Santosh Kamath of Franklin Templeton MF is back with a new credit AIF

In 2023, Kamath stepped down as head of fixed income of the mutual fund segment to head the newly set-up alternatives business.

According to a private presentation accessed by Mint, the AIF will only lend to financial services-related companies and is targeting an internal rate of return (IRR) of 11% to 14%.

Franklin Templeton said the fund will focus on developing the missing middle segment of the credit market. They are targeting pockets where they can get 10-15% returns. It said that sub-10% (2-3% over risk-free rates) AAA/AA-rated companies have access to funding through banks and capital markets. Those at the other end, above 15%, are accessed through high-yielding debt/distressed funds/venture funds.

The fund will make periodic payments through quarterly coupons/amortization. It will seek to “minimize liquidity drag on investor returns through predictable and time-bound capital calls.”

“Subject to market conditions, the intent will be to deploy within 3 months of fundraise. Under current market structure investor returns get diluted by ~1.5-2.0%,” it added. The fund has no restriction on minimum credit rating requirements and has to allocate a minimum of 51% in unlisted securities.

Kamath declined to comment on his new venture.

The fund manager’s journey

Kamath joined Franklin Templeton MF in 2009 and started investing in bonds that most others were not touching due to their subpar ratings.

His credit risk strategy worked well until it didn’t. During the covid-19 pandemic, when investors panicked and rushed to withdraw their funds, the ninth-largest fund house realized there wasn’t enough liquidity to service all the investors. As a last resort, it tried to borrow to service the redemptions, but when that also fell short, it resorted to winding down the six debt funds in April 2020.

This meant investors could not take out their money and had to wait for the bonds to mature or become liquid. To be sure, investors got their dues on a staggered basis and by August 2023, after 40 months, they got back their money in full. It returned 109% of the AUM that was there on the date (April 2020) when the funds were winded.

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In the aftermath, Sebi imposed a penalty on Franklin Templeton trustee services ( ₹3 crore) and eight others, including Kamath ( ₹2 crore), on various counts of investment strategy mismanagement. 

The credit risk strategy popularised by Kamath lost its sheen after the 2020 debacle. From managing ₹61,837 crore of assets under management (AUM) before the crisis, the ‘credit risk’ MFs as a category now manage a mere ₹20,862 crore, a decline of 66%. Interestingly, the missing hold is increasingly being filled by CAT-2 AIFs willing to take on high-risk private debt.

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Private credit AIF

Kamath seemed to have learned from his past experience. This time, the AIF fund is structured to take on risky bets. For instance, a close-ended fund structure will ensure that it will not be impacted by other investors’ reactions.

Since MFs largely look at only the high-rated (AAA/AA category), AIF funds have a large space to play around with the middle segment (BBB/A category), which comprises close to 3,500 companies. But due to the nature of high ticket size in AIFs, the average investor stays away from such strategies

Ravi Saraogi, a Chennai-based RIA and founder of Samasthiti Advisors said, “Target IRR (of Kamath’s AIF) is 11% to 14% which is before adding cost and tax. Now remove management fee and opex of 1.5% and tax of 33%, for many the tax might be 40% as well, and so if the fund generates, let’s say 13% IRR, we are down after expenses to 11.5%, and after tax (33%) it will be around 7.5% post-tax return.”

Launching a private credit AIF seems like a strategic move for Santosh Kamath, as it aligns with his core expertise in credit strategies, said Dhirendra Kumar, founder & CEO of Value Research. “An AIF structure is well-suited for such an approach, offering the flexibility and control needed for managing these investments effectively, especially after the challenges of 2020.”

Given the 2020 debacle with credit strategies in open-ended funds, this shift to a private AIF is a prudent approach, he said. It caters to financially sophisticated investors who have a clear understanding of the risk-reward dynamics and the risk tolerance required for such investments, he added.

Who should consider investing in the new AIF

This fund is ideal for opportunistic fixed-income investors who are seeking above-average returns and are comfortable with the associated risks, Kumar said.

“Investors willing to take higher credit risk in their debt portfolio for at least six years (four-year tenure, which is extendable by another two years) and with a minimum investable corpus of ₹1 crore can consider this AIF for investment,.” Abhishek Kumar, RIA and founder of Sahaj Money, said.

“As the focus of the fund is to invest in senior debt of companies in the financial space, which are rated between A and BBB, the fund manager is looking to skim the bottom of the debt pool to vie for a moonshot,’ he added. 

Similar strategy had disastrous consequences for small investors who had invested in debt MF managed by same fund manager, Kumar said. “So the fund manager has moved to AIF space to launch a similar fund but with a higher ticket size and is a close-ended fund, so providing immediate liquidity before the maturity of AIF would not be required.”

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