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. 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 practice 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. 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. 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. 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. 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. 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. To control the redemptions and to attract further investments, the income distributed under US-64 was made tax-free for three years from 1999. 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. 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. 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.

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.