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Aarati Krishnan

TO THE rational bystander, the package put together by the government to induce investors to stay with the Unit Scheme 64 after May 2003 (and thus prevent a run) would seem to be an exercise in futility. But, in reality, the package shows a rather good understanding of the investor psyche. It tries to exploit one weakness of most investors — sheer inertia.

After all, none of the sops announced makes any significant difference to fact that investors would be better off exiting the fund in May 2003. The dividend tax and the capital gains concessions are merely cosmetic. True, the Government has now removed the May 31 deadline by when investors were to sell their units back to the UTI for receiving the fixed repurchase price of Rs 10 and Rs 12 per unit. But with the intrinsic value of a unit of US 64 now hovering around Rs 6, and the Government offering to buy back units for twice this figure in May 2003, what could possibly induce an investor to stay with the scheme beyond that date?

Yet, evidence suggests that if investors are given an opportunity to postpone a decision, they will, in all probability, do so. Even if this involves taking a substantial opportunity loss. Take the case of the US-64 itself. From 1998, the scheme has been beset with crisis after crisis. But after each revelation, redemptions from the fund have invariably been at lower levels than expected. In September 1998, the fund's negative reserves and the unsustainability of its dividend payouts first came to light. This was followed by a series of exposes on the fund's indiscriminate investment practices. Yet, the unit capital of the fund shrank by no more than 13 per cent in the turbulent June 1998-June 1999 period.

In the subsequent year, the US-64 sharply cut its dividend payout. The Government infused Rs 3,300 crore into the fund to meet its liquidity requirements. There was clear indications that the days of populist dividend payouts were over and it would only be a matter of time before the US 64 moved on to an NAV-based system. Despite these signals, the US-64 faced little redemption pressure, with its unit capital actually swelling to Rs 15,146 crore by June 2000.

In July 2001, the US-64 faced its next big crisis. Out of the blue, the fund announced that it would be closing its repurchase window for six months, leaving investors with no exit option from the fund. After considerable furore, the fund offered a "special liquidity package" for small investors holding less than 3,000 units (later revised to 5,000 units). This package promised that irrespective of the scheme's NAV, the fund would start repurchasing units at a price of Rs 10 or more starting from August 1, 2001.

The package offered an inducement to investors staying in. The repurchase price would be hiked by 10 paise per month for every month, until May 2003. In May 2003, the special liquidity package would be closed, when the repurchase price would stand at Rs.12 per unit.

But if one thought that the temporary freeze on redemptions, and the low NAV would have jolted investors into pulling out of the fund at the earliest opportunity one would be mistaken.

The fund actually saw little redemption pressure since August 2001. Between June 2001 and June 2002, a mere 3 per cent of the US-64 unitholders redeemed their units. This meant an opportunity loss for investors staying with the scheme. Over the past year, quite a few debt mutual funds have managed returns of over 13 per cent per annum.

This could mean one of two things. Either all the investors in the scheme are wholly rational. They have preferred to stay with the fund so that they would be in a position to take advantage of the highest repurchase price of Rs 12 per unit in May 2003.

This would mean they have preferred to trade an assured return of around 9-10 per cent on their holdings in the scheme, for the uncertain (but higher) returns available on investment avenues elsewhere.

But (especially given the past experience with the US 64) it could also mean the opposite. That given the choice between acting immediately and postponing the decision to a future date, investors often choose to do the latter.

If this is indeed the case, the Government's offer to keep the repurchase window open indefinitely after May 2003 may indeed help to stem panic redemptions from the fund in May 2003. So, are US 64 investors really rational, or are they merely beset with inertia? May 2003 will provide a decisive answer.

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