Normally I do not write any mutual fund specific posts because I do not recommend specific funds. But in this case I will make an exception because many people I know have invested in Franklin India Ultra Short Bond Fund and are shocked to see it go down by 4.36% in one day! Yes even ultra short term debt funds go down. Most people forget or ignore the credit risk involved in debt funds. If you want absolute safety of investment go for liquid funds or overnight funds.

Anyway, back to the point, I don't have all the information at this point and will try to update this post as needed. Right now it looks like Franklin India decided to write-off some bad papers. I have a suspicion that one of them is Vodafone Idea 2020 papers. The ultra short term fund has a 4.27% allocation to it. It could be because the Supreme Court rejected a plea by the telecom operators to review its October 24 verdict. So there is good chance that Vodafone will default since the payment to government has to be done by January 23. And Vodafone might go bankrupt if it has to pay the dues. Anyway more news will come and we will know more. For now Franklin India has written-off something big.

If and when the money is recovered, the NAV will go back up if there is no side-pocketing. If there is side-pocketing, which I suspect there is, given that Franklin India sent a circular a few months ago regarding the creation of a segregated portfolios, then your money will be locked in a segregated fund.

So what should you do? Well, if there is side pocketing and if you need the money, you can sell the main fund. You cannot sell the segregated fund anyway until the issue is resolved and if the fund house gets anything out of the junk papers you get some money. If there is no side pocketing then selling and immediately buying might help only if you are already sitting on a loss and there is a chance of recovery. Otherwise there is no point doing anything. Don't definitely do one thing -- which is to sell and invest in another debt fund, because then you are making the loss permanent.

Updated [17 Jan 2020 3:00 pm]

So Franklin India has released an update. It seems like this is a mark-down to zero and "does not indicate any reduction or write-off of the amount repayable by VIL". Which means the AMC will "take appropriate steps to recover the investment proceeds in the best interest of its unitholders". The rating of Vodafone is still BBB- by two rating agencies. Since side pocketing cannot be done without a D rating, it seems like Franklin wanted to protect value for existing unitholders and took this step.

Is it the right thing to do? Well of course it is. If Franklin did not do it then many investors might have redeemed a lot after hearing the SC ruling which would have put pressure on the AMC to sell good papers. Remember there will be few takers of Vodafone papers, so some good papers have to be sold to pay for the redemptions. Which means the existing investors will be left holding bad papers. I totally support Franklin's decision.

Now comes the other side of the coin. We know that there was no side-pocketing but the papers were marked down and hence the NAV has come down by quite a bit. This is like a juicy offer for new investors who want to take advantage of the situation by buying a lot at this low NAV and if the Vodafone debt was recovered in future, the NAV will go up. So it is a free ride for new investors. How does the AMC discourage such behavior? By limiting the amount of new investments. Franklin has limited investments to a maximum of Rs. 2 lakhs per investor (identified by PAN), per day in all plans in aggregate. Well done Franklin!

Fresh/additional purchase (including switch-in, SIP & STP-in) by an investor on a single day across Plan(s) under the scheme will be allowed/accepted only up to Rs. 2 lakh aggregated at
the investor level (same holders/joint holders identified by their Permanent Account Numbers (PAN) in the same sequence)

Update [26 Jan, 2020]

I just received an email from Franklin which clears things up for everyone. So it seems like Vodafone has been downgraded to BB by CRISIL. A rating of BB or below on a bond means it is considered as junk bond (below investment grade). Franklin took it as an opportunity to move Vodafone bonds into a new segregated portfolio. If you were invested in Franklin on the date of credit downgrade (Jan 24, 2020), you will receive your segregated portfolio details with in five business days. So expect something before the end of this month. Also the segregated portfolio will be listed on a stock exchange with in ten working days. I assume now there will be no Rs. 2 lakh restriction that was put in place earlier. Business as usual, unless Vodafone somehow manages to pay up.

The lesson for investors is that debt funds are also risky even the ultra short term ones. So know where you are investing and don't be alarmed if the risk plays out. There is no such thing as high returns and no risk.