Commentary
The US-64 DEBACLE
EARLY THIS month when UTI declared a 6-month freeze on the sale and repurchase of units under its most popular US-64 scheme, an era of innocence for the small investors ended in the Indian financial system. The US-64 is India’s largest and oldest mutual fund scheme with around 1.9 crore individual investors. Most of these are loyal investors who have remained invested with the scheme through thick and thin. In the volatile and most often rigged stock market system of India, the UTI, and its US-64 scheme in particular, provided small investors with a stable source of income.
Over the years small investors have depended upon UTI for safety of principal, regular income and liquidity. The decision to freeze repurchase, therefore, was a rude shock as it did away with one of the most important features of the scheme, viz., easy liquidity. Against the backdrop of falling interest rates, declining returns in equity market and absence of alternative investment opportunity, the small investors flocked in droves to the scheme in the recent past. The US-64 scheme mobilized Rs. 42.3 billion for FY 2001 (30% growth). There was a decline in redemptions (repurchases), and the net flow into the US-64 scheme was Rs. 21.1 billion compared to Rs 5.5 billion in the FY 2000.
Despite the tremendous faith reposed in the UTI by the small investors, the UTI has once again failed to live up to its name. The Finance Minister, already dogged by one controversy after another, was apparently quite uneasy with the decision, but refused to own up responsibility (UTI directly reports to Finance Ministry and is not under purview of SEBI, the market watchdog). The UTI Chairman had to resign and a limited repurchase program was announced to generate some confidence among investors. Simultaneously, an enquiry was ordered into the investment decisions of the UTI in the past, large-scale redemptions by big corporates just before the book closure in June 2001, and the linkages of the UTI officials with the brokerages. On 20th July, a probe has been ordered.
The writing was on the wall ever since the meltdown in the tech-stocks, the weightage of which had increased significantly in recent times. Coupled with this, the disconnect between the net asset value (NAV) and sale/repurchase prices offered arbitrage opportunity to the investors. This got accentuated as over time coporate investors found it a good place to park their funds. As on December 2000, in value terms, more than 50% of corpus consisted of investments by corporates. Thus, although the scheme was for the small investors it attracted lots of corporate funds, and the corporates, in the course of time, actually benefited from insider information and tended to destabilise the scheme by sudden massive withdrawals.
THE PROBLEMS at UTI are not new. In 1998, through a similar crash in the stock market, the UTI’s reserves had turned negative. The government had to come up with a rescue package of around Rs. 3,000 crore to restore the confidence of the retail investors. At that time the government had constituted the Deepak Parekh committee to look into the working of UTI ( See Box).
Precious little has been done to implement the recommendations of the committee with the result that as of June 2001 there was a gap of over Rs. 6,000 crore between the market value of net assets and the scheme’s value at its administered re-purchase price. A hole of Rs. 6,000 crore in a Rs. 20,000 crore scheme and with US-64’s net sales turning negative from October 2000, there was no alternative but to put a freeze on repurchase.
There is much that is wrong with the way the UTI functions. As one Commentator has pointed out “Every aspect of UTI business seems imperfect: products, positioning, perception, performance and practice……It is a balanced fund which is perceived as income fund, which many years ago was a debt fund, in mid-’90s was rewarding as an equity fund, and is priced like a bond which does not guarantee return but government works out a bailout package when equity assets deplete: pretty confusing. And its offer letter does not state anything.” (Dhirendra Kumar, in Economic Times)
The US-64 had exposure to equity to the extent of 66% of its corpus, in flagrant violation of Deepak Parekh Committee recommendations, to reduce equity exposure to 49%. It did not sell the shares even when the market touched the historic high of 6000 points and its NAV had surpassed the repurchase price. Not only it had high exposure to equity, there was a high exposure to momentum stocks like Global Tele, Himachal Futuristics, Softwares Solution and Zee Telefilms in which rise/fall is steeper than the rest of the market. This was clearly an attempt to reap the maximum benefits of the stock market boom. But the UTI, like other mutual funds, overlooked the composition of the US-64 scheme.
