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Fixed Income

Actionable: Opportunity courtesy Vodafone Idea [Premium Unlocked]


[This is a Premium UNLOCKED post]

Update, 11 July 2020: We exit this trade with Vodafone Idea paying Franklin in full, and the trade nets a return of 5% in 6 days. (Read the closing post)

Franklin Templeton UST has recently announced that it will be taking a full hit on its Vodafone Idea exposure owing to concerns with its financial health. Franklin UST has a 4.27% (Rs 722 Cr according to Dec 31st 2019 portfolio) exposure to Vodafone Idea debt and that will be effectively marked down to zero. What makes it interesting is Franklin Templeton UST has not done side pocketing. Because you can’t do a side pocketing unless rating agency confirms the firm has defaulted. And Vodafone Idea till now has not defaulted. This provides an interesting opportunity, where on the upside you make 4% and downside you lose nothing.

Note: This strategy is suitable for investors with risk appetite. If you are not comfortable investing in debt funds, please refrain from the strategy.

The Opportunity

Upside of 4%, Downside of losing nothing

Action to be taken

  • You Invest Rs 2 lakh (daily limit) in Franklin UST fund.
  • You will not take any hit of Vodafone Idea exposure as the debt has already been marked to zero.
  • The NAV has already taken a hit of 4.3%. The NAV has dropped from Rs 28.34 on 15th Jan 2020 to Rs 27.12 on 16th Jan 2020.
  • Be invested till at least Jan 23rd. If Vodafone Idea doesn’t pay the AGR dues, rating agencies declare it as a default.
  • Once Default is announced, FT UST must create a segregate account for side pocketing. This will not change the NAV of the fund as Vodafone exposure is already considered zero.
  • Once the side pocketing is announced. You exit the fund. You will be roughly exiting at a same NAV at which you bought in.
  • You will be holding the FT UST on the day of creation of segregate fund; hence you will be holding a part of the segregate fund at zero cost.
  • In any case if Vodafone Idea pays back at later point, then you make 4.27% on your investment. If it doesn’t pay back, you lose nothing.
  • To add more, there is no exit load for redemption in FT UST. Technically it’s zero cost.

How Much Will I Make?

The answer is binary. You make either 4.27% or nothing. If Vodafone is going to pay back the bond, then it must do it in full, it can’t say I will pay half and will pay the remaining half later. If it does that then it is going to be classified as default. Then why pay full rather than pay nothing.

In case it defaults, then we can’t expect the money to be paid back soon. It will undergo the bankruptcy process and might take more than one year to see the payments happening. And we might not see a full payment coming in post-bankruptcy proceedings. As everyone will be taking a haircut. What’s for us to loose, whatever we get is a bonus even though it might be after three years.

What If Vodafone Idea Doesn’t Default on 23rd Jan?

Nothing changes. Your investment will be intact, and it will be a normal investment like any other investment in UST. The good thing is you are getting Franklin UST fund with zero exposure to Vodafone Idea. The only concern is it still has exposure to Edelweiss (4.9% of its AUM), which has been caught with cross hairs with enforcement Directorate. We don’t see any action happening in Edelweiss anytime soon (at least for next a month or so).

So you can hold a Franklin UST fund for another month or so and give some time for Vodafone Idea to default. You will get the normal returns of UST fund for next one month. If you are still not comfortable holding Franklin UST fund, then you an exit after Jan 24th even if Vodafone idea doesn’t default.

What are the chances of Vodafone Idea Paying Back The Franklin UST Bond?

Honestly, we don’t know. The only comfort here is

  • Bonds held by FT UST are due on 10th July 2020. Which is not a far-off thing. The bond INE713G08046 (which is held by FT UST) is the only bond maturing in next 7 months. Meaning if Vodafone Idea manages to hold strong (till end of Jul 2020) then we can see money coming back. Of course, there are interest payment happening in between, but they are comparatively minor in nature.
  • On top of that Vodafone Idea in its 12th Jan 2020 press release has stated that it will likely use Rs 2,826 Crs reserved for spectrum payments towards repayment of loans and redemption of NCDs.
  • If the government in next two days gives some leeway in payment of AGR dues, Vodafone idea gets some room to breathe. It might just help Vodafone Idea surviving a bit longer, may be till the end of this year.

This doesn’t mean in any sense that Vodafone will not default, its just increases the probability.

You have 50% chances of making some neat 4% returns on your 5 days of investment and zero probability of seeing a loss.

Background Reading

The recent Supreme court ruling stating that telecom companies need to pay the AGR dues to DoT withing Jan 23rd has left telecom firms gasping for cash. Vodafone which already has liquidity concerns is the worst hit.

To get a clear idea of what went wrong with Vodafone Idea, read our article titled “Vodafone Idea – The Potential Hit to Mutual Funds Due To The Supreme Court Ruling

If Vodafone pays the AGR dues on 23rd Jan it might survive the day, but will be left with little cash to honour its debt commitments. If it doesn’t pay, rating firms will term it as a default. Then all the funds holding Vodafone Idea will need to mark down to zero and segregate for Side pocketing.

To understand what side pocketing is, read the article titled “What is this DHFL Default and Debt Mutual Funds Crashing”

Franklin Templeton UST owns roughly 4.27% exposure of its AUM. As a pre-emptive measure FT UST has marked it to zero and have not done side pocketing. Vodafone Idea has not yet defaulted. This gives an opportunity for investors to take part in the side pocket without being invested in the side pocket. Franklin Templeton UST currently has limited the investor from a single account to Rs 2 lakh/ day.

Update, 11 July 2019: We exit this trade with Vodafone Idea paying Franklin in full, and the trade nets a return of 5% in 6 days. (Read the closing post)



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