Coping with the markets

Print edition : October 24, 1998

Unit Trust of India, which has played a major role by trying to protect the stock markets from a free fall in the past few years, now faces a severe crisis that has its origin in the stock market collapse.

UNIT Trust of India (UTI), the pioneer in the mutual fund sector in the country, is facing the worst crisis since its inception in 1964. Its flagship venture, the Unit Scheme 1964 (US-64), which has a corpus of over Rs. 22,000 crores, is under tremendous pressure. The adverse sentiment in the stockmarket about the scheme has resulted in a wave of panic selling of US-64 units. UTI has acknowledged that more than Rs. 558 crores worth of US-64 units were redeemed between October 5 and October 8.

The wave of redemption by US-64 investors started after the UTI Chairman P.S. Subramanyam admitted in late September that the sale price of the US-64 unit was higher than its net asset value (NAV). However, the pressure on UTI to redeem the claims of investors really started after the collapse of the Bombay Stock Exchange Sensitive Index (Sensex).

On October 5, the Sensex fell by 224 points - the biggest fall in a single day in 1998. This was widely believed to have reflected adverse market sentiment about the US-64 scheme. On October 13, the Sensex went down further, by 40 points, touching its lowest level in 22 months, again under selling pressure by Foreign Institutional Investors (FIIs). Reports in the media indicate that the sharp decline in values of stocks was caused by the FII-led bear cartel. Media estimates of sales by FIIs indicated that they were net sellers of stocks worth about Rs.136 crores on October 5. There were also reports that Morgan Stanley India was a net seller of stocks worth about Rs. 94 crores between October 5 and October 8.

The Government of India, which has a direct interest in the revival of the stock market owing to its plans to divest its holdings in public sector companies, is reported to have asked public sector banks that have substantial holdings of US-64 units to check the operations of the FII-led bear cartel. Union Finance Minister Yashwant Sinha initially reacted by saying that the Government would disinvest "at the going market rate" without waiting for the "market to turn". When he was in Washington to attend the International Monetary Fund-World Bank meeting, Yashwant Sinha announced: "This is a major departure in policy. Therefore we are confident that we are going to disinvest and that the markets in India will improve." The Government also indicated that it had warned FIIs to desist from exerting further selling pressure on the bourses.

Although the market was quick to blame the UTI for the stock market collapse, analysts said that the markets had been on a prolonged downswing, which started in early 1995, and added that the "UTI factor" only partly explained the recent fall. A senior analyst at a leading financial institution in Chennai told Frontline: "Although there are problems in the manner in which the UTI has managed its scheme, the madness in the market cannot be explained by the problems at UTI alone."

The US-64 scheme is unique because it predates all other mutual fund activity in the country. Basically modelled as an income scheme offering regular and stable dividends, it had a strong emphasis on debt rather than equity until about 1979 when the Foreign Exchange Regulation Act (FERA) was diluted, allowing foreign companies to hold a maximum of 40 per cent equity in Indian companies. The UTI's exposure to equity increased substantially after 1979.

The UTI announces dividend in June and sets a repurchase price for its US-64 units in July every year. The spread between the repurchase price and the sale price of units is meant to take care of the administrative costs of managing the fund. UTI Executive Trustee Dr. P.J. Nayak says that the administered pricing of the scheme is meant to protect the investor from the vagaries of the market.

There has been some controversy about whether the NAV of US-64 units should be declared at regular intervals so that investors can gauge the intrinsic value of their investments. Chairman Subramanyam said that the UTI was not obliged to do this because the US-64 was an income scheme and added that there were technical problems in computing the NAV because the UTI investment portfolio included real estate and term loans. Nayak argued that the pricing was based on a forecast but accepted that there was a possibility that the price may sometimes be out of sync with the NAV of the units. Accepting that this pricing strategy may not be in line with the pricing theories in vogue, he asks: "Which other mutual fund scheme is designed to create confidence by providing this degree of insulation from market volatility?"

Basudeb Sen, UTI Executive Director, told Frontline that the US-64 scheme was unique because it offered a regular annual return besides allowing a gradual rise in repurchase and sale price within a year. He says that those investors who want an NAV-based dispensation can opt for other UTI schemes such as Mastergain, which offers avenues for capital appreciation without regular dividends. He says: "If an investor wants US-64 to retain all its plus points and also have the NAV orientation of schemes without such plus points, he or she is expecting too much."

