US-64: What should UTI do?

S. Vaidya Nathan

US-64, a quasi-pyramid scheme (at least for the last seven years) run by the Unit Trust of India has virtually come to a grinding halt.

This is no surprise as most such schemes tend to do so. It was a matter of `when' and not `if'. As with any standard pyramid scheme, US-64 was also sold in a manner that did not reflect the reality.

Regular income, liquidity through the year, safety and the trust of two crore investors were the selling points for this scheme -- as far as UTI was concerned. Unfortunately, its portfolio composition and management were never designed to back the positioning of the scheme.

In absolute terms and especially if adjusted for the risk factor of 65-70 per cent equity exposure, the dividend yield and returns based on repurchase price has been pathetic. But the UTI never cared to tell its investors the ground realities at any time.

Nor did it have qualms about the detrimental effect the entry and exit of corporate investors had on retail investors. The dividend tax-break granted in 1999, due to run-out in 2002, made even the lower dividend rates attractive for such investors.

From 1993-94 onwards, the US-64 has largely been a vehicle for dividend stripping by corporate and other big-ticket investors. Such investors take the dividend and book a short-term capital loss which can be used beneficially to set off against other gains. Such money was by its very nature volatile.

The UTI did not care and even courted such funds. This was evident even in June 2000 when for the first time the scheme was left open for a fortnight in search of such hot flows. The malaise of attracting hot money to achieve `fund mobilisation' targets, which took off during Mr S. A. Dave's tenure in the early 1990s, thus continued. It had net inflows of around Rs 3,000 crore in April-June 2000.

Contrast this with the picture in 2001 when net outflows were Rs 4,151 crore. Ninety per cent of this was by corporate investors. Some of them may have wanted to avoid any loss due to a switch to NAV-based pricing. Some may have opted out due to the tax restrictions on dividend stripping.

But the unprecedented bunching of outflows in April-May -- a first for the scheme -- clearly points to some kind of informed/insider-trading. This deserves to be probed by the Government and any misdemeanor punished.

The key sensitive information that has filtered through to the corporate sector is that the liquidity window through the repurchase window would be shut, come July. All this will hurt retail and long-term investors in the fund.

The Finance Ministry must have been aware of this. But not once did the Government deem it fit to ask the UTI to give investors the full story. Nor did it bring US-64 under SEBI's auspices to ensure better disclosures. There has been poor governance by the UTI and at the government level.

Investors will now pay the price. May be the taxpayers at large too would pay a price if there is going to be a second bail-out of US-64 (the first one was in 1999).

What can UTI do now?: All this extensive backdrop may sound familiar. The following are some aspects that need to be looked at:

*No security should ever be allowed to be sold as something that is not. In simple terms, an apple should not be sold as an orange.

*All securities sold to the public must automatically come under the SEBI umbrella to ensure proper disclosures.

*Pyramid or quasi-pyramid schemes have to be dealt with a heavy hand and the promoters of such schemes (sometimes as in US-64, they may acquire the attribute), even if it is a government-owned institution such as the UTI, should pay a stiff price.

*The Government must accept the reality that open-end funds can, under exceptional circumstances, close the repurchase window for some time. This is allowed under the SEBI regulations.

*Having said this, in the case of US-64 now, this attribute -- anytime liquidity -- was a fundamental one and should have come only after offering investors an option (the UTI would not have done this as it would have meant a run, which even now only stands postponed by six months). Given the manner in which the UTI sold the scheme, its top brass need to be made accountable even as a bail-out package is put in place.

The package: There is a need to open the sale and repurchase window. The cleanest way would be to switch to a NAV-based system straight-away. This may be an embarrassment to for the UTI as the NAV may be 20-30 per cent below the face value. But any plan to provide liquidity still must be linked to this aspect. Else, the ponzi character will remain and come back to haunt sooner than later. The following should be the core of any package:

*The package must be linked to the NAV.

*The thrust must be on providing a graceful exit to all retail investors whose holdings have been with US-64 at least for ten years with the protection of their capital of Rs 10 per unit. (For such investors, the Government should foot the difference as part of a bail-out package -- by rough calculations, this may be Rs 2,250 crore at the maximum.)

*For retail investors who have been with the scheme for a lesser period, the capital protection should not be made available. The scheme's character began changing in 1992-93 and the first signs of trouble were clear even by July 1994. Investors should be expected to be more careful with what they were doing with their money. So such investors should be offered liquidity at NAV-linked prices only.

*If the UTI is concerned about a run (which is a virtual certainty now), it should cap the repurchase quantity at 5,000-10,000 units per retail investor.

*The repurchase window should now be opened only to investors with a holding of less than 10,000 units. Such investors, according to the UTI, account for 55 per cent of the capital of Rs 10,778 crore. If it opened to all, it is quite likely that small investors may not get a good deal.

*Once the long-term unitholders are paid out, the Government should look for a way to wind down the scheme in a phased and orderly manner or make sure it is run on NAV basis under SEBI's auspices at all times.

*The UTI or any other issuer of securities should not be allowed to get away with false promotional campaigns.

From a structural perspective, the UTI should be given complete autonomy, placed in the hands a high quality chairman who would attract good talent, and also brought completely under SEBI's ambit by scrapping the UTI Act. The Government should also make it clear that it does not provide any backing for UTI schemes in trouble. Two bail-outs for US-64 may be two too much for tax-payers.