Again the share of corporates increased from 39% to 53% in its unit capital, despite the Parekh Committee recommendation of reducing it as it was partially responsible for its troubles.
The other major recommendation of the Parekh Committee was to conduct strategic sales of holdings in companies where the Trust held large stakes. While UTI has tendered some of the shares held by it in the case of companies which announced open offers, it has, by and large, failed to carry out the Parekh Committee’s recommendation of strategic sales of its equity holdings to the highest bidder.
UTI has extremely large number of stock holdings. UTI holds a portfolio of 1,426 equity investments which is quite a large number to monitor. Its portfolio across debt and equity instruments aggregates to as many as 1,900 unique companies. Whereas, the number of persons monitoring these investments is less than 25. Even UTI’s research team claims to track 200-250 companies only.
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Deepak Parekh Committee recommendations – A summary THE IMPORTANT recommendations of the Deepak Parekh committee are summarised as under : (i) The US-64 portfolio of PSU stocks to be transferred to a Special Unit Scheme 99 (SUS-99). The transfer of PSU portfolio be at an acquisition cost of Rs. 4810 crore. The Government of India would subscribe to SUS-99 by issue of dated GOI securities. (ii) As the market value of PSU portfolio is Rs. 3,100 crore, the transfer at acquisition cost will add Rs. 1,700 crore to equity portfolio of the scheme. (iii) US-64 will receive government backed securities as a consideration. On these securities, it will earn 11 percent interest per annum. These securities will mature after 5 years and the scheme will get cash inflow of Rs. 4,810 crore or an equivalent basket of government securities. (iv) The bail-out package would reduce the equity exposure of the scheme from 79.3 percent to 54.5 percent. (a) As a one time measure, contributors to the initial capital infuse Rs. 500 crore immediately into the scheme. (b) A strategic sale of significant equity holding by negotiation to the highest bidder to ensure fetching the best value. (c) As a special dispensation, investment in US-64 should qualify for tax rebate even if its equity investments constitute less than 50 percent of its long term investment for the next three years. Similarly, dividends from US-64 be rendered tax free in the hands of investors for three years while the scheme is being restructured. (d) Rs.1500 crore towards the corpus of a new equity related scheme to be promoted by the Trust as a revival measure. (e) The committee has observed that there are several qualitative changes that need to be made in the functioning of the trustee UTI. They are: US-64 scheme should, sooner than later, be a NAV-driven scheme. The committee is of the view that a period of about three years should suffice to make US-64 NAV-driven. (f) The UTI Act needs to be amended to increase the size of the Board of Trustees so as to induct five additional independent trustees. (g) The committee has strongly recommended appointment of separate and independent teams of funds managers for each scheme. (h) Trust should create a separate Asset Management Company for US-64 with an independent Board of Directors. (i) Inter scheme transfers, if any, should be effected on the basis of independent decisions and requirements of the fund managers of the concerned schemes. The transfers should be at a market determined price. The committee has observed that the dividend policy of the UTI has to be revamped. The committee is of the opinion that the assured return is not the order of the day. The committee is also of the opinion that the US-64 scheme of the UTI has to be brought under the purview of the SEBI. |
ALL SAID and done it must be recognised that UTI is not just any ordinary mutual fund. Its nearest competitor is almost a tenth its size. Its equity holdings’ value exceeds 5% of the entire stock market capitalization of India, and its operations have significant effect on the market movements. It has a very large base of retail investors who are more or less long-term investors. It has to be understood that at least some of the present woes of UTI can be traced back to the past decades when UTI was used as a buffer and market stabilizer in the crucial years of India’s economic development, that it was looked upon by the politicians to rescue falling markets; that it has been playing dual role of a development financial institution as well as a mutual fund, in difficult market conditions. And in the initial years of PSU disinvestments it had to pick up a significant number of PSU shares which have under performed and have now become a drag.
