Everyday you wake up, thinking that today will be better; we all have learnt to live life, one day at a time, cautiously.

Today, obviously, for many retail investors, it was a bad day. It was a bolt from the blue – one of the biggest mutual funds around the world, Franklin Templeton, in India, overnight announced that it was shutting down 6 of its debt schemes.

For those who have invested, at this juncture where every bit of cash counts, this is bad as such abrupt closure means they can neither exit not get any dividends. The hapless investors will get their money back only under two circumstances now – wait till maturity over the next few years or if the mutual fund manages to find buyers for these debt instruments. Essentially, the money invested in the funds now stays locked with no returns; the Rs.24,000 crore worth of debt fund, as of now, has zero value.

The mutual fund stated in a Presser that due to the pandemic, liquidity in the Indian bond market for most debt securities was sapped out, further aggravated by unprecedented levels of redemptions. The six debt funds had a high exposure to low rated debt securities, where liquidity as such was an issue. The Fund anticipated that huge redemptions would as such force it to sell the bonds at very low prices, which in turn would have eroded the underlying value. So Franklin has defended itself by saying that this closure is actually protecting the value of the investors.

Franklin is right from its point of view but this sudden stoppage has put the entire debt mutual funds industry in a state of complete jeopardy. There is bound to a surge in redemptions across all funds. When a huge fund like Franklin Templeton announces closure, there is bound to be panic.

Many in the industry now fear contagion – like a domino, one falls, all will fall – that is the fear. Wonder what the mutual fund industry lobby, Amfi will do? If has tried to assure investors by saying that there is no need to panic as Franklin’s six schemes just constituted 1.4% of the total mutual fund industry. No one is really listening as no one is now sure what will prevent the others from closing their funds?  

It is wrong for these debt MF investors to cry foul today; they knew when they were investing that the higher return on the debt comes not from Govt and large corporate bonds but from lower rung bonds which carry higher risk and thus the higher return. So if they had indeed read the “offer documents carefully” they would have been aware of the risks from before. But the perception is always that debt is safer than equity. But its actually the other way – the risks in equity is known as thus easier to handle while in bonds, you don’t know.

Our advice – best to exit from debt MFs as cash in hand is worth more that it lying dead in some fund. Equity schemes need not really fear as the logic given by our Editor, SP Tulsian makes sense. He says, “indirectly, this will benefit the equity as inflows will increase” and has urged retail investors to never put money now in debt MF.

In this rush to park funds in well known FII mutual funds, many ignored the often-repeated risk factor – “Mutual funds are subject to market risk.” Unfortunately, now we know the risks.