From THE HINDU group of publications
Sunday, July 08, 2001


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US 64: A ticking time bomb

Aarati Krishnan

THE UTI has risked widespread outrage to buy itself a six-month reprieve to set its behemoth equity fund -- the Unit Scheme-1964 -- in order.

In the process, it has left investors without any liquidity by suspending repurchase. But given the size of the fund (a shade over Rs 10,000 crore), the limited time at its disposal, and its concentration on a few stocks, this is going to be a tall order. The UTI would have done its investors a greater service if it had changed over to a NAV-based system with immediate effect.

After all, by setting a six-month freeze on its corpus, the US-64 is probably only postponing the inevitable. Now that the markets have a good idea of the stocks in the behemoth's portfolio, it is difficult to see the fund liquidating any of its holdings without impacting the stock prices well ahead of the event.

The fact that some stocks that feature in the top holdings in the US-64 portfolio have tumbled at the first whiff of the scheme's troubles is indication enough of how difficult it is going to be for the fund to clean up, or reshuffle, its equity holdings. The replacement of a large part of the equity holdings with debt is about the only way in which the fund can continue to live up to its carefully built-up, but misleading, image of a vehicle that offers regular income.

Going ahead, the options are limited. A change-over to an NAV-based system immediately after the six-month lock-in is bound to result in a capital erosion for investors who invested in the fund over the past decade.

This could trigger redemption pressure on a large scale. Any continuation of the artificial pricing system will push shareholders further into the abyss. But the repurchase premium will have to come out of the fund's capital.

Of course, the fund could have a second reprieve, like the one last year, in the form of a recovery in the equity markets. But even this may only serve a limited purpose. When the crisis in US-64 first came to light in 1999, investors continued to have the option to redeem their holdings; which in itself was a comfort factor. And the government-sponsored bail-out package also did its bit. Now the abrupt closing of the repurchase window and the dramatic resignation of the chairman are bound to have sent disturbing signals even to the most loyal UTI investor. This could push up the pent-up demand for repurchase once the window opens after six months.

Given these circumstances, it is difficult to see what purpose the temporary shutting down of the repurchase window will serve. True, given the state of the equity market, this is not the ideal time one would have chosen for the fund to go NAV-based. The change-over would have probably been best effected in February/March 2000, when the fund was claiming that its reserves position was comfortable and its NAV was close to the prevailing repurchase price.

But a change-over, even at this point in time, may not be as difficult to handle as the UTI fears (it will certainly be more difficult after six months). After all, Indian retail investors in mutual funds have shown themselves to be a patient lot.

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Investors in a host of private-sector-sponsored mutual funds have lost 25-50 per cent of their investment to the falling equity markets over the past year and yet have not rushed to redeem their investments.

There has been no marked increase in redemption pressure on private-sector-sponsored equity funds in recent months, though fresh inflows into these funds have slowed considerably. Apart from the fact that retail investors do not generally trade actively on their investments, experience suggests that they would rather wait it out for long periods in the hope of a recovery than take losses.

And it should be remembered that the staying investors in the US-64 are the ones who already had a couple of warnings of the fund's troubles and therefore are not totally ignorant of the state of affairs at the fund. The revelation of the negative reserves position in 1999 and the steadily falling dividends would have been signal enough of the fund's troubles. Therefore, it is unlikely that the fund's most recent problems would persuade these investors into a panicky `run' on the fund.

Even if there is fear of a run on India's largest mutual fund, it may be in the best interests of the US-64 investors, and indeed of the Indian equity market at large, for the regulators to force a quick denouement to the US-64 saga.

Given the size of the fund, it has immense potential to wreak havoc on investor confidence. With assets of around Rs 10,000 crore and two crore investors, the US-64 manages around half all the mutual fund assets invested in equities and covers an investor base that is probably larger than all the private sector funds put together.

To allow a fund of this magnitude to function without the regulatory safeguards that SEBI imposes on other much smaller private sector mutual funds, renders the very regulation ineffective. Given what is at stake in the US-64, the Government can scarcely afford to fob off this problem with temporary patch-up solutions, only to let it resurface to destabilise investor confidence and the equity market time and again. This may be the right time to force US-64 and all of the UTI's funds into the SEBI's regulatory fold.

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