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 US-64 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.

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