Business: Breach of Trust

Revelations that UTI's flagship US-64 scheme is eating out its reserves has shattered investors confidence.

A century ago, Charles Ponzi, an American financial trickster, pioneered the "pyramid" schemes, repaying a previous loan from a second loan and then borrowing from a new creditor to keep the date with the previous creditor. Ponzi always had a few extra notes sticking in his wallet, the current loan being somewhat fatter than the previous. But the pyramid had to crash some day, with creditors getting to know about his trick and so refusing to part with their money. Ponzi went bankrupt and was jailed for fraud.

The spirit of Ponzi is alive and kicking in India at least, with a series of public fund scams wreaking havoc on investors' confidence. However, nobody suspected that a fund as august as the Unit Trust of India (UTI), owned by the Union Government and founded in 1963 by an act in Parliament, might reopen the pages of Ponzi's book. On September 30, a wrangle between the trustees of UTI and its auditors led to the startling disclosure-from the fund's newly-appointed Chairman P. Subramanyam-that the reserves of the fund's flagship scheme, the US-64, had turned negative by a dizzying Rs 1,098.49 crore.

It means that the scheme distributed to its investors that much more money than what it had earned, thus dressing up as "dividend" cash picked up from the till of new investments. The scheme had earned no profit, the estimated present net asset value (NAV) of each of its units with Rs 10 face value being around Rs 9.50 (UTI studiously refrains from declaring the US-64 NAV). Yet it gave a largesse of Rs 2 for every unit in July to tempt new investors who would buy the unit at Rs 14, a premium of 40 per cent on the face value. It was a dividend paid not out of earnings but out of the cash flow of the business.

The market was petrified. D.R. Mehta, chairman of the watchdog agency Securities & Exchange Board of India (SEBI), asked for an explanation from Subramanyam. On Monday the Sensex fell by 224 points. The Ministry of Finance, much of it in Washington then, readily suspected a foreign hand and directed SEBI to ascertain if the foreign institutional investors were shortselling. UTI itself turned pro-active, selling GILTs worth Rs 500 crore and driving the index up by 41 and 89 points on Tuesday and Wednesday. Simultaneously UTI also told corporates that any offloading of units would be met by offloading of their stocks in the market.

Nervous investors meanwhile were tormented by the question: Is it time to sell? Deepak Parekh, hdfc chairman and UTI director who is on a US tour, said droves of Indians had traced him in Washington last week to ask the same question. Some would not wait for an answer. In the first three days of the week, UTI redeemed (or rather investors sold) units worth over Rs 100 crore.

The investors felt cheated. As Jamnadas Murjiani, a UTI investor who offloaded US-64 worth over Rs 10 crore -belonging to trusts, his company and personal investments-put it: "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?" Satish Hana, an engineer with Larsen & Toubro, was in queue to dump 20,000 units which he had been holding for five years. "Why carry paper of doubtful value? Let me turn it into cash now for who knows what will be its worth tomorrow.''

By Wednesday night North Block mandarins began a full-scale firefighting operation, with Finance Secretary Vijay Kelkar announcing that "the Government will stand fully and firmly behind UTI". The market dropped again by 112 points on Thursday though as there were persistent doubts about the business practices adopted by the leading mutual fund organisation in the country. Doubts because the erosion of US-64 reserves did not take place suddenly. 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 that there were serious flaws in the manner the funds were being managed.

Clearly, the payouts burnt holes in the scheme's reserves (see chart) in 1996-97, turning it into negative during the next year. Significantly, the scheme's general reserves, in which UTI puts the retained profits of a good year to meet the exigencies of a bad year, dropped from Rs 1,594 crore in June 1994 to Rs 1,367 crore in 1997. This fact, which violates the prudential norms, was brought out in two successive internal audit reports of the SEBI, but none in the Finance Ministry took note of it.

