MICROVIEW / Time to bring US-64 down to earth

The scheme should shift to NAV-based pricing immediately

R Jagannathan

By the end of this month we will know how Unit Scheme-64, UTI’s flagship fund, will reward its investors. Given the weakness in stock prices and interest rates this year, there is little likelihood of the scheme holding positive surprises. The scheme paid a dividend of 13.75 per cent last year, which gave investors an annual yield of under 10 per cent on the July 1999 sale price of Rs 14 per unit. Nothing spectacular, but nothing to sniff at either, since it’s all tax-free.

The operative word is “yield”, and this lies at the root of the scheme’s past successes and failures. The scheme sees huge investor interest only because of the income it doles out — regardless of the performance of its underlying portfolio. Scheme prices are reset every month with metronomic regularity, with prices lowest in July and highest in the month before dividends are paid out. Its very predictability attracts volatile corporate flows, making the scheme fundamentally unstable.

The retail investing public sees the US-64 as a gilt-edged debt scheme, when it is actually a risk-prone balanced fund with nearly two-thirds of its assets in equity. This is at the core of US-64’s dilemma. UTI cannot meet investors’ income expectations unless it shifts more assets to debt. But this will lower returns in the short run since selling equity in a bear market looks foolish. Alternatively, it could remain a balanced fund and start changing investor expectations on its performance by pointing out that in bad market years, dividends could be lower.

No mutual fund can be all things to all people all the time. Time ran out for the US-64 in 1999, when its net asset value (NAV) fell far below repurchase prices, leading to a crisis in investor confidence. The government had to step in with an expensive bailout of Rs 3,300 crore. The bailout worked this way: the government subscribed to a Special Unit Scheme- 99 by issuing it securities worth Rs 3,300 crore. US-64 would, in turn, swap these securities for dud scrips in its own portfolio. The idea was to earn income from these securities while stabilising the underlying NAV of the scheme. The breathing space would be used to rejig the overall portfolio.

While this part of the bailout is working, there is no evidence yet that US-64 is anywhere near achieving its goal of shifting to NAV-based sale and repurchase prices. The deadline to do that is March 2002 but UTI, for inexplicable reasons, has been dragging its feet. There was a time last year when the scheme’s NAV was actually in alignment with (or even slightly above) its sale and repurchase prices. That would have been the best time to make the shift. But now that the markets are ruling weak, the scheme can shift to NAV-based pricing only if it lowers its prices — causing a capital loss to its investors.

If the UTI is far away from its NAV targets, it is no nearer to repaying the government’s Rs 3,300 crore, given the pathetic performance of the SUS-99 scheme so far. At the end of June 2000, the scheme’s investments had depreciated by Rs 2,000 crore — a value erosion on the initial Rs 3,300 crore capital base of nearly 60 per cent. Given that only dud scrips were shifted to this scheme in 1999, the chances of appreciation since June 2000 are practically non-existent. Result: the UTI is unlikely to return the government’s money anytime soon — unless a roaring bull market comes to its rescue.

So whither US-64? Actually, there are no soft options left - unless the government wants to attempt another bailout. The UTI’s bosses have to bite the bullet and make an immediate shift to NAV-based pricing once the scheme reopens for business in July. This may mean a drastic cut in sale and repurchase prices in July, but that brings pluses as well as minuses. While a shift to NAV would leave investors unhappy due to the capital loss, it could also bring in new investors eager to gain a low-priced entry. Moreover, if the scheme manages its resources well in the future, it should be able to maintain its payouts as before, especially if it slowly shifts assets from equity to debt.

Investors should also have another consolation: currently, whenever the NAV is below the repurchase price of units, people exiting the scheme are effectively robbing those who stay. With a shift to NAV-based pricing, UTI can no longer reward those who exit at the cost of those who stay.

For the Trust, though, a shift to NAV would have other consequences. It will no longer have huge annual inflows (or outflows), and will lose some market clout. But it will not have to manage excessive volatility either. Over time, US-64 will probably become a smaller, more normal-sized fund. And that’s not such a bad thing. The time to make the US-64 a normal scheme is now.

R Jagannathan is Editor, myiris.com