April 26, 2020

The Agony Of Being A Franklin Templeton FoF Investor

By a former Franklin Templeton employee

I have a significant investment in one of the 6 “yield oriented” funds that Franklin Templeton (FT) has decided to wind up.  But it’s my investment in Franklin India Dynamic Asset Allocation Fund  of Funds (FT DAAF) which, despite being comparatively smaller, has caused me much more pain.  Indeed, I will not be surprised if most investors in this, and FT’s other domestic fund of funds (FoF), share this feeling. In this piece, I want to put on record what they have had to endure.  While I shall briefly touch upon my first-hand experience as an investor, I write this more as an observer. Please note that all references here to FoFs are to domestic FoFs.

On Friday, 24 April, I put in a request to switch out of FT DAAF.  For those who may not know, it invests its debt allocation into Franklin India Short Term Income Plan, one of the 6 funds being wound up.

To be honest, before I put in the request, I wondered how was it that this FoF was open for subscription/ redemption, when one of its underlying funds had been shut down.  I couldn’t find any information or fine print.  And when I put in my switch request on the FT website, I can’t remember seeing any cautionary note, either.

The next day, I was in for a shock.  The NAV of this hybrid fund had dropped by over 16%.  This was way, way more than the fall in the NAVs of the underlying funds.  Clearly, there was more to it than met the eye.

After much enquiry and searching, it came to light that FT had applied an “illiquidity discount” of 50% on the NAV of the underlying debt fund.  Quite frankly, this felt like a stab in the back.  But that feeling was quickly overshadowed by what I felt on seeing the fall in the NAV of another FoF: Franklin India Life Stage Fund of Funds- 50s Plus Plan.  As the name might suggest, it is targeted at people in their fifties or older. It tends to have an 80% allocation to debt funds, so it’s quite like a conservative hybrid fund.  You can therefore understand my shock on seeing that its NAV had fallen by over 25%.

It is worth bearing in mind that these funds are not ordinary products.  These are solutions/ quasi-solutions and are positioned as such.  Thus, morally, if not legally, I believe that there is a greater fiduciary responsibility on Franklin Templeton in the way they are structured and managed.  In that backdrop, I’d like to present a few points.

Firstly, it is worth asking as to why did most of these FoFs have such a high exposure to those “yield oriented” funds?  In fact, one of the FoFs can only invest its debt allocation into “yield oriented” funds.  In that respect, one could say that their very design was dubious.  But then it is also worth asking that, as the credit quality of these funds deteriorated over the past 12 months or so, why did FT not make appropriate changes to these FoFs?  I must point out that around 6 months ago, several amendments were made to one of the FoFs: FT DAAF.  The underlying equity fund was changed, as was the basis for the debt:equity allocation.  Yet FT persisted in continuing the underlying “yield oriented” debt fund.

Secondly, when FT took a decision, a few months ago, to allow for segregated portfolios (or side pocketing) across its debt funds, why did it not include the FoFs?  Sure, there would have been difficulties in doing so but then did FT really make a serious effort?  And if it wasn’t possible, why did it not then consider amending the allocations of those FoFs towards high credit quality funds?

As a case in point, look at what happened when the Vodafone holdings were marked down in January this year.  Investors in the underlying “yield oriented” debt funds got the benefit of segregated portfolios.  On the other hand, investors in the FoFs were left in the lurch, having no choice but to take a hit on their investments.  

Which brings me to the current issue, which actuated this piece.

For starters, without getting into the legality of it, was the idea of an “illiquidity discount” in itself the best solution that FT could think of?  Indeed, was it even in the best interest of investors (as FT likes to frequently proclaim)? 

Far from it. 

The decision to shut the 6 funds wasn’t taken overnight.  FT could have simultaneously worked on transitioning FoF investors into high credit quality funds.  In the worst case, they could have temporarily shut these schemes till the transition was over.  What FT has done is to virtually force the illiquidity discount on its FoF investors. 

Be that as it may, I wonder what is the basis of a 50% discount. These were not individual bonds- these were funds managed by FT itself.  What’s more, such a stiff discount throws open the possibility of short term investors jumping into these schemes and diluting potential gains for the existing investors. 

And having done what they did, couldn’t they have clearly communicated this to FoF investors?  The decision to apply this discount was taken on the night of 23 April.  As far as I can make out, there was no mention of this in any press release.  The only public document that I have seen was a plain paper note on their website which states that effective 24 April 2020, the “illiquidity discount” would apply.  That document appears to have been uploaded on 24 April at 11:23 pm.  That’s more than 24 hours after FT’s valuation committee decided on this “illiquidity discount” and over ten hours after the cut-off time for redemptions/ switches on 24 April.  While I would dispute the lawfulness of the “illiquidity discount” per se, applying it on the NAV of 24 April is especially questionable.

But personally what I find most striking in all of this is the pettiness of the amount involved.  All together, these FoFs hold merely ~1% of the AUM of the 6 “yield oriented” funds.  I struggle to see how FT’s actions can be fair and equitable to the investors in these FoFs.

I mentioned earlier that I felt as if FT had stabbed me in the back.  But if I keep aside my experience as an investor and look at the present episode as an ex-employee, I actually feel an even greater pain, and some sadness.  The Franklin Templeton that I remember, when I worked there many years ago, was a firm that truly empathized with its investors.  I used to take great pride in being a part of this firm.  I sincerely hope that all of this is a mistake and that FT rectifies this injustice to its FoF investors.

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