To rebuild trust

Print edition : January 19, 2002

The Net Asset Value of the US-64 fund and the new norms for repurchase of units announced by the UTI bring little cheer to small investors, but its plans to reposition the fund give them some hope.

WHEN the Unit Trust of India (UTI) announced the Net Asset Value (NAV) of its flagship fund US-64 on December 28, it brought to an end an era of opaque pricing, when investors had no idea of the value of their holdings. Unfortunately, however, the NAV-based price, which opened at Rs.5.81 a unit, is far lower than what the market expected.

At the UTI office in south Mumbai. The Tarapore Committee Report has exposed the UTI's nexus with tainted brokers.-SEBASTIAN D'SOUZA/AFP

The government-appointed Tarapore Committee, which studied the UTI's investment decisions over a 10-year period, has made it clear that mismanagement and a certain rot within the UTI are responsible for the low NAV. The Committee, headed by S.S. Tarapore, former Deputy Governor of the Reserve Bank of India, presented its report to the Central government last month. Among the principal reasons identified for the fund's poor performance was the presumably unauthorised investment of Rs.3,000 crores in shares and debt instruments of as many as 24 companies between 1997 and 2001; serious deficiencies in the sanctioning process; and sanctioning of investments beyond the Chairman's delegated powers. "The sanction and disbursement process does indicate that the sanctity of the sanctioning powers and the laid-down processes have on many occasions not been observed," the report said.

The Committee has recorded several such irregularities. For instance, as on June 30, 2001, the value of shares of Visual Soft Limited in the UTI's portfolio was just Rs.8.37 crores against their face value of Rs.106 crores. The UTI had built up this position over a two-and-a-half-year period despite adverse reports prepared by its equity research cell. The Committee, adverting to transactions in Visual Soft shares, observed that long-term investments were not supported by internal process notes.

The UTI's investment in Ispat Industries Limited in February 1994 illustrated the serious deficiencies in its approval system. The investment decision, which apparently "baffled" the Committee, was made without key aspects of the transaction being brought to the notice of the Executive Committee. Furthermore, despite realising that the company had diverted funds, the UTI did not take any action to protect its funds deployed in the company.

The UTI's investment in Oswal Chemical and Fertilisers Limited is seen as another instance of corruption in the system. The Committee described this investment as "prima facie imprudent, and [one that] has turned out to be wrong". According to the report, in spite of the earlier bad experience with the company and other companies of the group, the UTI's Executive Committee approved further investments. Such acts gave the impression that the UTI was attempting to rescue a company that was in serious financial difficulty. To make matters worse, the chairman apparently relaxed the conditions placed by the Executive Committee for disbursement of money to the company.

In another instance, the UTI gave the Essar Group Rs.1,049 crores between 1990 and 1999. The investment was made in spite of Essar failing to repay earlier loans or redeem its non-convertible debentures within the due dates. And this was after the UTI was cautioned repeatedly against increasing its exposure to Essar. Moreover, Essar fell into the Non-Performing Assets (NPA) category. The UTI's policies prohibit the fund from investing in such companies.

According to the report, the modus operandi of the companies was simple: they applied and got one set of terms passed by the UTI's Executive Committee. Later, they sought changes in the terms and got them passed by the UTI Chairman. On several occasions the Executive Committee was apparently bypassed, while in other cases it acted as a rubber stamp. The Tarapore Committee also notes that most of the investments were made by former UTI Chairman P.S. Subramanyam.

Besides bad investments, the committee has exposed the UTI's strong nexus with tainted brokers such as Ketan Parekh. Its investment in Himachal Futuristic Communications Limited, a Ketan Parekh favourite, perhaps represents the most dramatic slide in value in a single investment in the Indian context. As on June 30, 2001, the UTI had invested Rs.1,050.7 crores in HFCL's equity, the market value of which had depreciated by 92 per cent. The UTI was not far behind Parekh when it came to pumping up shares. The report reveals that the UTI "went on building up its portfolio in the Global Telesystems [Private Limited] scrip to facilitate the upward trend in its prices", It also said that "decisions not to offload the stock to book profits when the prices were favourable or cut their losses in adverse circumstances raises doubts". Incidentally, Global Telesystems was another favoured scrip of Parekh. "India's largest mutual fund appears to have taken recourse in brokers for certain transactions, which seem to be in the nature of inter-scheme transfers, and thus has violated its own guidelines," says the report.

Although there were warning signs as early as July 2000 that the US-64 fund was in trouble, a direct hit came when the Ketan Parekh scam erupted and the market began its downward spiral. The fund was left holding vast amounts of devalued stock and Subramanyam decided to freeze the fund.

US-64 was conceived as a savings instrument for pensioners and salaried persons, and its credibility lay in the fact that it offered a regular and safe income. The highest-ever dividend yield was around 18 per cent, in 1993-94. When the corruption within the fund was uncovered and Subramanyam was arrested, US-64's dividend yield touched an all-time low of 7.5 per cent.

Sale of US-64 units was suspended in July 2001. But before panic set in, the government offered a bail-out package; repurchase was allowed up to 3,000 units an investor. With its December 28 announcement, the UTI recommenced sale of units at the NAV and enhanced repurchases up to 5,000 units. For those holding more than 5,000 units, it gave two redemption options: at the NAV or at Rs.10 a unit, whichever was higher, if the redemption was done on May 31, 2003, and at the NAV-based repurchase price if the units were redeemed between January 1, 2002 and May 30, 2003. For investors holding up to 5,000 units, there was an assured repurchase price of Rs.12 a unit if the units were redeemed on May 31, 2003.

MARKET analysts and brokers are divided in their opinion on the impact of the NAV-based price. "The NAV at Rs.5.81 will obviously make investors unhappy and there could be some panic among them in the short term," said A.P. Kurian, Chairman of the Association of Mutual Funds in India (AMFI). "Yet, small investors with units up to 5,000 are not likely to be affected as they have an option to redeem them at the administered prices up to May 31, 2003." In fact, Kurian felt that this was the right time to invest in US-64 as the entire portfolio had been restructured by making provision for all NPAs.

However, one market analyst was bitter that the UTI "juggled with the small investors' hard-earned money". He said, "The recent announcement does very little to assure them as the NAV is dependent on how the market performs." Bharat Kotecha, vice-president of the Investors' Grievances Forum, said: "With this announcement, investor confidence in the UTI has fallen further, and in future investors will not have much faith in the country's largest mutual fund." For the UTI to regain its credibility, he said, the fund managers should be made accountable for their investment decisions.

Sharing the UTI's burden, the Government of India has committed itself to bridging any shortfall between the NAV and the assured repurchase prices announced by the Trust. Going by current figures, the government may be faced with a bail-out cost of approximately Rs.5,120 crores. The present NAV at Rs.5.81 a unit is 42 per cent lower than the assured repurchase price of Rs.10 a unit for those holding more than 5,000 units. It is 62 per cent lower than the assured repurchase price of Rs.12 for investors with fewer than 5,000 units. Unless the market condition improves, there is very little hope of the government's bail-out cost coming down.

The UTI has indicated that it is going to reposition the US-64 fund. It plans to invest up to 75 per cent of the funds in debt instruments. In equities the minimum investment would be 25 per cent, going up to a maximum of 55 per cent. The fund will also have income and growth options. Under the income option, investors will get an income distribution or have the option of reinvesting. With the growth option, the income will be accumulated. Additionally, the UTI said that it would comply fully with the Securities and Exchange Board of India (SEBI) regulations for the US-64 scheme by December 2002. It also plans to constitute an asset management company on the lines suggested by the Tarapore Committee, and revamp its board under a package approved by the Union government.

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