Unit 64

Unhappy investors Quote in 1998

"They were invested blindly in stocks, they have cheated us. 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?”

In 1998, investors of Unit Trust of India’s (UTI) Unit Scheme-1964 (US-64) were
shaken by media reports claiming that things were seriously wrong with the
mutual fund major. For the first time in its 32 years of existence, US-64 faced
depleting funds and redemptions exceeding the sales. Between July 1995 and
March 1996, funds declined by Rs 3,104 crore. Analysts remarked that the
depleting corpus coupled with the redemptions could soon result in a liquidity
crisis. Soon, reports regarding the lack of proper fund management and internal
control systems at UTI added to the growing investor frenzy. By October 1998,
US-64’s equity component’s market value had come down to Rs 4200 crore from
its acquisition price of Rs 8200 crore. The net asset value (NAV) of US-64 also
declined significantly during 1993-1996 due to turbulent stock market conditions.
A Business Today survey cited US-64’s NAV at Rs 9.68. The US-64 units, which
were sold at Rs 14.55 and repurchased at Rs 14.25 in October 1998, thus were
around 50% and 47%, above their estimated NAV. Amidst growing concerns
over the fate of US-64 investors, it became necessary for UTI to take immediate
steps to put rest to the controversy.

CREATING TRUST

UTI was established through a Parliament Act in 1964, to channelise the nation’s
savings via mutual fund schemes. This was done as in the earlier days, raising
the capital from markets was very difficult for the companies due to the public
being very conservative and risk averse. By February 2001, UTI was managing
funds worth Rs 64,250 crore through over 92 saving schemes such as US-64,
Unit Linked Insurance Plan, Monthly Income Plan etc. UTI’s distribution network
was well spread out with 54 branch offices, 295 district representatives and about
75,000 agents across the country.The first scheme introduced by UTI was the
Unit Scheme-1964, popularly known as US-64. The fund’s initial capital of Rs 5
crore was contributed by Reserve Bank of India (RBI), Financial Institutions, Life
Insurance Corporation (LIC), State Bank of India (SBI) and other scheduled
banks including few foreign banks. It was an open-ended scheme, promising an
attractive income, ready liquidity and tax benefits. In the first year of its launch,
US-64 mobilized Rs 19 crore and offered a 6.1% dividend as compared to the
prevailing bank deposit interest rates of 3.75 - 6%. This impressed the average
Indian investor who until then considered bank deposits to be the safest and best
investment opportunity. By October 2000, US-64 increased its capital base to Rs
15993 crore, spread over 2 crore unit holders all over the world.However by the
late 1990s, US-64 had emerged as an example for portfolio mismanagement. In
1998, UTI chairman P.S.Subramanyam revealed that the reserves of US-64 had
turned negative by Rs 1098 crore. Immediately after the announcement, the
Sensex fell by 224 points. A few days later, the Sensex went down further by 40
points, reaching a 22-month low under selling pressure by Foreign Institutional
Investors (FIIs). This was widely believed to have reflected the adverse market
sentiments about US-64. Nervous investors soon redeemed US-64 units worth
Rs 580 crore. There was widespread panic across the country with intensive
media coverage adding fuel to the controversy.

