What is the liquidity drawback in a debt scheme?


What is the liquidity drawback in a debt scheme?

Well, as people say you learn from experiences, it turns out, you do. I was a lover of debt schemes that used to give constant returns of 9-11% on your investments. By debt schemes, I mean investing in debt mutual funds. But soon after Franklin debt schemes closure happened, I just realized I was not allowed to withdraw or invest any more in their fund. Amidst the worsening economic situation, a lot of investors started to pull out there money and it put huge financial stress on Franklin. There were many debt schemes that were stopped and these schemes had an asset under management of close to 31,000 crores. My money was stuck and so was other investor's money. I am grateful to my mentors that I know the importance of diversification and this didn't impact me much.

But where do you think I went wrong or why did the company fail to repay the money back to investors, when demanded?

This is where I went wrong and I am telling you, so you could be careful while investing too. So, I had invested in the Franklin ultra-short bond fund direct - growth. What I failed to notice was that though this scheme was giving astounding returns, it was because it was investing in high-risk corporate bonds and debts and commercial papers which were not particularly AAA rated. Just like individuals have their cibil score, which is checked when you go to a bank for a loan, these instruments i.e. the bonds and debts also carry ratings. So, Franklin was investing in AA- and below rated bonds and debts which accounted for around 90% of the portfolio. The instruments that are not rated AAA are difficult to sell in the market.

Still, you may wonder, but why couldn't the company simply sell the bonds and coupons to banks and give the money back to the investors. Well, here lies the problem. In this COVID-19 situation, neither the company's have liquidity to pay off the debt prior and nor do the banks have the liquidity to buy such risky investments. Banks also try to maintain a low default rate on the money lent and these low rated instruments did not give any bank the feeling of assurance that the money will be definitely repaid, and that too when all companies are suffering from daily losses due to stopped operations.

So, it is extremely important first of all to know that when you are investing in debt funds what is the rating of the bonds and loans that the mutual fund agency is investing in and also, be aware of the situation of the companies that are taking the loan. For eg. one of the borrowers in this scheme was Vodafone but due to the non-payment of debt, there was an immediate reduction in NAV(Net asset value) of investors.

Does this mean, that the money will not be returned to the investors?

No, (a sigh of relief). The money will be returned. However, in normal circumstances, you could withdraw the whole amount but now the situation is different. The company is going for a staggered redemption of the money. What I mean by staggered is, there are some bonds which will mature in 6 months, some in 1 year and some in 3 years. So the company is going to wait for the loans and bonds to mature and then they will return the money to investors. There is another possibility, that the economy may get better in just 1 year if the COVID ends, and then there will be liquidity for these low rated bonds and loans. The company will simply sell them in the market and redeem the investor's money.

Contrary to debt schemes, if you are invested in stocks through MFs, then you can be rest assured that you will have very high liquidity, just that you might have to sell at a lower price when redeeming.

I hope this was interesting for you.

Thanks for reading!
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Comment on any query you had like me to address.

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