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The Rediff Business Special/ Nikhil Faleiro

1998-99 results turn money market's focus back to UTI

Today, the Unit Trust of India -- UTI -- India's largest, oldest mutual fund, has announced its financial results and dividend for 1998-99. This is bound to be a point of debate in the weeks, perhaps even months, to come among its teeming millions of investors, better known as unit-holders.

The announcement marks the first major statement by UTI after the controversy erupted in late 1998 over the net asset value of its flagship scheme US-64. The scandalous issue besmirched UTI's reputation, eroded its credibility, unsettled the Union government and wreaked havoc on the stock markets.

The storm has subsided. UTI has seemingly pulled up its socks. At this juncture, it would be worthwhile to look back at the making of the controversy, why it became, arguably, India's biggest ever financial controversy, how UTI negotiated it and how UTI plans to shape up to safeguard the interests of millions of patrons in future.

The story begins with chit funds. They were given to raising new monies to pay old depositors, and kept the ring running until they would go bust when the chain broke.

In 1964, the then finance minister, T T Krishnamachari convinced the government of the need to have a national level mutual fund so that small savings can be put to productive deployment. Thus was born UTI through an Act of Parliament.

However, chit funds continued with their activities merrily; old ones would down shutters to be replaced by new ones. Several big-scale operations that seemed fool-proof at one time, like the CRB Capital Markets of C R Bhansali, too did a similar stunt with fixed deposit schemes and went bust.

Ditto has been the case with plantation companies. Last year, the Bombay police arrested several individuals -- including one Ashok Sheregar -- who ran schemes that promised to double investors' money, based on the assumption that new depositors will pay for the old ones.

Indeed, Bombay's money market has a name for it. Any scheme that earns less than it pays out and pays by raising new money is dubbed "Sheregar Scheme". Although disturbing, small investors who have lost millions in these small and medium scams, have taken much of this bad news in their stride.

But nothing could have prepared them for what emanated out of UTI -- the holy cow of Indian investors with total investible funds of Rs 600 billion -- on September 30, 1998.

Thanks to a wrangle between the trustees and the auditors, a shocked investing populace was told that the reserves of the premium scheme US-64 had turned negative by Rs 10.98 billion. In simple terms, this means that the net asset value (or the total value of assets held under the corpus of over Rs 220 billion had fallen) had dipped and the trust made provisions for the same. In other words, UTI's trustees paid dividend not out of earnings but out of the money that new investors had brought in.

Naturally, the market reacted. D R Mehta, chairman of market regulator the Securities and Exchange Board of India, shot off a letter to UTI chairman P S Subramanyam asking for details. The wrangling at UTI savaged the BSE Sensex, India's premier index, by 225 points on October 5, spoiling the cheer of the Diwali season.

Finance ministry officials (many of them in Washington at that time) suspected a foreign hand and reacted by shooting a letter to Sebi asking for details of short-selling by foreign institutional investors. The needle of suspicion pointed to Morgan Stanley, which was said to have moved a large corpus of funds from India to other southeast Asian economies overnight, an allegation it angrily denied.

UTI itself turned pro-active the Monday following September 30. In a move to bolster market confidence, it sold SGL securities worth Rs 5 billion and pushed the Sensex up by 41 and 89 points on October 25 and 26. Simultaneously, UTI also clearly told corporates that any offloading of units would be met by offloading of their stocks in the market.

Nervous investors, meanwhile, continued to hound UTI and other investment consultants on the crucial question: should they hold or sell? Deepak Parekh, chairman of the Housing Development Finance Corporation, who was in Washington, revealed that over two score people -- corporates and investors -- traced him in Washington to ask the same question! Some though were not waiting for answers. In the first three days of the week beginning October 5, UTI redeemed (or rather investors sold) units worth over Rs 1 billion. Some out of fear, some out of pique, some to play safe while many were simply angry.

Many though felt cheated. As Jamnadas Murjiani, a UTI investor who offloaded US-64 units worth over Rs 1 billion -- belonging to trusts, his company and personal investments -- put it: "Yeh to dhoka kiya hai. I am telling everyone to sell. If they are stupid and offering Rs 14.25 for paper worth Rs 9, why should I let go of the opportunity?"