DISTRUST IN TRUST
Unlike the usual practice for mutual funds, UTI never declared the NAV of US-64
- only the purchase and sale prices for the units were announced. Analysts
remarked that the practise of not declaring US-64’s NAV in the initial years was
justified as the scheme was formulated to attract the small investors into capital
markets. The declaration of NAV at that time would not have been advisable, as
heavy stock market fluctuations resulting in low NAV figures would have
discouraged the investors. This seemed to have led to a mistaken feeling that the
UTI and US-64 were somehow immune to the volatility of the Sensex.Following
the heavy redemption wave, it soon became public knowledge that the erosion of
US-64’s reserves was gradual. Internal audit reports of SEBI regarding US-64
established that there were serious flaws in the management of funds.
Till the 1980s, the equity component of US-64 never went beyond 30%. UTI
acquired public sector unit (PSU) stocks under the 1992-97 disinvestment
program of the union government. Around Rs 6000-7000 crore was invested in
scrips such as MTNL, ONGC, IOC, HPCL & SAIL.A former UTI executive said,
“Every chairman of the UTI wanted to prove himself by collecting increasingly
larger amounts of money to US-64, and declaring high dividends.” This seemed
to have resulted in US-64 forgetting its identity as an income scheme, supposed
to provide fixed, regular returns by primarily investing in debt instruments.
Even a typical balanced fund (equal debt and equity) usually did not put more
than 30% of its corpus into equity. A Business Today report claimed that eager to
capitalise on the 1994 stock market boom, US-64 had recklessly increased its
equity holdings. By the late 1990s the fund’s portfolio comprised around 70%
equity. While the equity investments increased by 40%, UTI seemed to have
ignored the risk factor involved with it. Most of the above investments fared very
badly on the bourses, causing huge losses to US-64. The management failed to
offload the equities when the market started declining. While the book value of
US-64’s equity portfolio went up from Rs 7,943 crore (June 1994) to Rs 13,627
(June 1998), the market value had actually declined in the same period from Rs
18,334 crore to Rs 10,029 crore. Analysts remarked that UTI had been pumping
money into scrips whose market value kept falling. Raising further questions
about the fund management practices was the fact that there were hardly any
‘growth scrips’ from the IT and pharma sectors in the equity portfolio.In spite of all
this, UTI was able to declare dividends as it was paying them out of its yearly
income, its reserves and by selling the stocks that had appreciated. This kept the
problem under wraps till the reserves turned negative and UTI could no longer
afford to keep the sale and purchase prices artificially inflated.Following the
public outrage against the whole issue, UTI in collaboration with the government
of India began the task of controlling the damage to US-64’s image.

RESTORING THE TRUST

UTI realised that it had become compulsory to restructure US-64’s portfolio and
review its asset allocation policy. In October 1998, UTI constituted a committee
under the chairmanship of Deepak Parekh, chairman, HDFC bank, to review the
working of scheme and to recommend measures for bringing in more
transparency and accountability in working of the scheme. US-64’s portfolio
restructuring however was not as easy as market watchers deemed it to be. UTI
could not freely offload the poor performing PSU stocks bought under the GoI
disinvestment program, due to the fear of massive price erosions after such
offloading. After much deliberation, a new scheme called SUS-99 was launched.
The scheme was formulated to help US-64 improve its NAV by an amount, which
was the difference between the book value and the market value of those PSU
holdings. The government bought the units of SUS-99 at a face value of Rs 4810
crore. For the other PSU stocks held prior to the disinvestment acquisitions, UTI
decided to sell them through negotiations to the highest bidder. UTI also began
working on the committee’s recommendation to strengthen the capital base of
the scheme by infusing fresh funds of Rs 500 crore. This was to be on a
proportionate basis linked to the promoter’s holding pattern in the fund.
The inclusion of the growth stocks in the portfolio was another step towards
restoring US-64’s image. Sen, Executive Director, UTI said,
“The US-64 equity portfolio has been revamped since June. During the last nine
months the new ones that have come to occupy a place among the Top 20
stocks from the (Satyam Computers, NIIT and Infosys) and FMCG (HLL,
SmithKline Beecham and Reckitt & Colman) sectors. US-64 has reduced its
weightage in the commodity stocks (Indian Rayon, GSFC, Tisco, ACC and
Hindalco.)”
To control the redemptions and to attract further investments, the income
distributed under US-64 was made tax-free for three years from 1999. To
strengthen the focus on small investors and to reduce the tilt towards corporate
investors, UTI decided that retail investors should be concentrated upon and their
number should be increased in the scheme. UTI also decided to have five
additional trustees on its board. To enable trustees to assume higher degree of
responsibility and exercise greater authority UTI decided to give emphasis on a
proper system of performance evaluation of all schemes, marked-to-market
valuation of assets and evaluation of performance benchmarked to a market
index. The management of US-64 was entrusted to an independent fund
management group headed by an Executive Director. UTI made plans to ensure
that full responsibility and accountability was achieved with support of a strong
research team. Two independent sub-groups were formed to manage the equity
and debt portion of US-64. An independent equity research cell was formed to
provide market analysis and research reports.

