Putnam Investments is on the opposite side of Carl Icahn’s massive short bet against mall owners’ debt. So is Alliance Bernstein.

The short trade on malls’ debt has been in the news for a while now, alongside a relentless stream of retail chain belly-ups and mall closures. The juggernaut of convenient online shopping has spelled doom for America’s retailers and birthed the term “the next big short” for a seeming no-brainer of a trade.

Short the malls’ debt.

Only if it were that simple. That trade has already claimed one short-seller as a casualty. Eric Yip, founder of New York-based Alder Hill Management, was forced to wind up his trade (and $300 million hedge fund) after his short trades didn’t quite go the way he’d planned.

Enter Carl Icahn. His ‘elephant gun’ short trade stands to make $400 million or more if mall owners are unable to service their debts. According to the WSJ, Icahn is perhaps the largest short seller of mall debt. By the same token, Putnam and Alliance Bernstein, who are on the other side of Icahn’s trade, are the biggest longs.

Putnam Investments on Carl Icahn

Putnam says Icahn is wrong to think malls are on death row. Putnam’s view stems from their fundamental observation that commercial real estate vacated in malls by retailers is finding takers. Only, the new tenants are service providers such as movie theaters, yoga schools, offices, even residences.

“We don’t think the U.S. retail spender is dead,” says Brett Kozlowski, portfolio manager at Putnam. “We constantly are seeing malls shift away from apparel and more into services.”

A Reuters report last year said Putnam had built up a position comprising more than $1 billion of derivatives that were bullish on mall debt. Putnam is convinced enough on the trade that they’ve increased the exposure.

It boils down to cash flow. Will the mall owners earn enough to be able to service their debt? It’s also about time. When do the debts become past due?

CMBX.6 – the playground

The CMBX.6 is a commercial real estate mortgage index which references a basket of 25 BBB- rated commercial mortgage-backed securities. According to an Alliance Bernstein White Paper, there are 37 underlying malls linked to the CMBX.6 index.

Putnam Investments and Alliance Bernstein are selling derivatives that bet that the mortgages in the CMBX.6 will not default (therefore, selling ‘protection’). Carl Icahn, on the other hand, is buying ‘protection’ because his view is negative on mall-owners’ ability to meet their commitments.

The devil could be in the details

It’s true that the macro picture on malls is grim, but is CMBX.6 representative of the macro picture? No, says Alliance Bernstein.

“Even if the American mall were dying, short selling the CMBX.6—which holds less than half of one percent of malls in the US—to express that view is inefficient.”

“Our fundamental research suggests that not only will overall loan losses likely be modest, but also returns on the CMBX.6 will ultimately be attractive, even under extremely stressful scenarios.”

Why?

An analysis reveals that non-retail assets back most of the CMBX.6. These have enjoyed:

• Growth in net operating income
• Considerable CRE appreciation since 2012
• More defeased loans than usual.

[Related Story: Carl Icahn Takes Stake in HP, Pushes for Xerox Merger  ]