Units Of Despair

FORMER railwayman Kenneth Williams spent almost his entire savings to buy 5,000 units of US-64 in the early '70s, mainly for his daughter who was just a baby then. Today the daughter, who works for a sister organisation of UTI in Mumbai, is advising her father to sell off the units. Says she: "Whatever happens, what is for sure is that now there is no way US-64 will be able to pay 20 per cent dividend any more. Besides, if we get out of the scheme now, we can still get more than Rs 14 per unit. It's time to say goodbye to US-64, although dad is rather sentimental about the units."

Williams is just one of the 2.5 crore Indians who put their hard-earned savings into India's oldest and biggest mutual fund scheme. Like Williams, for many middle-class Indians, it is very likely their only investment to take care of their old age and finally to be passed on to their children. On October 5, as the US-64 fiasco forced the Sensex down by 224 points (over 7 per cent), the sharpest dip in 18 months, panic was deeply etched on the faces of investors standing in the long queue at UTI's Mumbai office, Lotus Court, to redeem their US-64 units. "All I know is that US-64 is no longer a safe investment. My son who is working in a 5-star hotel insisted that I sell the units while the going is good," said Mrs M. Patel. Piped in another harried investor: "I am redeeming the units as US-64's net worth has been eroded."

What happened?

US-64 is basically an open-ended mutual fund scheme going under the euphemism of an income growth scheme. That is, the investor buys US-64 units, and UTI invests this money in the stockmarket and pays dividends from the profits made to the investor. Periodically, UTI announces prices at which it will sell US-64 units to the investor, and also the price at which it will buy back the units from unitholders. For the last 33 years (the scheme started in 1964, hence the name), US-64 has been declaring uninterrupted dividends. For the year ended 30 June, 1998, it again declared a 20 per cent dividend.

Now the Sensex is down by almost 1,000 points over the last year. With almost 64 per cent (some claim 70 per cent) of the scheme's corpus exposed in equity, US-64's net asset value (NAV, the market value of all the shares and other investments it has made with the unitholders' money) has been going down. Yet, to maintain a front of safety and security and to avoid a panic in the stockmarket, UTI has been paying dividends and maintaining a high repurchase price.For the month of October, it has announced a repurchase price of Rs 14.25. Most analysts believe that the NAV would not be over Rs 11. So, for every unit it buys back, UTI is actually incurring a loss of Rs 3.25! To pay a dividend of 20 per cent this year, US-64 had to dip into its reserves. Reserves per unit have dropped from Rs 4.90 in 1993-94 to Rs 1.30 in 1996-97. During the past year, when the Sensex has taken a massive fall, it is clear that reserves have been wiped out.

How bad is it?

 Very. This is a scheme with Rs 32,000 crore invested in it. It has the largest base of investors in the world. UTI is maintaining a brave face by repurchasing shares at Rs 14.25. But it cannot continue to do so indefinitely. If not next month, then the month after that, US-64 must lower the repurchase price or sink deeper into the red. At any rate, it cannot pay out a healthy dividend next year, and probably for several years to come. UTI says it will reduce its exposure on equities, but even at 60 per cent exposure, UTI would require more than its fair share of luck to be able to maintain dividend and its premium for repurchase of units. For UTI to be able to do that without suffering losses, the Sensex would have to almost double its present value. Even the biggest optimist on the planet would be daunted by this prospect.

Why did it happen so suddenly?

The answer to that lies in the very definition of this strange beast called the Unit Trust of India. This massive organisation which deals with thousands of crores of honest taxpayers' money is, strangely enough, accountable to no one. It has successfully resisted all pressures on it to disclose details about its functioning and investments by saying that since it was created by an act of Parliament that pertains only to UTI, it is not bound by any laws that govern mutual funds. It has, for example, been able to stay outside SEBI's purview. Unlike all other mutual funds, UTI does not reveal its investments and the NAV of its various schemes to its investors. This is patently unjust and has finally contributed to this sudden seismic shock. The truth is that UTI has revealed the sorry state of US-64 only when it realised that things were going totally out of control and it had to come clean.

Successive Indian governments have also nurtured UTI's freedom from any accountability, in spite of repeated allegations of corruption and stupid investments. This is because the government has traditionally and happily used UTI to interfere in the stockmarket. It has repeatedly used UTI to shore up sagging stockmarket indices, in effect forcing it to make bad investments. It had to tell on the schemes at some point of time. It now has, disastrously.