Satish Hana, an engineer with L&T, was in queue to dump 20,000 units which he had been "holding for five years, because I have been influenced by the news that the mutual fund does not have any money. Why carry useless paper in my hand, let me make some money. I am also disappointed that UTI could do such a thing. This is our money, so let me take it before it disappears.''

What upset unit holders was not just the news of value erosion but the fact that nobody from the government had made any effort to assuage their concerns. Devidas Tharwani, a BSE broker, had said, "If they have to use their capital reserves then this just shows their desperation. They also have not said what they plan to do so. How can a small investor rest assured? It is better to sell now than be sorry." Tharwani sold 3,000 units and by October 27, even the MoF mandarins, busy in Washington attending the International Monetary Fund meeting, woke up to the crisis. Finance Secretary Vijay Kelkar announced that "the government will stand fully and firmly behind UTI."

Firefighting it was. But the larger question was: What pushed India's largest and historic mutual fund to this pass?

A SEBI internal audit report of the US-64 and other UTI schemes had brought out the fact that the Trust was paying out of its reserves and there was a serious lacunae in the manner the funds were being managed, facts which are now in public domain.

Indeed, the reserves position of the US-64 scheme is clearly in tune with the fortunes of the capital market. Most investors and the Sensex hit a high in 1994-95; so, in that year, the reserves moved up from Rs 58.42 billion to Rs 60.83 billion. Thereafter, the reserves have dropped to Rs 40.07 billion in June 1996, Rs 17.78 billion in June 1997 and turned negative in keeping with the overall crash of market capitalisation in June 1998 to touch negative of Rs 10.98 billion in June 1998.

Also important is that the general reserves of the scheme have dropped from Rs 15.94 billion in June 1994 to Rs 13.67 billion in 1997. Despite this, there was no move to curtail the payout of dividend. It was kept artificially high at 20 per cent from 1996 to 1998, a fact that has been brought out in two successive Sebi internal audit reports.

A senior official at the Industrial Credit and Investment Corporation of India points out: "When the economy is facing fundamental problems and a downtrend of two years preceded by a cash crunch of 18 months, it is only to be expected that corporates would turn in bad results. To expect UTI to be insulated from the environment it invests in would be naive. Obviously they will be hit. But how badly would depend on the manner in which the funds have been deployed."

Typically, the top holdings of the scheme are mostly heavyweight Sensex scrips. And these tend to lean more on companies in the core sector, the commodities sector and public sector enterprises. Worse, most of the companies in its high weightage packet have performed worse than the Sensex by a long yard.

US-64 had lost Rs 22.49 billion in value just in ten private sector scrips with five of them dipping well over 25 per cent in a 12-month period (June 1997-98) compared to the Sensex. Similarly, PSU shares that UTI bagged as part of the disinvestment programme of the Manmohan Singh regime have weighed the scheme down by Rs 20.71 billion with some like SAIL and ONGC losing over 50 per cent of their worth in just 12 months.

Of course, it would be too simplistic to dub all the blame just on the swings of the capital market. Former UTI chief S A Dave has put the blame squarely on the manner in which the scheme has been run. It is his contention that the weightage of equity (that is investment in shares) has gone up phenomenally from Rs 79.57 billion (around 39 per cent of the total portfolio) to over Rs 136.26 billion or 68 per cent of the total in 1998. What this means is that UTI has gone ahead and invested in equity when the market was obviously in a slide. For instance, UTI's investments in equity have gone up from Rs 116.89 billion to Rs 136.26 billion between June 1997 and June 1998, during which period the Sensex dropped by a huge 24 per cent.

The role of successive governments also needs to be understood. UTI has been the saviour of governments in distress. Be it the fall of the Deve Gowda regime in March 1997 or the nuclear tests -- which Subramanyam ascribes much of the erosion in values to -- it is UTI which has been asked to prop up the market.

Subramanyam puts the damage or loss of value in equity in just one year at Rs 35.66 billion. As a senior RBI official puts it: "Just as the IMF is pressed into service internationally to prop economies artificially, the government has been pressing UTI into service." However, a market analyst counters that the mopping operations undertaken by UTI to oblige successive governments had cost the trust and thus investors dearly.

