US-64: UTI's flagship or nemesis?

The developments at UTI are most unfortunate. Abhijit Roy presents a balanced sensationless analysis of what went wrong.

"HISTORICAL EVENTS occur twice - the first time as tragedy, the second as farce." - Karl Marx The Unit Trust of India has played a pioneering role in the development of the Indian capital market. Launched in 1964, the US-64, an open-ended balanced fund, is its flagship fund. The scheme had a size of Rs. 12,778 crores as on June 30, 2001, about 13 per cent of the entire mutual fund industry. For the first time in 37 years, UTI decided to suspend the purchase and sale of its US-64 scheme for six months and a furore followed. The UTI justified this extreme step on the grounds that the restructuring of the scheme's huge and varied portfolio would require time. The Finance Minister had to face the flak and the UTI chairman lost his job. The UTI, with Government backing, has now come up with an exit option for small investors. The question that arises is why did this scheme come to such a sorry pass. Since its inception, the US-64 distributed dividends on a regular basis, and thus acquired its enviable reputation. In the early part of the 1990s, the UTI decided to distribute the reserves built-up over the years to unitholders in the form of higher dividends, preferential offers, rights and bonus shares.

Savvy individual investors and corporates caught on to the bonanza pretty quickly, and the funds collected by the scheme spurted. While the dividend rate rose from 18 per cent in 1990 to 26 per cent in 1995, unit capital more than doubled from a little over Rs. 7,000 crores to over Rs. 15,000 crores.

Around this time, a few decisions were taken by the management that became the genesis of the problems faced by US-64 today. While the reserves were being distributed liberally, the scheme was not moved to a net asset value (NAV)-based system. Further, the UTI management increased the equity proportion of the scheme to around 70 per cent of the holdings, and yet the US-64 continued to play the role of a regular income scheme to unitholders. In fact, in the 1990s, the US-64 completely distorted the market yield pattern for other instruments as it yielded high return from a seemingly risk free instrument.

Bailout package

When the stock market fell in the later part of the 1990s, the NAV of US-64 fell substantially, and the fund was in serious trouble. In February 1999, the Government appointed Deepak Parekh Committee came out with its recommendations for saving the fund. Following the report, the Government announced a bailout package of Rs. 3,300 crores which basically consisted of transferring select public sector holdings from the fund to a separate scheme and in lieu thereof government bonds were issued to the US64 scheme.

Any first year student of finance will tell us that a mutual fund can generate steady returns when the securities are mainly debt oriented while in an equity based scheme the returns may be more in the long run but the returns are more volatile. Further, no mutual fund scheme should have an administered price that is not related to the NAV. The Parekh panel conveyed to UTI these simple lessons. However, a funny thing happened.

The UTI decided to continue running the fund exactly as it was doing earlier, and not surprisingly again ran into trouble. The more knowledgeable unitholders knew that the US-64 was in trouble again so they withdrew their money, the net repurchases in the recent past being over Rs. 3,000 crores. Meanwhile, there are accusations of insider trading as the scheme saw huge redemptions by corporate houses prior to the book closure. Frankly, one is surprised that so many corporate fund managers stayed on with the fund for as long as they did. Now the post-mortem has begun. Critics say that the UTI should have taken advantage of the ICE stocks related boom during 1999-2000 for exiting stocks and transformed the fund to a debt-backed scheme. Additionally, there are many dud shares in the portfolio. The public has not been told the NAV of the scheme, so the exact extent of damage is not known. Depending on the actual NAV, the shortfall could be around Rs. 4,000-5,000 crores. There is an urgent need for carrying out a due diligence on the fund by a leading accounting firm. Additionally, restructuring of the fund during a bear period is doubly difficult.

For UTI and the Government, there was no clear-cut option for arriving at a bailout plan. Somebody had to pay the price; the options being UTI's reserve fund, the ordinary taxpayer through a government bailout and the unitholders. So, it is a mixture of all three. In order to ensure partial liquidity to the units, UTI will be availing of loans from a consortium of financial institutions and insurance agencies. These institutions are granting UTI a loan of around Rs. 3,000 crores against securities held by it in various companies. The Trust has decided to fix the maximum redeemable units from an investor at 3,000 units. The redemption price should not be fixed below the par value of Rs. 10, and the investors can redeem the units at either the par value or the NAV whichever is higher. In order to retain investors in the scheme, the price of US-64 will be increased by 10 paise every month till May 2003. The Trust also plans to shift to NAV based pricing from January 2002.

