Star fund manager let down by his own creation

As investor ire rains down on Franklin Templeton over its decision to scrap six bond schemes and halt redemption indefinitely, the spotlight is on Santosh Kamath, the firm’s high-profile chief investment officer (CIO) in charge of debt assets. Known as the pioneer of an investing style that involves bets on low-rated papers in India, Kamath played for higher stakes in the past decade, helping him generate extraordinary returns for the firm’s debt scheme unit holders. But the investment strategy Kamath helped shape for the Indian market has ended up being some kind of a Frankenstein’s monster.

FRESH STRATEGY PAYS

Most debt fund managers in India have grown up in the system handling the duration strategy— putting bets on interest rates by investing in government and toprated bonds. The issue with the strategy was that it did not make money when interest rates rose. So, Kamath was an outlier when he chose to branch out into the credit part of fund management where the wager is on the company’s ability to repay. Having worked as credit risk analyst with Crisil, the move was a natural progression for Kamath, a management postgraduate from XLRI.

The differentiated investment strategy which was generating better returns worked well for Franklin and Kamath as the fund’s debt schemes started attracting huge flows. Franklin’s debt schemes were favourites of investors and financial advisors alike. Under pressure to replicate Franklin’s early success, every mutual fund CIO was under pressure to offer credit risk funds.

Industry officials said Kamath started off well in the previous decade, cherry-picking investments in the absence of major competition. He managed to escape unscathed in the 2008-09 global financial crisis, when the credit markets across the world had frozen. A senior industry official said Kamath survived because the corpus he managed then was much lesser than today and the quality of securities too were better.

STAR PERFORMER

As Kamath’s reputation to generate superior returns rose, investors started pouring money into Franklin’s debt schemes. Analysts said many of its debt schemes returned about 200-300 basis points over most rivals. The speculation in the industry was Kamath got an eye-watering bonus of Rs17-18 crore a couple of years ago. This could not be independently verified.

QUALITY CONCERN

As assets under management grew exponentially, quality also suffered. Franklin had exposure to most indebted groups or stressed promoters, including Anil Ambani’s Reliance group, Essel Group, DHFL among others.

“Flows into credit related debt funds have multiplied in recent years without any filter,” said Ritesh Jain, a former mutual fund CIO. “The issue is fund managers have not been able to find the assets without compromising either the credit pricing or liquidity. This is a wake-up call.”

Another senior industry official said Kamath was the first port of call for lowly-rated companies seeking funds quickly. “He is sort of an expert in credit risk who took quick decisions,” the official said. Kamath extracted his pound of flesh with better rates and more collateral.

Franklin’s dream run in debt was initially interrupted in 2015-16 when its investment in JSPL papers was downgraded to junk. But, after IL&FS defaulted that has a knockdown effect on several NBFCs and indebted companies, investors started raising questions about Kamath’s investing model. Financial advisors, who have been his fans, went against him as Franklin struggled to deal with the pile of lowly-rated papers in its portfolio.

The closure of six credit schemes is a harsh culmination of an investment strategy that paid rich dividends for Franklin Templeton in India. A seasoned debt fund manager said that over a period of time, Kamath ignored ‘liquidity risk’, which is crucial to credit investing. It is also a possibility that Kamath may have known that he was riding a tiger all along.