The current problems of the US-64 scheme can be traced to 1992, when share prices rose to astronomical levels until the securities scam ended the longest bull run in the history of Indian bourses. That year the UTI hiked the dividend for investors in the US-64 scheme to 25 per cent from 19.5 per cent the previous year. Between 1991-92 and 1994-95, the rate of dividend remained at 26 per cent although share prices had fallen substantially by then. Since then the annual dividend has remained at 20 per cent. Large-scale purchases of stocks in a rising market resulted in a tilt towards equity instead of debt instruments in the US-64 portfolio. While equity accounted for about 34 per cent of the US-64 portfolio in 1992-93, it now accounts for about 63 per cent.

UTI Chairman P.S. Subramanyam.-

Although the market revived briefly in 1994 when there was a spate of Global Depository Receipt (GDR) issues by Indian companies, the stock market has been under a prolonged downswing since early 1995. Consequently, the market value of the investments that the UTI made during this period has declined. In order to maintain its dividend payout, the UTI resorted to depletion of reserves. The present crisis has been caused by the fact that the market value of the assets declined below investment at cost. Matters were worsened by the fact that the reserves turned negative in its balance sheet in June 1998 when they reached Rs.1,098 crores. In June, after the stock markets reacted adversely to Pokhran-II, the value of equity in the UTI portfolio fell by more than Rs. 3,500 crores. Subramanyam has said that this notional loss, reflected in the books of the scheme, resulted in the depletion of reserves. Since then the UTI has claimed that the negative balance in reserves has been reduced to Rs.150 crores.

Several other factors have contributed to the current crisis. The tax breaks offered on the US-64 units were hugely popular among Indian corporates, which would often park surplus funds in the units. Since 1994, the tax benefits have been phased out gradually. Nayak told Frontline in Mumbai that the "key reason for the tilt towards equity was the large-scale corporate disinvestment." He explained that disposal of debt, as opposed to equity, was a cheaper option for financing the redemptions.

In response to the crisis, the UTI, upon persistent questioning by the media, said that it was committed to shedding some equity in its portfolio to correct the bias towards equity as opposed to debt. There were also rumours that the UTI called on corporates in which it had picked up substantial equity investments and which had also subscribed to US-64 units to desist from exerting redemption pressures in the current situation. While this was construed by some media commentators as arm-twisting, a top UTI official told Frontline that these were "mischievous reports". The UTI's problems would not have appeared so insurmountable if it had the freedom to offload stocks at will, just like any other investor in the Indian bourses, and take advantage of the movements in the market.

Small investors in Mumbai waiting to sell their US-64 units on October 5.-SHERWIN CRASTO /AP

The UTI, which has assets worth more than Rs. 60,000 crores, is the biggest player in Indian bourses. Its portfolio of company stocks is estimated to be about 10 per cent of the entire market capitalisation in the Indian stock markets. The value of UTI equity holdings amounts to Rs.13,000 crores: the second biggest mutual fund, Morgan Stanley, holds about Rs.700 crores. The UTI's size makes it the only potential countervailing force to the power and might of the FIIs, which have the ability to bring capital from abroad. UTI has played a major role by attempting knowingly or unknowingly to protect the market from a free fall in the last few years.


Indeed, its bias towards equity may have been a consequence of the burden that it has carried during the ongoing three-year slump in the market. The serious industrial slowdown in this period and the slump in primary issues in the capital market have also contributed to the prolonged downswing. Interestingly, when the markets collapsed under pressure from FIIs on October 5, the UTI was the dominant buyer. Although UTI spokespersons have claimed that the shares were bought because they made sound commercial sense, nobody believes that the Government did not have a hand in bidding UTI to prop up the markets.

There have been suggestions from some quarters that the UTI be hived off into "smaller, more manageable units". However, sources in UTI aver that the tremendous size of UTI in terms of the number of schemes (more than 70) and the volume of funds it manages offers it great advantages. A break-up of UTI, they say, will deprive it of possibilities of utilising its large inter-scheme trading to balance the US-64 portfolio.

UTI now finds itself in a unique situation. As it is the biggest player in the stock market, efforts to balance its US-64 portfolio by shedding equity will cause a fresh wave of unrest in the market unless there is an improvement in stock market activity. However, it is also clear that this extreme bias in the US-64 portfolio is incompatible with UTI's stated objective of a being a stable and steady growth fund and could severely affect its large number of retail investors, many of whom have placed their life savings in the fund.

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