Repositioning of UTI -- Indebted to investor stake

S. Vaidya Nathan

THE Malegam Committee's report on corporate repositioning of the UTI is out. It calls for a delinking between the Government and the UTI by abolishing the UTI Act, introducing of a strategic partner and quantifying liabilities under US-64 and assured return schemes. It also suggests that these liabilities be tackled before the taking up restructuring.

The UTI management has placed the report for public examination and feedback on the UTI website www.unittrustofindia.com. Some of the key changes proposed for India's largest mutual fund and its investors (who number anywhere between 40 lakh and 2 crore, according to different UTI versions).

For those invested in the UTI, the sections on US-64 and assured return schemes are worth reading. Some of the points therein could have a bearing on what you realise from these schemes.

The UTI's very survival and growth could, however, hinge on timely restructuring. For only an induction of new ownership and management could bring about the much needed improvement of governance and transparency that has been mostly absent. This would have been the long-term issue at stake.

Assured return schemes

The UTI has Rs 27,420 crore in assets under management in its assured return schemes. This accounts for 49 per cent of its net assets. What are the implications for investors in these schemes?

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*The Malegam Committee has underscored the problem of the shortfall between what the UTI owes investors and the underlying assets in these schemes. But, significantly, the Committee has not quantified the gap. The buck has been passed to a to-be-appointed independent valuer.

*The Rs 1,535-crore Development Reserve Fund will not be enough to meet the shortfall.

*If remedial measures are not taken, investors in these schemes will have to take a cut in the returns assured. In the Committee's view, this would lead to a loss of confidence among investors in the UTI.

*Notably, and what should be of some comfort, the Committee has noted that the sponsors/AMCs would have to chip in to meet the shortfall in promised/assured performance under the SEBI Mutual Fund guidelines. In the UTI's case, now there is neither a sponsor nor an AMC. Thus, only the government would have to step in with a package.

*The privatisation, which is at the core of the recommendations, cannot happen without settling the issue of shortfalls in the assured return schemes. It does seem likely that the government would have to provide some kind of a one-time package for these schemes if it wants to proceed with the re-positioning of UTI.

*No sponsor or strategic partner would commit funds without these risks being addressed. So, investors in the pending assured return schemes may not have much to worry about on this score. But one signal is clear: It is actual performance, and not just assurance of returns, that counts.

*By clearly specifying that liabilities on this score would have to be quantified, the Malegam Committee appears to have implicitly placed the ball in the Government's court. As most of the pending assured return schemes are under SEBI regulations and as the regulator has, in the past, vetoed cutting of assured rates, investors are likely to get what is promised.

Whipping up the portfolio

Recognising the shortfall, that it is unlikely to be bridged and the need to close the gap, the Committee has made some suggestions vis-a-vis the portfolios of these schemes. The salient ones are:

*The problems have been identified as pertaining to the equity component of these schemes. The Monthly Income Plans typically provide for an exposure of up to 15 per cent of the corpus.

*The equity component has been acquired at high prices. The scourge of inter-scheme transfers has also taken a toll of these schemes. As the maturity period ranges from one and 19 years, some schemes have become the parking place for equity through inter-scheme transfers. The main beneficiaries have been US-64 and Mastershare, two schemes where a dividend payout every year is a must.

*The Malegam Committee has suggested that in the assured return schemes, the UTI should move away from equity and into debt. This is unexceptionable and it would be the obvious thing to do to match investment objectives.

*A suggestion has been made that funds should be moved to government securities and debt instruments carrying higher rates than government securities so as to reduce the gap. This may not actually serve the purpose of reducing the gap. But it may keep the gap from widening further.

Difficult but needed exercise

Such an exercise is easier said than done. Across its various MIPs and other assured return products, the UTI holds more equity than any single growth fund. Only US-64 has more equity than these schemes put together. Some of these exposures are in stocks where liquidity would be a problem. Or it may come at a stiff price. So the UTI may have to look at booking some losses to re-orient the portfolio.

This process too cannot be completed quickly. The selling of equity would impact the UTI's growth schemes as well as the value of the US-64 equity portfolio. There is, thus, one more dimension to this reconstruction of the portfolio.

The yield on government securities of a five-year tenure or less as well as on top-rated corporate bonds are at least two percentage points lower now than the returns promised by the UTI at the time of launch. So, even the debt-oriented portfolio is bound to earn lower returns. So, any package would not only have to provide for existing shortfalls but also for lower returns in the residual period to maturity. An evaluation under various scenarios shows that the UTI may be looking at shortfalls in the Rs 4,000-8,600 crore range (see Business Line, August 19).

Though the portfolio reconstruction would entail some losses upfront, it would ensure against further capital erosion. The UTI has also given a capital protection guarantee under all its assured return products. The NAVs of the growth options of most of these products are below Rs 10 per unit.

Minor tinkering

After 1999, the UTI generally avoided assuring returns for the entire five-year tenure of such schemes. It has, instead, moved to assuring returns for one year. The rate is usually announced at the beginning of each year.

The Malegam Committee has said that the UTI should also align the rates to what it can realistically earn. This is only to be expected of any rational fund manager. Essentially, what this means is rates much lower than those available on other debt options of mutual funds, including the UTI's Bond Fund and other debt instruments. The equity component may well lower the returns assured in the next two years than what a normal debt-oriented portfolio would offer.

Apart from subtly indicating the need for the government to step in to meet the shortfall, the Committee has also suggested that dividends from such schemes not be tax-exempt in the hands of investors. This would enable these schemes to avoid the dividend tax of 10.2 per cent now.

In the Committee's view, this may also help reduce the shortfall. But it may not be all that easy to implement as it would mean selectively carving out a few schemes for differential tax treatment. The situation here is different from US-64, where dividend tax exemption was given.

But it was couched as an incentive to schemes that invest in equity. US-64 and other open-end mutual fund schemes with an exposure of more than 15 per cent to equity were exempt from dividend tax. No such carving out may be possible here unless the government decides to give the to-be privatised UTI special treatment.

If implemented, the Malegam Committee's recommendations could go a long way in reducing the concerns of investors in the UTI's assured return schemes. Going forward, it may be better to go by performance than assurance while investing in debt products. All open-end debt schemes have independently delivered decent returns.

That ought to be better than having an assured return not backed by performance -- one that is bedevilled by a lack of transparency and inter-scheme transfers.