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US-64: Investors can hold on

Suresh Krishnamurthy

BL research Bureau

THE bail-out package designed by Unit Trust of India (UTI) offers investors a chance to exit from the scheme at Rs 10 per unit in August or postpone their redemptions. This package is applicable only up to 3,000 units held by an unit-holder.

On the face of it, postponement of redemption to May 2003 when the units will fetch a minimum of Rs 12 per unit appears a sensible proposition. Still, the choice is not that clear-cut. Investors have to consider other factors and need to evaluate their o ptions constantly.

Holding on until May 2003 would fetch investors a yield to maturity of 10.46 per cent. That is, the return that an investor would get for postponing the redemption to May 2003 is 10.46 per cent. According to UTI, the Government has agreed to stand fully behind UTI to support implementation of the above scheme for small investors.

If this is interpreted as a guarantee by the Government, then the yield of around 10.5 per cent on an instrument that has 22 months to maturity appears attractive. Barring a few private sector banks and foreign banks, the yields on less than two-year ter m deposits offered by banks range between eight and 10 per cent.

There are, however, a few issues for investors to consider. For one, the interest rates prevailing in the economy can change between now and May 2003. If interest rates rise, it would then necessitate evaluation of the repurchase option afresh. Another i mportant factor that investors need to consider is the changes in the net asset value of US-64, which would be disclosed beginning from January 2002.

Two factors would affect the NAV -- stock market trends and the restructuring of the assets under US-64. Any rise in stock prices would enhance the chances of receiving dividends. In addition, the NAV can rise above the repurchase price. This would enhan ce the value of holding until May 2003. On the other hand, if the equity-debt proportion were recast in favour of debt, then the favourable impact of stock price increase would be on a relative basis limited.

Investors, therefore, have to assess the cumulative impact of the changes in interest rates and changes in stock prices before deciding to hold or redeem. For example, if stock prices do not increase adequately and at the same time interest rates on comp arable investments rises. Investors may then have to redeem their units and reinvest the proceeds in alternative investment options.

Overall, investors need to consider themselves as having a 22-month instrument with a yield to maturity of 10.5 per cent with three options. One is an anytime put option -- the right to sell back to UTI at anytime. The others are an option to receive div idends and a higher price if the NAV increases. Viewed from this perspective, the value of the instrument is enhanced by these three options, at least in theory.

In reality, however, the value of the options is reduced by the following factors:

*The prospect of rise in interest rates is limited.

*The indifferent quality of fund management and the level of erosion in reserves of US-64. Both suggest that the possibility of receiving dividends or a higher NAV linked redemption price is limited.

Effectively, the value of the three options is considerably reduced. Still, the yield is attractive considering that it appears to be backed by the guarantee of the Government.

Investments in excess of 3,000 units will remain locked-in till January 2002. In addition, investments in excess of 3,000 units can be liquidated only at NAV-related prices. From January 2002, sales and repurchases of US-64 would be NAV-based. However, i nvestors need to be prepared to redeem unit holdings in excess of 3,000 when the liquidity window opens in January 2002.