It's not without reason. The uncomfortable fact is: US-64 had burnt its fingers by overdrawing on equities whose prices kept tumbling. A senior ICICI official points out, "When the economy is facing fundamental problems, the stock values cannot but fall. It is naive to expect the UTI to be insulated from the investment environment." Typically, the top holdings of the scheme (see box) are mostly heavyweight Sensex scrips. And these tend to lean more on the companies in the core and commodities sectors and the public sector enterprises. What's more, most of these companies have performed worse than the Sensex by a long yard leading to a loss of Rs 2,249 crore in value in 10 private sector scrips. Similarly, PSU shares that UTI bagged as part of the disinvestment programme of the Manmohan Singh regime have weighed the scheme down by Rs 2,071 crore with some like sail and ONGC losing over 50 per cent of their worth in just 12 months.

Former UTI chief S.A. Dave has put the blame squarely on the manner in which the scheme has been run over the past two years. He points a finger at the sharp increase in the share of equities in the scheme's investment portfolio (see chart), and that too when the market was on a downslide. Part of the reason no doubt is political. UTI's "buying" operations to save the market and oblige successive governments have cost investors dearly.

However, UTI's problems are not just limited to the US-64 scheme. Each of the eight top mutual fund schemes of UTI is now traded at a discount to its projected NAV-some, like Mastershare and Mastergrowth, by as much as 50 per cent. Murjiani says the real picture of the UTI may be a lot worse than what now shows because the fund is yet to "spell out the volume and value of shares they hold of companies that have folded up or are under BIFR".

Much of these losses are the product of the corporate-government nexus. Besides, in total contravention of established fund management norms, managers of UTI have regularly sold shares held by one scheme to the other and vice versa to prop up sagging returns by fudging the books. Investment analysts are worried about UTI schemes other than US- 64. They smell a rat in the fund's debt portfolio which includes long-term loans to core sector companies that have gone bad but have been rolled over. There may also be a large erosion in the holdings of non-convertible debentures that have been defaulting on interest payouts.

However, if the veterans of the market would not give up hope on the UTI, it is because of its gigantic size-Rs 64,000 crore in investible funds and stock investment accounting for 8 per cent of BSE's total market capitalisation. Besides, the UTI Act puts the fund within parliamentary monitoring range. Parekh, for example, says: "As the economy turns around the UTI will recoup the dip in the reserves."

What is being prescribed by financial captains is a bailout plan for the fund. If banks can be bailed out to the tune of over Rs 12,000 crore and the oil pool account saved with Rs 18,500 crore of petro bonds, UTI, which is the mother of all Indian financial institutions, deserves every rupee of the necessary recapitalisation benefit. But the UTI too must clean up its act by getting its accounts properly audited and coming clean about the real NAV of its schemes. After all, it must learn to write off bad investments rather than sweeping them under the mat.

Interview: P SUBRAMANYAM
"US-64 is still the safest investment"

.P. Subramanyam, a former executive director of IDBI, came to UTI as its chairman in early September and was aghast to find deep holes in the reserves of its main scheme, US-64. Sitting in the middle of the storm, he spoke to Principal Correspondent Robin Abreu:

Did you anticipate this crisis when you took over?
Frankly, it is quite a scary welcome gift which I do not want to experience again. Things moved so fast and panic set in so quickly that there was no time to react.

Why did it happen?
Our (UTI's) reaction time to the crisis was very slow. We were focussing on the wrong scrips. We should have concentrated on certain specialised sectors.

How does UTI plan to get out of the mess?
We have decided to invest heavily in the debt segments of the National Stock Exchange where we'll get higher returns. Our strategy includes developing a secondary debt market.

Do you suspect someone is targeting UTI?
I hope not. We've large holdings in companies which we can sell, particularly when we have strategic holdings in these companies.

Aren't investors worried about future dividends?
We'll make attempts to pay 20 per cent dividend next year, and the year after that. It (US-64) is still the safest investment. Show me if there is anything better.