The problem with UTI is not just with the US-64 scheme. It is rather symptomatic of the manner in which the fund has been performing over the years. Or more pertinently, the way it has been used by the corporate-government nexus that has forced UTI managers to perforce pick up both equity and debt from corporates at the edge of desperation.

What is worse is that in contravention of established fund management norms, UTI managers have regularly sold shares held by one scheme to the other and vice-versa to justify or prop up returns that could not be justified. And it is in the light of these very practices that former Sebi chief G V Ramakrishna waged a war with UTI to bring it under Sebi's inspection.

Murjiani says UTI is yet to come clear. "They need to spell out the volume and value of shares they hold of companies that have folded up, that have been referred to the BIFR, that they bought in private placements that went bad. They must value their NPAs in equity also which they are happily valuing at Rs 10 when it could be zero."

Indeed, investment analysts are strongly advising their investors to pull out of US-64. They are worried about the other schemes and more importantly about UTI's debt portfolio. For it includes long-term loans to core sector companies that have gone bad but have been rolled over.

As a fund manager at a private mutual funds points out, "A larger erosion is estimated to have occured in the holdings of non-covertible debentures that UTI is holding stock of companies which probably won't be able to pay up, which are not paying regular interests and of companies which have simply vanished. Over 3,000 companies are either delisted or are missing from the trading lists of stock exchanges."

What has also not helped matters is the continuous change in taxation over the last four years. First, the dilution of the 80-M provision which kept the corporates locked in and then the complete abolition of the tax break pushed corporates out of the US-64 fold. One top corporate is reported to have offloaded over Rs 5 billion worth units in the last two years as it failed to serve any purpose.

As the vice-chairman of a large corporate explained: "Earlier it was a great instrument for tax planning. We would borrow at lower rates in the market and deploy in units as we got the tax break as also returns higher than the rates we borrowed at. Plus we could always borrow against units."

Dave contends: "Even those who had investible surplus were forced to cash in their units in the aftermath of the inflation control programme unleashed by the Rao regime." The programme, he says, pushed corporates to liquidate assets to meet their capital shortfall. This turned the fund from a largely wholesale investors bracket (which ensures some consistency) to a retail number bringing in larger number of unit investors.

A large number of private funds were competing for the same money since 1996. So UTI had to perforce keep its redemption levels high, to attract new investors, to ensure that they could bridge the gap between falling reserves, falling income and a rising need to pay out. In the context of the economic downtrend, the credit crunch and the external crisis, the problem at UTI does not seem surprising. The point is, why was not it spotted earlier?

As a senior investment analyst points out: "It is fine for Dr Dave to say now that the ratio was altered and it damaged the fund. Why didn't he speak up earlier?" A senior Sebi official has a more serious issue to raise. "The entire board of trustees need to answer the investors as to why they kept quiet when this was happening. What was the executive trustee doing? What were the representatives of the finance ministry, the chief economic adviser of the Government of India and the representatives of IDBI and RBI doing while this chain game was being played?"

Obviously, not much. Apparently, Finance Minister Yashwant Sinha was not even appraised of the problem at UTI and possible ramifications till four days after the problem hit the fan.

The good news though is that not many -- besides nervous and angry investors -- feel the situation is out of hand. HDFC chairman Deepak Parekh, who went on to head the panel instituted by the government to suggest ways to nurse US-64 back to health, says it is unfortunate that so much was made out of the problem. "It is the oldest scheme going. As the economy turns around, UTI will recoup the dip in the reserves."

The managing director of a diversified group though feels a more permanent solution would be for the two owners -- the RBI and IDBI -- to bring in fresh equity. "When a company goes bad, they don't clamour for debt. They bring in equity to tide over. Similarly, IDBI and the RBI should bring in equity."

Senior bankers agree. After all, if banks can be bailed out to the tune of over Rs 120 billion and the oil pool account bailed out with Rs 185 billion petro bonds, UTI deserves to be helped by whatever the gap is. However, UTI must get itself audited by reputed audit firms. Unless it lives up to its motto -- wise deployment leads to prosperity - it will continue to be under a shadow.

Part II: The Deepak Parikh Committee's recommendations to restore the lost glory to UTI

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