year later, the fund house launched another fund – Kothari Templeton Prima Plus. The return for this fund since launch is 20.36% which while lower compared to the above two funds, is still way above many other funds with similar length of operation. For example, State Bank of India launched its SBI Global 94 fund in the same period and the return for that fund since launch has been just 16.08%

To close off, we shall analyze another fund that started off as the first Direct only plan and remains Direct only till date. It has one of the lowest expense ratio’s of 1.25% on assets. While the performance as we shall see has been better than HDFC Top 200 fund, its Assets under Management is a partly 416 Crores. The fund started off only in 2006 and hence the data history is limited compared to that of HDFC Top 200

To make it even, I shall analyze the funds starting from 1st April 2006 to make all of them comparable as well as to provide a better understanding of the risks one saw when the markets dipped in 2008.

First off, a comparison chart of the above funds.

(click on the above chart to get the full picture)

As can be seen, all the funds have beaten the benchmark (Nifty Total Return Index) by a pretty significant margin. In a way, this points out the advantage of actually investing in a fund versus investing in a ETF that tracks the benchmark index. Then again, since all these funds have investments in Mid and Small Cap firms), the logic of using Nifty as a benchmark in itself maybe faulty. But since we do not have the data (Total Return Index of CNX 500), we cannot but compare with what we have got.

While its clear that the funds have performed way better than the benchmark, what a investor should look at is how they performed when markets literally fell through in 2008 / 09. Since Mutual funds need to hold a minimum of 70% of their assets in stocks, when markets crash, they too unfailingly start falling though depending on how good the allocation of the fund manager is, some funds maybe better off than others.

For instance, right now, Quantum Long Term Equity Fund has its max level of cash (nearly 30%). In the event markets crash, this amount cash not only means a lower draw-down but also the fund manager is not compelled to sell stocks at their lows due to investor withdrawals.

While CNX Nifty touched its low in late October of 2008, we shall take the low of March 2009 (right before markets took off) to see how much the funds lost compared to the Index.

In the chart above, what you see is that when markets made their final bottom in 2009, it was performing much better than the Templeton twins. A near 70% draw-down in Prima Plus seems to suggest that while funds perform brilliantly in bull markets, thanks to moves in mid and small cap stocks, when one hits a bear market, its those very stocks that drag the performance to hell.

With markets being strongly bullish, investors are once again rushing to invest into mutual funds. A quote from a recent article in Mint shows how bullish Indians have become in the just concluded financial year compared to 2008

Mutual funds (MFs) invested a record Rs.38,627 crore in Indian stocks in the year to 31 March—more than double the previous highest in the year ended March 2008

Even investments into Portfolio Management Schemes has shot up substantially, but as the above data shows, the question that should be asked is, are investors prepared to wait it out in case things do not turn out as anticipated. After all, markets are not a one way street to riches but a way to channel earnings for a better return in the long term than one that can be achieved elsewhere.

Investing by just looking at performance can be risky if such performance was delivered by taking higher risks. One needs to understand that while there is always a give and take relationship, when the shit hits the fan, all kinds of logical thinking are quickly thrown out of the window with investors keen to get out at any rate possible regardless of the fact that cycles are common and one never knows when this will end and the next begins.

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