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S. Vaidya Nathan

Mr M Damodaran

INVESTORS in the flagship fund of the Unit Trust of India (UTI) must count themselves lucky that the Government is set to bail them out for a second time, footing a bill that may comfortably exceed Rs 5,000 crore at current equity price levels. Yet none will get away unscathed as the dent that fund managers have left on the US-64 corpus is even larger than that.

From January 1, the UTI has started NAV-based sales and repurchases of units at a dismal net asset value (NAV) of Rs 5.81 per unit. The UTI has also come up with a series of modifications to the Special Liquidity Package for those with holdings of less than 5,000 units and a new package for holdings in excess of 5,000 units.

In the context of these announcements, what investors in various categories could do was featured in the detail in the issue of Business Line dated December 30, 2001. A summary is provided in the accompanying box (What investors should do). Here we look at some important signals the case throws up for investor behaviour and the failure of governance in the UTI (see accompanying story).

Always seek transparency

If the US-64 throws up a major signal for investors, it is this: they are always better off with an investment option that provides for a high degree of transparency. In a mutual fund scheme, the level of the NAV is the key factor in this regard. US-64 followed an opaque pricing structure for buying and selling that was far removed from the value of underlying assets except for a brief period in late 1999 and early 2000, when there was bull run in stock prices.

All mutual fund schemes announce NAVs regularly and also disclose their portfolios. The release of such information may be no substitute for monetary returns, but they ensure that investors know the value of their investments and where their monies are invested.

US-64 was anything but transparent though portfolio disclosures have improved in the last year and going forward, the NAV may give a better picture of the state of affairs.

It is now clear that the UTI has consistently hidden extremely poor investments from investors over the years and now US-64 investors and tax-payers are set to pay a stiff price (bailouts aggregating around Rs 8,500 crore in a three to four year time-span between 1999 and 2003).

Dividends are not all

The US-64 case shows that investors should not be lured into any scheme by the current levels of dividend payment. What matters is how sustainable is the dividend payment, in the future. A scrutiny of the revenue and asset profile of US-64 in 1994 shows that it was running a show that had to end sooner than later.

No scheme promising steady dividends, leave alone the kind of populist policy followed by US-64, can keep the show going with a 60 per plus exposure to equities. The US-64 dividend policy was totally out of alignment with the underlying portfolio. Now investors have to face a capital loss of sizeable proportions.

Dangers of chasing inflows

For the last decade, the UTI's policy has been to set targets for fund mobilisation and US-64 has been placed at the fore of achieving these targets. But, in the process, the fund has coveted hot flows from corporate investors. Tax benefits of various hues have made the scheme attractive for hot flows.

Most of these monies tend to flow out quickly after taking advantage of the dividend. The most recent was the pullout of around Rs ****5,000 crore in April/May 2001, just before the repurchase facility was withdrawn. Corporate investors have had little to lose. It is the long-term investors who have paid a big price.

The high level of such inflows and a populist dividend policy over time has led to the UTI taking more and more risks. And when these monies went out, it had no option but to sell the top end of the portfolio, such as ITC and Hindustan Lever, as well as government securities.

The two stocks largely excluded from this selling were Reliance Industries and Reliance Petroleum. Only in 2001 did the UTI resort to some sizeable selling in the latter. So the hot monies coveted by the UTI led to value erosion for the long-term investors.

Yet to this day, the UTI continues to maintain that US-64 is a good long-term investment and exhorts investors to take a long view without any track record to support it.

The `hot money' inflows and outflows also led to losses due to the lack of linkage between the underlying value and sale/repurchase prices. Not once has the UTI indicated the harmful effects of such flows in US-64. Once, in the mid-1990s, it said it would tilt US-64 towards small investors but that was just on paper.

Performance, not assurance, counts

Investors should go in for investment options where returns (by way of dividend and/or capital appreciation) are based on performance. Relying on assurance of returns and perceptions of a government backing (re-inforced by consistent promotional campaigns by UTI stressing the safety aspect of US-64) does not help.

It is like hanging on to a lifeline that could come unhinged anytime. This cannot be a suitable approach for a lifetime of investments. Of course, investors never had the NAV details to see for themselves how US-64 was performing. But a look at the income composition, portfolio composition, changes in capital base, reliance on inter-scheme transfers and the dividend rates would have provided warning signals as early as 1994.

The weak reasons, such as existence of term loans and real estate, to avoid NAV disclosure was another tell-tale sign that things were not in good shape. The UTI's pricing structure ensured that investors never knew what they were buying or selling. This strikes at very basis of investing, and investors should avoid patronising such schemes as troubles always lurk around the corner.

Risk adjusted returns

The graphic shows the dividend yield on US-64 over the years. The absolute level of dividend may look attractive, especially in the mid and late 1990s when dividend percentages were in the 18-26 per cent range.

But if one looks at the risk-adjusted returns — which takes into account the equity component, the size of the portfolio, and the fact that the portfolio's carrying value and realisable value had a big gap due to the size (except for a year or two), they present a dismal picture. Risk-adjusted returns from a portfolio loaded with equity have been lower than even plain debt instruments.

Risk and return can never be kept apart. From the most staid debt investment option, such as government securities, to Ponzi schemes that rely on fresh inflows to keep the show going, this fact cannot be ignored. For long, the UTI has tried to suggest that this aspect could be ignored but it has failed, with serious consequences.

Investors who had taken cognisance of the risk factor in US-64 would have bailed out early and avoided the agony thrust on investors by the UTI's incompetent management of funds and total lack of transparency till the crisis broke out officially for the second time in July 2001.

Despite the dismal risk-adjusted returns and total returns (dividend plus capital gain/loss), the UTI continues to maintain that US-64 is good for long-term investors. It is still trying to give small investors a picture that is divorced from reality.

The very fact that the UTI has never talked of risks in the context of US-64 tells the tale. Investors need to recognise the signals: Existing investors must brace for losses but nonetheless pull out in May 2003; others can stay away.

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