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UTI Crisis & After
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What was the Crisis that Overtook UTI during 1999 to 2002 In the words of Mr.Yogi Agarwal, columnist of "india-syndicate.com"-
What is the US 64 scheme and what exactly is the US 64 crisis all about? "The US 64 is the largest mutual fund scheme of the Unit Trust of India (UTI) having about 20 million investors. In its peak days, it had a corpus exceeding Rs300bn while now its corpus is about Rs200bn. "The US 64 invests in GOI Securities, shares and debentures of corporates, provides term loans to corporates and also participates in the call money market. About 65% of its investments (at investment price or "book value") are in shares while the rest are in various income/interest-bearing instruments. "US 64 earns dividends on its share investments and interest income on bonds/debentures/loans. It also earns profits/incurs losses on sale and purchase of shares and debentures. The net earnings through dividends, interest and profits on sale less losses on sale is the "distributable income" of the scheme ie it is this component which the US 64 can distribute to its unit holders. Any undistributed part out of this distributable income is reinvested/ redeployed in assets and adds to the holdings." "The US-64 is undoubtedly the largest of the UTI's problem schemes; and the one with the potential to wreak the maximum havoc on investor confidence. But the Unit Scheme-64 is certainly not the first UTI scheme to get into trouble. Nor is it likely to be the last. Leaving aside the US-64, the UTI manages assets of over Rs 25,885 crore under various assured return products. And several of these are neck deep in trouble. "For nearly a decade now, the UTI has launched a steady stream of monthly income schemes, a few ``assuring'' returns for five-year terms, a few for one year and a few promising to protect the investor's principal at the time of maturity, once the scheme runs its five-year term. "The MIPs (I, II, III and IV) of the 1997 series have, for instance, assured returns ranging between 13-15 per cent for their full five-year term. Returns which are clearly unattainable in the present interest rate scenario. "Several of these have been dipping liberally into their reserves to keep the annual dividend payouts at the promised levels. But this has taken a toll on the NAVs of the ``growth'' options of these schemes (which do not pay out dividends but instead accumulate surpluses so that the assured returns are paid in lumpsum at the time of redemption), and all of the 1997 MIPs have NAVs which are at present below par. "With all of these schemes coming up for redemption in 2002, the UTI will be forced to make good the difference between the prevailing NAV and the promised redemption price (for the cumulative option) and the face value (for the dividend options) of these funds. The 1997 MIPs manage a total corpus of Rs 5,600 crore. "Then, there are the various Institutional Investors Special Funds of the 1997 and 1998 series which have also assured returns of 13.5-15 per cent for a five-year term, which are also likely to come up for redemption over the next couple of years. These manage net assets amounting to Rs 3,500 crore and also have NAVs below face value.
"There is more. There is also a relaunched version of the Chidren's Gift Growth Plan and the Rajlakshmi Unit Plan, which the UTI floated as late as 1999, again with assured returns after a fixed tenure. The UTI recently attracted flak for abruptly redeeming the first Rajlakshmi Unit Scheme 1992 after it found it impossible to meet the promised level of returns on the fund". What was the origin of the problem? "The US 64 crisis was essentially a case of a mutual fund paying out higher returns to investors than what it earned on its investments. This decision was taken by the trustees of the UTI. The trustees probably felt that a non declaration of dividend or a decline in the dividend rate would result in investors losing confidence in it (ie UTI) and substantially hamper fresh collections for US 64 as well as other schemes. "The origin of this decision lies in the manner in which US 64 units are marketed to and perceived by investors. Traditionally, US 64 is perceived to be a fixed interest-bearing instrument like a fixed deposit or a bond. The UTI is perceived to be another kind of Government sponsored bank with the concept of a mutual fund not widely understood in any case. Many lay investors use the vernacular word for "interest" when they refer to US 64's annual dividend. Never has the UTI ever said in words or in any other form of direct communication that US 64 is a scheme with minimum assured returns payable every year. However, over the years, its behavior has introduced and reinforced this perception. As they say, actions speak louder than words. Listed below are some of the actions of the UTI that served to reinforce the popular perception that US 64 is a fixed return scheme. "The US 64 has never declared its NAV by giving the reason that its assets contain illiquid assets like term loans and real estate which cannot be easily valued due to lack of marketability. It has been arguing the matter with SEBI for almost 6 years on this matter. Instead of publishing NAV on daily basis, it publishes the sale and repurchase value. The sale and repurchase prices never fluctuate in a manner that reflects the value of its underlying assets and these prices are purely arbitrary based on some system which values investments at the original purchase price. The value goes up almost every month and the pricing is designed to give a feeling of safety and predictability to investors. Neither has the repurchase price gone up significantly when the stock markets were in a boom phase, nor did it go down when the markets were in a bear phase. Most retail investors would be surprised to know that US 64 invests in equities let alone the fact that almost 65% of the investments are in equities. The entire impression sought to be created is that US 64 has no connection to stock markets which most of its retail investors believe is "speculation". "The annual dividend of US 64 either remains constant or goes up irrespective of market conditions. In the one year that the dividend went down, US 64 declared a bonus issue and tried to give the feeling that the overall return did not go down. "The US 64 is one of the few instruments approved for investment by trusts like the various Port Trusts and various religious and charitable trusts on the grounds that it is a "safe" instrument from a "government run" company giving "predictable", "annual" returns. The said approval for investment has been given by either the central government (Ministry of Surface Transport) for the port trusts or by the competent authority in various state governments. The same trusts have been denied permission to invest in debt/income schemes floated by private sector mutual funds on the grounds that they do not give "guaranteed" returns. "The UTI has consciously targeted individuals who have retired or nearing retirement as potential investors. Nowhere does its marketing literature declare the extent or percentage of funds invested in shares and other volatile assets; instead the focus of the literature is on US 64's "consistent" dividend paying track record. "Up until 1992, the US 64 was one of the most active money market instruments with daily trading volumes ranging in hundreds of millions of rupees. It is a rare case where an instrument with more than 60% of underlying investments in equities was one of the most active instruments in a market which is focussed completely on safe returns. "The last thing is the strong linkage evoked with the government. Most investors believe that if there is any "problem", the government will not allow the UTI to " go under" and bail them out. What events in the last 4 years triggered the crisis "In order to understand this, it is imperative to understand the events in the stock market - events, which had a bearing on more than 65% of the investments in US 64. The stock markets have done very badly in the last 6 years. The BSE Sensex crossed 3000 for the first time in early 1992. Since then it has gone up and come down several times but has remained in the same range. Effectively, the total return has been almost zero for a seven year period. The prices of many leading stocks of yesteryear have fallen more than 50% in these seven years and if one considers the fact that the Sensex has been changed several times, with all the weak stocks having been weeded out, the effective returns on the old Sensex existing in 1992 have been substantially negative."
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