Small investors' dilemma

The moot point is whether small investors will continue with the scheme or exit as soon as they can. A guaranteed increase of 10 paise a month on a base of Rs. 10 means a return of around 12 per cent per annum, which is an excellent tax-free fixed rate of return. However, as the base par value increases, the rate of return will fall. Further, those investors who wish to invest in a balanced fund will probably find other mutual fund options more attractive. Paying investors holding up to 3,000 units a minimum par value of Rs. 10 with a guaranteed addition and paying interest on the loans arranged, would lead to a further depletion of the value of the remaining units. It is not clear who will bear these losses. The UTI management has faced a lot of criticism for the way in which the trust has been run. Ironically, the Chairman lost his job for a decision that he had to take. The UTI was forced to announce suspension of sale and repurchase of units for six months given the huge redemption and the current state of the equity market. More and more investors would have lined up to withdraw their money from the fund. Every redemption at a value substantially more than the NAV value would have depleted the value of the units of those remaining invested. The bailout plan that has been put in place has led to substantial losses for the unitholders, so the Government has not been

able to come up with a miracle cure. The line of credit extended by public financial institutions was possible on account of Government pressure.

To become NAV based

At the end of this exercise, the US-64 will hopefully become an NAV based scheme. The Securities and Exchange Board of India will probably now have jurisdiction over the scheme, unlike in the past. A few heads will roll and UTI will be restructured to some extent. But is this a long-term cure? It is widely believed that vested interests have taken advantage of the UTI set-up including large corporates, brokers and cronies of the political- bureaucratic set-up. The truth is that UTI as a government owned organisation cannot be reformed beyond a certain point.

The usual questions valid for other public financial institutions arise. Will UTI be corporatised? Can it be run professionally? For example, good quality fund managers and marketing people need to be paid market related salaries. A chief investment officer (CIO) of one of the private funds may earn, including bonuses, around Rs.40-50 lakhs annually. The top management of UTI does not earn one- fifth of such amounts, while managing much larger funds.

A related development is the gain that private mutual funds will make at the expense of UTI during the next few years. Till now, the UTI could convince the ordinary investor that the Government stood behind it. However, that belief has suffered a rude jolt. According to the latest data, the total mutual fund assets at the end of June 2001, were estimated at Rs. 97,953 crores. Out of this, UTI managed Rs. 55,924 crores in assets as on June 30, which is about 57 per cent of the mutual fund industry's total assets. In the last couple of years, UTI has been steadily losing market share which stood at 78 per cent at the end of March 1999.

With the entry of a large number of private players in the industry, many of whom are providing better service than UTI, one really does not need a huge Government owned and badly managed asset manager. Hence, one solution could be to break up the UTI into, say, four parts, and then privatised, that is, sold to four asset management companies (AMCs). With a fund base of around Rs. 56,000 crores, fund management fee would yield substantial income to the buyers. On top of that, there is an investor account base of around 40 million spread over nearly 90 schemes. By these criteria, the government can earn substantial amount from divestment.

However, investor confidence in UTI has been badly shaken on account of US-64. There is another time bomb ticking in UTI in the form of guaranteed income funds. Hence, privatisation will not be easy.Then there are political ramifications of privatisation, as most of the successful fund managers in India have foreign shareholdings. So the system will probably allow UTI to muddle along while it continues to lose market share. An effective chairman of UTI may be able to stem the rot for a while, but a slow death of UTI is the probable forecast, that is, privatisation by default. US-64: Facts UTI won't tell you

S. Vaidya Nathan

HAVING put together a deferred bail-out package for US-64 investors with holdings of up to 3,000 units, the UTI has taken out a big promotional campaign highlighting facts about US-64.

If the content (also put on its Web site, www.unittrustofindia.com) is anything to go by, one thing is clear. The UTI has not changed one bit. Economy with truth and material information, and expansiveness with falsehood characterise its campaign that ``the longterm investor has many reasons to trust US-64''. The least one would have expected of the UTI is for it to come clean and say a few things that reflect the true state of affairs affecting investors.

* The UTI now says US-64 would be made a well-diversified and balanced fund. It has been one all these years. The only difference is that the UTI sold investors the apple (of a balanced fund) as an orange (an income fund).

* The manner in which the fund was sold was based on total falsehood. ``Security, safety, regular income, trust of two crore investors'' was the plank. It was positioned as an income scheme with sketchy disclosures and this went right up to a few months back.

* The UTI never told its investors that the portfolio composition and its investment strategy could not lead to stable regular dividends (which was expected by the retired and the pensioners who had invested in as also the retail investors). No fund in India pays regular dividend with a portfolio a la US-64. It was an unsustainable approach.

* The steady decline in the dividend yield was never highlighted. The yield on July price for 2000-01 of 7.4 per cent was close to the levels that prevailed 30 years ago.

* The UTI talks of how the dividend has been consistent and reasonable. But it never has ever mentioned that total returns in case of sale on repurchase price has been less than what can be obtained in a plain debt paper or deposit in bank.

* The fact that adjusted for risk of the 65 per cent exposure to equities, the returns are much lower and, in the process, unsuspecting investors have been put to great peril is, of course, something the UTI would never say.

* In asking investors to repose faith in US-64, there is no mention of the fact that the UTI has received a massive bail-out of Rs 3,300 crore at tax-payers expense just two years ago in 1999.

* In July 1998, later part of 1998, early 1999 and now, liquidity was never a problem. But one would never know the extent of it and the adverse implications it has for long-term investors. Even now, the UTI talks of borrowing anywhere up to Rs 4,500 crore. But no facts on who would foot the bill or how the monies would be repaid.

