The government is increasingly using the exchange-traded fund (ETF) route for disinvestment. Bloomberg Quint points out in a report that funds raised through ETFs have amounted to ₹48,325 crore since April 2016. This was nearly as much as what the government had raised using the traditional method of selling shares in the secondary market. Besides, the contribution of ETFs has been steadily increasing. In end-November, the government looked to raise ₹8,000 crore by selling an ETF made up of state-owned companies; then there was talk of a greenshoe option of between ₹4,000 crore and ₹6,000 crore. Such was the demand, it ended up raising ₹17,000 crore in all.
The relatively high demand for a portfolio made up of only government-controlled companies is intriguing. Especially after all the negative news about state-owned companies underperforming. In many of these companies, profit maximization often takes a back seat to other considerations. A classic example is the decision by oil marketing companies (OMCs) earlier this year to sacrifice part of their marketing margins to help the government contain fuel prices. BSE’s PSU index has declined 22% so far this year, compared to a 4.5% correction in the BSE 500 index.
What then explains the demand from investors? In one word, discounts. The portfolio of stocks that make up the fund have been offered at a discount ranging between 3% and 5%, with most offers ending up at the higher end of the range.
This offers large investors an easy arbitrage trade, which is to apply for the ETFs on offer and sell derivatives in the secondary markets. The trade can be unwound as and when the ETF units are allotted and transferred to the investors. As a result, even foreign institutional investors have jumped in to trade, apart from domestic institutions and high net-worth individuals. It’s worth mentioning that the participation of Life Insurance Corporation of India and Employees’ Provident Fund Organisation (EPFO) in ETF issuances has helped the government.
But unlike direct share sales, which had to be bailed out now and then by institutions controlled by the government, ETF sales have generated strong demand from other quarters as well (see chart above). Of course, thanks to the discounts and the ability to hedge positions in the derivatives market. “Distributors who sell to retail investors have also been pushing the product, highlighting the discount on offer,” points out a marketing executive at a mutual fund, requesting anonymity.
Needless to say, discounts can only generate demand to a limited extent. When arbitrage trades are unwound, there need to be enough investors willing to hold these risky portfolios, where decisions by the executive can change fortunes overnight.
In this backdrop, it’s little wonder that the government has had to rely upon other methods to raise funds. One of them is buybacks and large dividends by some state-owned firms. The other is getting one state-owned firm to buy the government’s stake in another firm, like what ONGC did with HPCL. If anything, such actions should alarm prospective investors even more about value erosion. But strangely they seem to be fine playing along, as long as there is a discount available.