The US-64 Controversy RESTORING THE TRUST

HOW THINGS WERE SET RIGHT

PSU shares were transferred to a special unit scheme (SUS’99) subscribed by
the government in 1998-99.
Core promoters such as the Industrial Development Bank of India added around
Rs 450 crore to the unit capital, thus helping to bridge the reserves deficit of Rs
2,800 crore in 1998-99.
Portfolios were recast in the current quarter to capitalise on the stock surge as
the BSE Sensex rose by 15%. Greater weightage was given to stocks such as
HLL, Infosys, Ranbaxy, M&M and NIIT. In US-64’s case exposure to IT, FMCG
and Pharma stocks rose from 20.45% to 22.09%. This was replicated across
funds. Between June 1999 - September 1999, 21 out of UTI’s 28 schemes have
outperformed the Sensex. UTI has become more proactive in fund management.
For instance, it bought into Crest at between • Rs 200 and Rs 210 in October
1999. The stock was trading at Rs 340 in November 1999. Stocks like Visual
Software, Mastek and Gujarat Ambuja have entered the top 50 equity holding list.
Scrips like Thermax, Thomas Cook and Carrier Aircon are out. Complete exit
from illiquid stocks such as Esab Industries. The divesture of around 83 stocks
released an estimated Rs 300-500 crore of extra investible cash.
Source: Business World, November 29, 1999. UTI constituted an ad-hoc Asset
Management Committee with 7 members comprising 5 outside professionals and
2 senior UTI officials. The committee’s role was clearly defined and its scope
covered the following areas:• To ensure that US-64 complied with the regulations
and guidelines and the prudential investment norms laid down by the UTI board
of trustees from time to time.• To review the scheme’s performance regularly and
guide fund managers on the future course of action to be adopted.• To oversee
the key issues such as product designing, marketing and investor servicing along
with the recommendations to Board of Trustees.One of the most important steps
taken was the initiative to make US-64 scheme NAV driven by February 2002
and to increase gradually the spread between sale and repurchase price. The
gap between sale and repurchase price of US-64 was to be maintained within a
SEBI specified range. UTI announced that dividend policy of US-64 would be
made more realistic and it would reflect the performance of the fund in the
market. US-64 was to be fully SEBI regulated scheme with appropriate
amendment to the UTI Act. The real estate investments made by UTI for the US-
64 portfolio were also a part of the controversy as they were against the SEBI
guidelines for mutual funds. UTI had Rs 386 crore worth investments in real
estate. UTI claimed that since its investments were made in real estate, it was
safe and it could sell the assets whenever required. However, the value of the
real estate in US-64’s portfolio had gone down considerably over the years. The
real estate investments were hence revalued and later transferred to the
Development Reserve Fund of the trust according to the recommendations of the
Deepak Parekh committee. By December 1999, the investible funds of US-64
had increased by 60% to Rs 19,923 crore from Rs 12,433 crore in December
1998. The NAV had recovered from Rs 9.57 to Rs 16 by February 2000 after the
committee recommendations were implemented.

DEAD END SCHEME?

Though UTI started announcing the dividends according to the market

conditions, this was not received well by the investors. They felt that though the
dividend was tax-free, it was not appealing as most of the investors were senior
citizens and they did not come under the tax bracket. The statement in media by
UTI chairman that trust would try to attract the corporate investors into the
scheme was against the recommendation by the committee, which had adviced
the trust to attract the retail investors into the scheme. This led to doubts about
UTI’s commitment towards the revival of the scheme.
However, led by improving NAV figures and image-building exercises on UTI’s
part, by 2000, US-64 was again termed as one of the best investment avenues
by analysts and market researchers. UTI had become more proactive in fund
management with its scrips rising in value, restoring the confidence of the small
investor in the scheme. The National Council of Applied Economic Research
(NCAER) and SEBI surveys mentioned that US-64 was once again perceived as
a safe investment by the middle class income groups.
However, the euphoria seemed to be short lived as in 2001, US-64 was involved
in yet another scam due to its investments in the K-10 stocks . Talks of a
drastically low NAV, inflated prices, increasing redemption and GoI bailouts
appeared once again in the media. An Economic Times report claimed that there
was a difference of over Rs 6000 crore between the NAV and the sale prices.
Doubts were raised as to US-64 being an inherently weak scheme, which
coupled with its mismanagement, had led to its downfall once again. This
however, was yet another story.
QUESTIONS FOR DISCUSSION:

1. Explain in detail the reasons behind the problems faced by US-64 in the mid
1990s. Were these problems the sole responsibility of UTI? Give reasons to
support your answer.2. Analyse the steps taken by UTI to restore investor
confidence in US-64. Comment briefly on the efficacy of these steps.3. As a
market analyst, would you term US-64 a safe mode of investment? Justify your
stand with reasons. 4. US-64 should have been NAV driven from the very
beginning like other mutual funds. Comment.

