US-64: FAQs on pricing

D. Sampathkumar

THE UNIT Trust of India (UTI) has an uncanny knack of hitting the newspaper headlines at regular intervals -- needless to say, for entirely wrong reasons.

The latest instance of this, of course, being its decision to suspend the `sale' and `repurchase' of US-64 units for a period of six months (incidentally, the suspension of `sale' of units is only of notional significance. They might as well have not announced it. For brave is the investor who might decide to buy these units at a time when the institution has decided to close the `repurchase' window).

The decision to suspend `repurchase' has inevitably led to a storm of protest, with questions being raised about what the UTI management should and should not have done. Here, then, is a catalogue of possible questions and answers.

Should the UTI not have adopted a net asset value-basis for pricing the `sale' and `repurchase' of units?

In the normal circumstances, all schemes, whether they have an equity orientation or a bias towards government securities, should be marketed with the NAV feature alone.

After all, even in the case of investment in government securities there is a potential for loss of investment value due to interest rate changes. So it makes sense to structure schemes with `sale' and `repurchase' based on NAVs. But the circumstances surrounding the launch of US-64 back in 1964 were anything but what one comes to expect in a mature market such as the West.

At the time of its launch there was no equity culture in the country. With the exception of promoters and a few stock brokers, very few owned shares in any company. As a matter of fact, it was precisely with a view to fostering such an equity culture among the investing public that the UTI was formed, as T. T. Krishnamachari, the visionary Finance Minister at the time, so eloquently put it when steering the passage of the UTI Bill in Parliament.

Now, basing the `sale' and `repurchase' of units on the NAV implies that the UTI warrants to the investing public that its portfolio at any point of time would fetch a certain value if sold in the market. The operative clause is `if sold in the market'. In a market where there are no investors, or at least not for the volumes of shares that the UTI holds, it is meaningless to talk of a realisable value in the market.

Whether they perceived it or not, there is no denying the fact that the situation presents a policy dilemma. Should the UTI have computed an NAV of the vast portfolio of stocks it has built up, by taking prices that mirror minuscule volumes of shares traded in the stock exchanges as benchmarks?

There is a problem with this approach. But not fixing any price for sale and repurchase too was not an option. Existing investors had to be provided with an exit option. The scheme had to also target fresh subscribers if the objective of fostering an equity culture had to fulfilled. In the circumstances, a `repurchase' price was arrived at, on the principle that the price so determined secures for the investor a reasonable return on the initial investment.

Once the `repurchase' price is fixed, the `sale' price for the next tranche of subscription gets determined automatically at a slight premium to the `repurchase' price. If this seems horribly unscientific one would do well to recall here that the UTI was no more guilty of artificial valuation of wealth than the goldsmiths of England who, in an earlier era, let circulate more pieces of paper evidencing stock of gold than what they actually possessed.

Should they not have switched over to an NAV-based system once the market had evolved to the point where there were more players of equal standing?

Strictly speaking, the market evolved to this state of growth only in the mid-1990s, when portfolio investments from foreign institutional investors began to match what the UTI had accumulated over the years. There is a basic inertia to alter the status quo, particularly when such status quo appears to have the added merit of having served the organisation well over the years.

It required a crisis of valuation to stir the organisation into taking the first steps towards an NAV-based regime for its flagship scheme. But, alas, as often is the case, the desire for action comes about long after the moment has passed. By the time the market had deepened sufficiently to permit valuation on the basis of currently prevailing prices, the market had already begun its long run slide in valuation.

Such a slide in valuation was, of course, inevitable considering that the profitability of the Indian corporate sector had been eroded thanks to liberalisation. Any switch over at this stage would have brought out the sharp dichotomy between the `sale' and `repurchase' prices at which the scheme was marketed just until then and the prices at which it would have had to be marketed if the switchover to NAV basis had happened.

The UTI would have been hard put to it to explain this to an investor who had just the previous day bought units at Rs 16 or Rs 17 only to see another investor buy it at Rs 12 or Rs 13 the next day because the UTI chose to market the scheme at levels that better reflect the current realisable value of its portfolio.

There would certainly have been cries of `fraud' and `cheating' directed at the UTI management from investors who had been forced to cough up more money for the same set of units just the other day. It was as if the UTI management, having initially chosen to ride the tiger of `non-market-related' prices suddenly finds itself gripped with an intense desire to get off it but is unable to do so for fear that the tiger would now devour it.

But surely they did have a gameplan? Did they not, after all, talk of a switchover to an NAV-based price regime at some time in the near future?

True, they did. In the gameplan they had, they basically hoped the stock market would somehow revive to a point where the NAV begins to closely mimic the current sale/repurchase prices. In a situation of convergence between unit portfolio value and sale/repurchase prices they could have seamlessly moved to an NAV based regime. There would have been none of those allegations of short changing of existing unitholders with regard to the pricing.

Of course, there was a risk of some existing investors (who had invested at lower market levels) questioning the management as to why the NAV-based sale and repurchase prices have not gone up to the extent the market had risen. But this is something that could have been handled with the cliched response that the US-64 was an unique animal and that conventional rules of portfolio behaviour did not apply to it.

Why did this gameplan fail?

For the market to revive, the corporate sector itself would have had to acquit itself a little better than it had done till then. Once the corporate sector began to post better results, earnings expectations for the future would have helped market players bid prices up, and the UTI management would have achieved its purpose of effecting a smooth transition to the NAV regime. But the corporate sector showed no signs of coming out of a sluggish earnings performance.

The software sector, for a while, was a shining exception to this rule. But even here, the US slowdown is threatening to undermine the prospects for sustaining a growth momentum. If till then, the UTI management was seen riding the tiger of a dangerously misaligned pricing practice, it was in effect hoping the tiger would somehow doze off and it could quietly get off and retire to the comforts of a treetop `machan'. But the tranquiliser of superior corporate performance to lull the tiger to sleep is nowhere in sight.

Pic.: The former UTI Chairman, Mr P. S. Subramanyam, and the Acting Chairman, Mr K. G. Vassal... Will the latter be able to set the US-64 pricing formula right?