A scheme with two faces

Having devised the bailout, UTI must quickly scrap US-64 safety net

Sourav Majumdar

Sourav Majumdar

After days of speculation, the Unit Trust of India (UTI) has finally come out with a package for the small investor. From Yashwant Sinha’s point of view, Sunday, July 15 was a day he scored a double — by allowing UTI to put forth the package he had committed would come by the end of the week, and putting in place a new chairman for the Trust who immediately took charge and cleared the exit window.

M Damodaran’s appointment comes at a crucial time for the country’s largest mutual fund. Public confidence in the Trust is possibly at its lowest ever (no matter how much UTI’s executive directors try and push it under the carpet), corporates have caused havoc with the flagship scheme US-64 by pressing huge redemptions in April and May, and the finance ministry itself has not aided UTI’s cause by its public sparring with the former UTI management which, Mr Sinha claims, had not bothered to keep the ministry informed of key decisions. Mr Damodaran has his task cut out: to bring back public faith in the institution and get UTI out of the unreal world where it lives and link its functioning with the market in which it operates.

In such a situation, the ‘‘package’’ which UTI announced on Sunday (I will not use the word ‘‘bailout’’ since Mr Sinha does not particularly like it), evokes mixed reactions. As someone who has followed UTI for the past decade, I am, of course, aware of the compulsions which have gone into devising such a scheme.

On the face of it, it looks rather well crafted, addressing most of the concerns in the given situation. But consider some issues that arise. The package creates a situation where UTI has decided to take its flagship scheme NAV-based, but with an implicit safety net for the small investors by continuing with an assured pricing set-up. If the net asset value falls below the assured repurchase price, the investor will get the assured price. This means even when the scheme goes NAV-based, the administered pricing set-up continues side by side for a section of investors which, by UTI’s own admission, is just under 50 per cent of the scheme’s total investors. So half the scheme’s investors continue to have an administered pricing mechanism. I am not clear what the scheme has transformed itself into. Is it a market-linked scheme? Is it a small savings instrument? Is it back to the days of assured returns? In fact, it’s a little bit of everything.

By pegging a repurchase price of Rs 12 for May 2003, UTI has taken a long-term view of the markets, hinging on the hope that at that stage the market will look healthy and the NAV of the scheme will be equal to or higher than the administered repurchase price. This means that in July 2001, UTI has taken a view almost 24 months down the line. Is that a prudent view? Only time will tell.

Now consider the scenario when UTI begins disclosing NAV, from January 2002 on. If the NAV at the time is lower than the repurchase price fixed for that time by UTI, you will then have a situation where, despite public knowledge that the NAV is lower, UTI will have to repurchase at that higher administered price, taking a hit for every unit repurchased. Will that be great for investor confidence?

While privately admitting that this is obviously not the most desirable scenario, UTI officials say that the existing unitholders in the scheme will not bear the brunt of the hit, since the package is being funded from other sources. Obviously, these sources are institutions and banks, and hence it is another way of the government bailing out UTI. A throwback to 1998. Bailouts by themselves are not bad things. They happen even in the most developed markets, but the important thing is that they must lead to lessons being learnt.

As I said, I am aware of the compulsions on the government side and that of UTI in having to devise this package, the obvious aim of which is to try and keep the investor in the scheme for the longest possible time. But even while doing so, UTI should now try to keep itself clearly linked to the market. In fact, the safety net component should be done away with as soon as the NAV is found to be equal to or above the administered price, even if it is before May 2003. These small investors can then be told that the NAV is equal to or above the assured price and hence the safety net is being withdrawn.

Investors must be made to realise that US-64 is changing into a more market-oriented scheme, and will not have the implicit subsidy element. That, coupled with prudent fund management and a thorough overhaul of the portfolio of the scheme, can ensure that rescue operations such as the recent one are not required every three years.