BOMBAY, 17 March 2003 — Unit Trust of India (UTI), the largest mutual fund of India, has the knack of making and remaining in the news. In the good old days, it was a newsmaker as it was the one and only mutual fund of India, lack of competition made it look like a winner always. But once the scene changed with competition arriving, the chinks in the strong armor of UTI became visible and quite a number of times, it all threatened to come down crumbling.
And now the latest news is that government has come out with a carrot once again for the US-64 unitholders. It has offered to buyback units of US-64 in cash or give investors an option to convert them into five-year tax-free bonds, with a face value of Rs.100 per unit, bearing an interest rate of 6.75 percent from this May. The units can be converted into tax-free bonds starting from June 1, 2003. This bailout package for India’s largest mutual fund works out to the tune of Rs. 106 billion. The government is committed to meet the shortfall if the net asset value is less than the assured return in US-64. Necessary budget provisions have been provided in the current fiscal as well as in 2003-04. Finance Minister Jaswant Singh has allocated Rs. 35.00 billion for bonds and Rs. 30.00 billion for cash redemption in the budget for 2003-04.
Under this new scheme, investors have been given an option of exchanging their US-64 units with the government guaranteed five-year bonds bearing a tax-free interest rate of 6.75 percent having face value Rs. 100 each. In case of odd lots of units worth less than Rs. 100, unitholders would be paid the amount in cash.
The bonds will not have any lock-in period and can be traded freely. Though the bonds are tradable, it is unlikely to be listed on any of the stock exchanges. This is the feature which demarcates it from the government security and the UTI bonds. UTI is also banking on exactly this feature to make the bond the best available bond in the market.
Analysts explain that for large corporate houses, which hold a substantial chunk of US-64 units, given their tax bracket of 35 percent, the bonds will give an effective return of 10.52 percent while it will be 10.07 percent for high net-worth individuals. This will be a great boon to them as surely, most of the corporates and high networth individuals would hold units in excess of 5,000. Almost 80 percent of units are in the 5,000-plus category. They, as per the earlier government commitment, will get Rs. 10 per unit as on May 31. Well, they also have the option of getting the units redeemed at net asset value, but it is unlikely that anyone would bite this bait as NAV is less than Rs. 10 and hence, no sane unitholder would want to redeem their units at NAV. And for the millions of small investors paying taxes at the rate of 10 percent, the yield from the bonds works out to 7.50 percent. As part of its package, UTI is now repurchasing from investors having less than 5,000 units at Rs. 11.80. In its efforts to make the scheme popular, UTI is cutting the entry load from 1.5 percent to 1.2 percent. For a single direct investment of Rs. 50 lakh or above, the entry load is reduced to 0.25 percent.
One of the main objectives to issue these US-64 tax free bonds is to stem the redemption pressures. The government and UTI officials reckon that the attractive pricing of these bonds, taking into account the higher effective yield, could well lure a lot of investors, especially when fairly risk-free investment options are limited. The pricing has to be attractive to retain investors. The government is hoping that a large number of unitholders would prefer the bond option than take home the cash. The investor response to these bonds is crucial for the government because if it turns out to be a big hit with investors, the government would take the same route to foreclose four long-term assured return schemes of UTI where the current shortfall is substantial.
So what should a small investor of US-64 now do? Given the current rate of Rs. 11.80, it is best to encash before May 31, 2003. And for those with more than 5000 units, it is best to use one’s own discretion. If cash is needed at this point of time, it is best to redeem but if they do not mind waiting for 5 more years and given the attractive yield rate, it is best to convert the units to bonds.