* Through three years of official tumult, not a word has been said on how the portfolio of US-64 has done in terms of returns generated. On portfolio management, the UTI has never told investors why it sells two or three stocks only in nominal quantities and holds them as if they were GoI paper.

* UTI has never told its US-64 investors why, after stating that the scheme would be oriented towards them, and US-95 would target big ticket investors, it has unabashedly raked in corporate flows.

* The ballooning of scheme size was largely on account of corporate flows which various UTI chairmen have coveted in their pursuit of self-set targets. Never has the UTI revealed the composition of inflows and corpus as between retail and corporate investors. Nor has it ever told long-term investors whom it is now urging to stay on as to the kind of impact that these hot money flows had on the value of assets.

* UTI's view that it has found it difficult to re-balance the portfolio with more debt paper as suggested by the Deepak Parekh Committee due to illiquid debt market, is another falsehood. One just needs to look at the quantum of debt investments made by private sector funds and UTI's open end debt funds in the last three years. These flows outstrip what UTI needs to rebalance its US-64 portfolio by a fairly long chalk.

* The Deepak Parekh Committee had recommended an NAV-based pricing system within three years. The UTI is to now move to that mode from January 2002. Though it has played up the ``higher than anything else return'' in the package for up to 3000 units, not a word has been said on the implications of the NAV switch. The fact that long-term investors could be staring at a 20 per cent erosion to face value and at least 5 per cent drop over May 2001 prices have been quietly brushed under the carpet. There would have been no harm admitting that things have gone wrong and what the gap now is so that investors can prepare themselves for the quantum of loss.

* No word has ever been said on how some parts of the US-64 portfolio are irrecoverable, and whether these have been provided for.

* The UTI has all along claimed that the US-64 had the trust of two crore investors. But, now, with problems breaking out, this number has been scaled down by 75 per cent to just 45 lakhs -- a sizeable scale-down by any yardstick.

Possible insider information on closing of the repurchase window lead to big outflows in April-May 2001, especially by corporates; strange investment decisions in the tech sector recently and, among others, in Reliance Industries in the mid-1990s; archaic pricing structure and its overall poor performance, have all hit long-term investors hard. Quite clearly, it is the long-term investor who now has little reason to trust US-64. Exit the scheme on the lines suggested in the articles on pages six and 12. US-64 exit level set at 3,000 units -- Repurchase facility from Aug; to be NAV-based from Jan, 2002

Our Bureau

MUMBAI, July 15

THE Unit Trust of India today decided to give an exit route to small investors holding up to 3,000 units of the Unit Scheme-64 (US-64). It has also decided to make the scheme NAV-based from January 1, 2002.

As per the relief scheme announced today, all investors holding up to 3,000 units of US64 scheme as on June 30, 2001 can avail themselves of repurchase facility from August 1, 2001 to May 31, 2003.

Repurchase price in August will be at the face value of Rs 10 per unit. Thereafter, the repurchase price will be increased by 10 paise every month.

Partially lifting the ban on sale and repurchase of US-64 scheme imposed from July 2, UTI said the scheme will be NAV-based from January 1, 2002.

The much-awaited relief package for small investors was announced after a meeting of the board of trustees chaired by Mr M. Damodaran, who took over as Chairman of UTI today.

Fresh sales of US-64 units will begin only from January 1, 2002 at NAV-linked price. Investors in the 3,000-bracket thereafter can have the option of availing themselves of the repurchase facility at the then prevailing NAV-based price or the administere d price announced now. They will be eligible for dividend as may be declared.

Addressing newspersons after the board meeting, Mr Brij Gopal Daga, Executive Director, UTI, said, ``Adequate liquidity arrangements have been made to ensure that any funds needed for redemption will be available without UTI having to resort to large-sca le sale of its investments in the market.'' He said the gap, if any, between the NAV and the applicable repurchase price will be met in such a way that this will prevent any NAV dilution on account of the relief package.

He said UTI is talking to banks and financial institutions for funds.

From January 1, 2002, investors are free to buy and sell any number of units at NAVbased price.

The sale and repurchase will be suspended in July 2002 for book closure, Mr Daga said.

Mr daga said investors holding up to 3,000 units account for 47 per cent of the unit capital of US-64.

Intercepted by the newspersons on his way out after the board meeting, Mr Damodaran, the new Chairman, said, ``We have put together a package in the best interest of the small investor. We expect that after seeing the graded system, the investors will st ay committed to the scheme.''

Mr K.G. Vassal, Executive Director, has been in charge as Chairman from July 3 following the resignation of Mr P.S. Subramanyam as Chairman.

Widen probe reference

THE terms of reference announced for probe into US-64 is fairly wide-ranging but two areas need to be added to get a complete picture:

* The impact of inter-scheme transfers for US-64 investors.

* The post-investment behaviour of the UTI in various cases such as the Reliance share switch, open offers and its passive role in watching vast sections of the corporate sector, play havoc with shareholder funds. There may be a tale here too.