EXHIBIT IUTI – OBJECTIVES & STRUCTURE

UTI's MandateUTI was formed to increase the propensity of the middle and lower
groups to save and to invest. UTI came into existence during a period marked by
great political and economic uncertainty in India. With war on the borders and
economic turmoil that depressed the financial market, entrepreneurs were
hesitant to enter capital market. The companies found it difficult to access the
equity markets, as investors did not respond adequately to new issues. To
channelise savings of the community into equity markets to make them available
for the companies to speed up the process of industrial growth.UTI was the idea
of then Finance Minister, T.T. Krishnamachari, which would "open to any person
or institution to purchase the units offered by the trust. However, this institution
as we see it, is intended to cater to the needs of individual investors, and even
among them as far as possible, to those Whose means are small."UTI was
formed as an intermediary that would help fulfil the twin objectives of mobilizing
retail savings and investing those savings in the capital market and passing on
the benefits so accrued to the small investors. UTI commenced its operations
from July 1964 "with a view to encouraging savings and investment and
participation in the income, profits and gains accruing to the Corporation from the
acquisition, holding, management and disposal of securities." Different provisions
of the UTI Act laid down the structure of management, scope of business,
powers and functions of the Trust as well as accounting, disclosures and
regulatory requirements for the Trust.Structure of the Trust UTI represents an
unique organisational without ownership capital and an independent Board of
Trustees. Under the provisions of the first UTI scheme, US-64, certain institutions
contributed to the Scheme's initial capital, which was redeemable at the
discretion of the Trust at such value decided by the Government of India.The
contributors to the initial capital of Rs. 5 crore for US-64 Scheme were Reserve
Bank of India (RBI), Other Financial Institutions, Life Insurance Corporation (LIC),
State Bank of India (SBI) & its subsidiaries and other scheduled banks including
a few foreign banks. In February 1976, RBI’s contribution was taken up by the
Industrial Development Bank of India (IDBI). The institutions were provided
representation on the Board of the Trustees of UTI. Under the provisions of the
Act, Chairman of the Board was appointed by Government of India. The Board of
Trustees oversees the general direction and management of the affairs and
business of UTI. The Board performs its functions based on commercial
principles, keeping in mind the interest of the unit holders under various
schemes. Since UTI does not have any share capital, it operates on the principle
of "no profit no loss" as all income and gains net of all costs and development
charges ultimately go back to investors of respective schemes. Formative Years:
1964-1974UTI commenced its operations with R.S. Bhatt at the helm. The first
product, Unit Scheme 1964 (US '64), continues to be the most popular
investment avenue to date. In the first year itself the scheme mobilised Rs.19
crore compared to the incremental commercial bank deposits of Rs.367 crore in
that year. The first year's dividend was 6.1% compared to the bank deposit rates
of 3.75 - 6%. With the increasing popularity of US-64 as a long-term investment
avenue, the Trust introduced a Reinvestment Plan in 1966-67 (automatic
reinvestment of income distributions to US-64 unit holders). After two successful
terms, when R S Bhatt relinquished charge, he had laid a solid foundation for the
Trust. During his tenure, unit capital had grown to Rs.92 crore, covering an
investor base of 3.64 lakh accounts.
Source: www.unittrustofindia.com

EXHIBIT IIDIVIDENDS DECLARED BY US-64

Year Dividend declared
1989-90 18%
1991-92 25%
1993-94 26%
1995-96 20%
1997-98 20%
1999-00 13.75%
1990-91 19.50%
1992-93 26%
1994-95 26%
1996-97 20%
1998-99 13.50%
2000-01 10.00%