US-64: Robbing Peter to pay Paul

S. Vaidya Nathan

THE UTI may have handed out a loss of Rs 5,490 crore to its trusting unitholders.

Subscribers of various Unit Trust of India schemes may have taken a hit of this magnitude in the last 30 months or so. The proximate reason: Not a fall in stock prices. But because of a peculiar game that the UTI plays for the benefit of its flagship fund US-64 (Unit Scheme 64), called `inter-scheme' transfers.

The UTI has transferred shares worth Rs 16,369 crore between January 1999 and June 2001. Assuming these stocks are held by the other schemes, they will be carrying a loss of Rs 5,490 crore. From these transactions, US-64 made a profit of Rs 2,493.4 crore.

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Investors across various schemes have been shortchanged by the UTI without any rationale and without any transparency. The obsession with paying dividend for US-64 may be cited as the reason, but it ought not to be at the expense of other investors. Truly a case of robbing Peter to pay Paul. `Inter-scheme transfers' have always been a problem with the UTI. As late as in 2001-02, the UTI may not have been able to pay any dividend but for the liberal in-house bailout in the form of inter-scheme transfers.

Big in-house bail-out

The UTI has transferred shares of 143 companies to various schemes. A staggering 640.59 million shares were loaded on other schemes to generate income for US-64. That US-64 has been casting a shadow on the performance of other schemes has been well known for at least five years now. But it was always difficult to gauge the extent and the schemes that had taken the hit. Now, a number can be placed at least on the former (see `Telltale numbers').

Since the extent of inter-scheme transfers over 30 months is known, a reasonable idea may be got by looking at the schemes that may have taken a knock. It is quite likely that ULIP 1971, Children's Growth Fund, Rajlaksmi Unit Scheme (since terminated), Mastershare and Mastergain also the equity component of the Monthly Income Plans bore the brunt of bailing out US-64. These are the schemes large enough to absorb the magnitude of the inter-scheme transfers put through.

Menace of inter-scheme transfers

Inter-scheme transfers are by their very nature opaque and raise doubts over the investment decision-making process. Normally, if a fund decides to sell a stock, it would be anachronistic for another scheme to buy the stock at the same time. This would be the case even if each scheme has an independent fund manager. There may be the odd occasion when in such a situation, a scheme which sells a stock, perhaps due to redemption pressure, finds a buyer in another scheme of the same fund.

This would require two things: One, the fund manager of the transferee scheme (the one to which shares are transferred) must think the stock in question is worth buying at the price. Two, the other scheme must have cash to carry out the deal.

Whether these two conditions were fulfilled in the UTI case is extremely doubtful. It is quite likely that the shares were simply dumped on the other schemes. Notably, the UTI also does not have a system of a separate fund manager for each scheme (it has indicated its intent to move to such a system for some time now without any ground level progress).

So, dumping shares on other schemes to benefit US-64 would have been a mere matter of accounting entries. Now that is no way to run any portfolio. But that is what investors in other UTI schemes have been subject to.

The SEBI mutual fund regulations require inter-scheme transfers to be done at the current market price. SEBI guidelines do not apply to US-64, and the other UTI schemes are bound only by voluntary compliance. So, it is difficult to determine how `arm's length' these transactions were.

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Interestingly, a study of mutual fund income profile for 1996-2000 shows that this is a disease peculiar to the UTI. For private sector mutual funds, with FII linkage in particular, income from inter-scheme transfers is nominal. It is less than one per cent of the total income and an even more smaller percentage of the assets. This suggests that inter-scheme transfer is not encouraged in such funds or in such mature markets as the US. These funds also have a view on a stock and act accordingly. So, there is no question of it moving from one scheme to another.

The hidden burden

The markets were in a bullish phase for much of the January 1999-June 2001 period. The effect of these transfers may not have been captured as unrealised depreciation/appreciation to the full extent in the accounts so far. Much of the transfers may also have taken place in the first half of 2001. For the transferee schemes, the market and the cost price in the transfers may have been close in June 2001 for the frontline stocks. So, the full effect of the inter-scheme transfers may be revealed only when the July-December 2001 accounts are published.

But what may be in store can be readily conjectured. If market conditions improve, the losses may be lower. But not by much though. Is it possible that a sizeable part of the transferred shares may have been sold? Quite unlikely. The UTI's approach in the last five years to portfolio management has centred around US-64. Any investment decision in another scheme that could hurt US-64 holdings seems unlikely.

This is also evident from the sluggish trends in the NAVs of other schemes and the highly of passive fund management. The latter is reflected in the low income-to-assets ratio for a number of years now for most UTI schemes. So, the most transferred shares may be lying in various portfolios hiding a burden for the present.

The burden is big

Of the shares transferred, 6 per cent is accounted for by those where US-64 has taken a loss in the process. These are shares of some dubious companies and some companies with poor prospects. Quite a few are not traded at all. In these cases, it is quite likely that the funds would have to virtually give up on whatever is the value in question. It is not very big and may not pose problems. But this part of the transferred set raises serious questions about the ethics of the transfer process.

Just because the UTI wants to clean up its flagship fund portfolio (it is a long way away from managing that), it cannot dump shares of any hue on other UTI funds. The big problem in terms of possible losses is the second set of transferred stocks. Of the 143 stocks transferred, in 62, US-64 booked profits. A sizeable Rs 2,493.4 crore at that. These are stocks that are reasonably actively traded. But they are also the ones to suffer a big erosion in prices compared to the rate at which they were transferred from US-64 (see accompanying table).

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Many of these stocks may not even remotely approach the prices at which they were transferred. Himachal Futuristic, Satyam Computer, Tata Engineering, Pentamedia Graphics and Mahindra and Mahindra are good examples. Just sample the price difference in these stocks in the table. Tata Steel, transferred at Rs 139, is now at Rs 69, Tata Engineering, transferred at Rs 222, is now at Rs 72, Larsen & Toubro is now Rs 155 while the transfer price was Rs 313. Pentamedia, Himachal Futuristic and Satyam Computers are down by 90 per cent or more compared to the average transfer price.Himachal Futuristic (loss of Rs 1397.1 crore to the transferee schemes at the current market price), Reliance Industries (Rs 681.55 crore), Satyam Computer (Rs 437.04 crore), Larsen & Toubro (Rs 375.83 crore) and ICICI (Rs 277.4 crore) are the first five in terms of magnitude of loss for transferee schemes now. Big numbers difficult to digest. But an investor in UTI schemes there is little choice.