So what are they doing about it now?

 Enough brave talk-up-the-market statements have already been issued by government and UTI officials. The finance minister and senior ministry officials have categorically stated that they would stand behind UTI if the need arises. "UTI is a strong financial institution and has adequate liquidity; we are fully behind it. The market seems to have overreacted and it will correct itself as UTI is presently a net buyer," said finance secretary Vijay Kelkar.

But UTI's cause has not been helped by its top brass, especially its newly-appointed chairman P.S. Subramanyam. First he said that the high repurchase and sale price he had announced reflected not only the NAV, but also the premium that the UTI brand name commanded. This is a logic never heard before in any stockmarket in the world, and cut no ice with anyone. The next day he announced that US-64 would reduce its exposure on equities by 4 per cent.This led to a bear hammering the likes of which the bourses had only experienced when Sitaram Kesri withdrew support from the Gujral government. Says Deena Mehta, a BSE stockbroker, "The UTI chairman's statement was interpreted as UTI selling 4 per cent of US-64's corpus in the market. That naturally prompted the speculators to start shortselling."

If Subramanyam wanted to sell, he made the worst possible move by announcing that he would sell. Once UTI becomes a seller, the market is bound to fall. Forearmed, bear speculators had a field day, and UTI, if it did sell, got lower prices than it would have if Subramanyam had not shot his mouth off. He later went on record saying that reduction of US-64's equities exposure by 4 per cent did not mean that UTI would become a seller: "What I meant was that the future investments of US-64 would be tilted towards debt and other money market instruments in such a fashion that exposure to equities would naturally come down to 60 per cent from the present 64." But the damage was already done.

What does the government mean when it says it will "stand behind UTI"? Does it mean that it will assure all US-64 investors of an above-15-per-cent dividend for all time to come? That will be possibly illegal, and anyway ruinous for either the government or the UTI or whoever has to bear the brunt of the payouts till the Sensex doubles. Does it mean that it will force the UTI to maintain a repurchase price of above Rs 14? This will also have the same effect. And anyway, this would mean the end of a fair stock-market system. The truth is that no entity in India has that infinite reserve of cash to keep US-64 looking hunky-dory while the core is actually rotten.

What should be done?

The crux of the US-64 problem cannot be solved till the government forces UTI to become more transparent. This can only happen when the government finally wakes up to the fact that in the new world economic order, using an institution like the UTI to fiddle in the stockmarkets can only have hurt the small individual in the long run, as he has been hurt by US-64. Indeed, US-64 could only be the beginning. As the power of UTI—and other above-public-scrutiny financial institutions like LIC and GIC—decreases in the stockmarkets, as it is bound to, we could be in for many more shocks like US-64. Today, there is no check on institutions like UTI passing on losses of various of their schemes to other schemes to hide the truth. But the buck has to stop somewhere. And as our stockmarkets mature, a lot of dirty linen could become public in the next few years.

The Indian investor too has to wake up to the new realities. US-64 in fact never promised dividends every year. Like any stockmarket instrument, it is subject to the usual risks. But the Indian small investor has always bestowed some divine power on UTI, which will have only the upside of risk and never the downside. Right now, he should sell his US-64 units, at least enough to break even on his investment in the scheme. The government cannot save him in the long term.

Is there a ray of hope?

Well, some people do think so. Says Parag Parikh, a well-known broker and chairman of Parag Parikh Financial Advisory Services (PPFAS): "UTI has always been a proxy for India's economic development. The woes which plague most of India's corporate giants are now well documented. Liberalisation has hit most Indian enterprises hard. UTI has been increasingly restructuring its portfolio for the future, chopping the blue-chips of a bygone era and adding stocks with an eye to the future.UTI's brand of safety and security should result in inflows remaining unaffected until its restructuring is complete."

Says a UTI official: "I agree it appears an uphill task for US-64 to even break even, but on a longer term, the situation is not that hopeless. Our GDP growth is expected to be the highest in the world this year. There is little reason for the markets not to take off in the long term. We should be able to tide this crisis over, once you look at the long term view."

 Yes, but that is small consolation for the middle-class investor who is watching his savings go up in smoke.