Guided Investing





Essel Stake Sale – Is there an arbitrage?

Category : Debt MF, Mutual Fund, Risk Management · by Aug 2nd, 2019

Essel group issued a press release on 31-Jul saying they were selling 11% stake in ZEE to Invesco Oppenheimer Developing Markets Fund for about 4,200 Cr. This will help bring down their total debt and also help repay some debt to Mutual Funds.

ICICI Prudential Mutual Fund released this document on 1-Aug (attached). Along with the information, they also “urged” investors to buy more of the same (troubled) funds citing an investment arbitrage. On the same day, Aditya Birla MF had a meetup wherein the sales team also suggested something similar. In this document, we essentially try to understand if such an opportunity actually exists and is it worthwhile to invest. Reading the ICICI MF document raised several questions rather than giving comfort. See this little snippet:

ICICI MF has funded the promoters of Zee on Zero Coupon Bonds against collateral of ZEE shares. Funding against shares is an activity of Banks and NBFCs. Why would a mutual fund provide funding? Or are the lines blurring between banking and asset management? Well the short answer is “in search of higher returns” or alpha as it is called in this industry. Is it prudent? Far from it.

Overall Zee promoters have about 12,000 Cr of debt and have pledged about 10,000 Cr worth of Zee shares to various institutions. Should it give comfort? A big NO. As an investor, I would be worried. During distress, can a MF sell that (so called) 1.5 times margin and recover its dues? In Jan-2019, two AMCs sold about 2.4 Cr shares of Zee, worth about 1,000 Cr and the stock fell 30% in a day. Good luck selling 10,000 Cr worth of shares. More importantly, they won’t find a counter party to buy those shares. The question begets – what is the purpose of a collateral if you cannot exercise it at the time of need. That is not all, ICICI MF also “recommend” those very funds and are seeking fresh inflows:

There are other major MFs who had similarly lent to ZEE promoters. This one stands out:

(This snippet is taken from this article:
https://www.morningstar.in/posts/50859/exposure-mutual-funds-zee-group-firms.aspx)
How prudent is it to have a single company exposure of 11% and 17% in a scheme?

The AMCs are now harking upon the investment arbitrage opportunity in these funds since the underlying bonds were depressed. They are banking on the press release by ZEE about stake sale. That money will be realized by end of Aug/Sep and they are hoping that the depressed prices of the underlying in these funds will also bounce. Does it qualify as investment – let us see

Since the debacle of ZEE became public, the YTM of these funds have shot up. Look at second column – total number of securities in the fund. All the funds have a respectable number. And this is what an investor in a debt fund would expect – that the fund manager would spread the risk over large number of securities so that no single event or default should affect the fund. However, the fourth and fifth columns paint a different picture.

  • Birla Dynamic Bond – 2 securities have 17% exposure in the fund;
  • Birla Credit Risk – 2 securities have 11% exposure;
  • ICICI Credit – single security has 4.4% exposure.

In short, the fund managers/AMCs have shown little or no regard to risk management nor to fiduciary responsibility.

And now, those very AMCs are banking on the oral assurance of Essel group that the funds realized from stake sale of ZEE will be used to clear part of debt. There is no arbitrage here. This is akin jumping in a deep well knowing very well that you might or might not come out. I would advice to stay clear from these funds. So, what is the way forward? Invest with a prudent fund manager/AMC who respects and follows risk management in the spirit. You might get few basis points lesser returns, but doing so will assure two things – Peace of Mind and Safety of Capital. Often overlooked components in modern scheme of things. Guess it is time to decide what one covets more.

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