October 06, 2021

FT’s Loss-Making Investment In Edelweiss NCDs

On 29 September, there was a sharp rise in the NAVs of some of the 6 schemes of Franklin Templeton MF (FT) that are being wound up.  From what I can make out, in large part, this was on account of NCDs of Edelweiss Rural & Corporate Services Ltd. (ERCSL) being sold off.  These NCDs were due to mature in 2027, and had been sold off for a much higher amount than what they had been valued at, in the books. 

Some investors that I know, saw it as a reason to be happy.  What most of them didn’t realize was that the jump in NAVs was, in effect, little more than a reversal of the fall in the NAVs a few months ago, that had happened on account of a change in the way that the same security was valued.  However, more than that, there is something else that investors need to be aware of.  These NCDs have been a loss-making investment whose outcome can be clearly attributed to choices and actions by FT that were firmly criticized by SEBI. 

Given their long maturity, there was no good reason for these NCDs to have been in the portfolios of some of the schemes.  Given the terms on which the NCDs were issued, they should never have been in the portfolio of any open-end mutual fund scheme. More specifically, as I had mentioned in a recent post, SEBI’s order documented FT’s failure to enforce a put option because of the way that the NCD agreements had been written.

In a nutshell, in April 2020, FT told ERCSL that it wanted to exercise the put option and exit.  ERCSL shot down FT’s request, and there was nothing that FT could do about it.  FT had itself only to blame for that, because of the terms it had agreed upon.  

If that put option had gone through, FT ’s schemes would have got back the investment at face value, which would have been the best outcome for the investors.  Instead, FT was compelled to look for buyers in the secondary market. What made matters worse was that, soon after that rejection, the rating of the NCDs was downgraded.  The NCDs then continued to remain on the scheme books for the last seventeen months, until their sale, last week.

In that backdrop, I now suggest you look at the sale value of the NCDs, relative to their face value, and the value at the time of announcing the winding-up. 

Face value of NCDs: 600 cr
Value as on 23 Apr 2020: 593 cr
Sale value (29 Sep 2021): 473 cr

I concede that the ratings downgrade may have impacted the sale value.  But would that have mattered if the terms of the NCD agreements allowed FT to freely exercise the put option?

Now that the sale has been made, it's easier to quantify the loss.  I would urge whoever looks at the appropriateness of SEBI’s fine on FT, to think about that while passing judgment.

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