There is an urgent need to refocus UTI’s operations. It was meant for the small investors and should remain so. It has to be NAV driven, and most important of all, it has to be freed from the unholy nexus of big business and politicians, who have had a big hand in its present conditions. A case in point is the investments made by Reliance a couple of year’s back to the tune of Rs. 800 crore in Units. As quid pro quo UTI invested in large number of Reliance shares (around Rs. 1,000 crore) at a very high price. Reliance then exited with higher than fair prices (its investments today in UTI are a mere Rs. 13 Lakh), the loss ultimately was borne by millions of small investors across the country. Such type of relations does give rise to suspicion about possibilities of massive insider trading in the UTI.
The quality of decision making too has to improve. Investment decisions are required to be made with commercial considerations and not under political compulsions. There has to be thorough professionalism in its approach and its pricing has to be transparent so that performance of fund managers is not hidden from public glare and the officials are made accountable for the decisions they take. It has to be a customer focused, profitable and robust institution.
The time has come to rewrite UTIs charter. Its objectives should be rewritten and an appropriate legal structure should be put in place to prevent such a debacle in future. Only then will it emerge as a world class institution – with its core strength of wide reach and size.
-- Girish Ghildiyal
Mutual Fund – Is a fund that takes money from the investors in return for a share in the ownership of the fund. The pooled money is then invested as stated in the offer letter. The profits on such investments are paid as dividend or reinvested in the scheme.
Appreciation -- The increased value of one asset held by the mutual fund, or by the total assets held by the mutual fund over a period of time.
Bear market -- A period of time in which the market, or securities in general, lose money.
Broker -- A salesman who sells stocks, bonds or even shares (units) of mutual funds. Only licensed individuals may sell these items.
Bull market -- A favourable market condition in which prices of securities increase greatly over a specific period time.
Closed-end fund -- A type of mutual fund that offers only a fixed amount of shares (units). Most mutual funds are not closed-end funds, they offer unlimited shares which may be purchased and redeemed directly by the individual.
Dividends -- Income distributed to shareholders. Dividends can be received from the ownership of stock or from mutual funds. Mutual fund share holders have the option to reinvest dividends automatically in order to purchase more shares.
Liquidity -- The degree to which an investment may be quickly sold in exchange for cash. Mutual funds are a liquid investment; at any time, shares may be redeemed. A 30-year savings bond is not liquid. It cannot easily be sold until the 30-year maturity date is reached.
Net asset value (NAV) -- The value of a mutual fund share. Determined by dividing the total value of the fund’s assets by the number of outstanding shares. This value is calculated daily by the fund.
Open-end mutual fund - A mutual fund that does not have a fixed number of shares (as does a closed end fund or stock). The mutual fund will offer as many shares as investors are willing to buy.
Portfolio - The collection of all the holdings of a mutual fund, such as bonds, and stocks. In a mutual fund’s annual report, a list of
the fund’s current portfolio will usually be contained.
SEBI -- The Securities and Exchange Board of India, a regulatory agency of the Central Government which regulates the functioning of stock exchanges and other market intermediaries but not UTI.
Redemption or repurchase -- To redeem shares of a mutual fund or stock. In a mutual fund, partial or full redemptions can be made. Some funds may impose an extra redemption fee to discourage market timers from pulling their money immediately after investing.
Yield -- Income or dividends received from a security or mutual fund.
UTI – UNIT TRUST OF INDIA was constituted as a trust under a special Act of Parliament in 1963. It was to act like a mutual fund by mobilizing savings of small investors under its various schemes and provide them the benefit of Pooled savings and investment.
US-64 -- Is the open ended flagship scheme of UTI. Is rated as one of the safest avenues after gold.
Insider Trading – Is trading in the shares/ units on the basis of price sensitive information not available publicly. The practice is illegal.