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US-64 borrowings account for 50% of assets base

B G Shirsat & Janaki Krishnan

Is the US-64 scheme being run like a hedge fund? Looks like, because money has been borrowed in the market and from other schemes to make up the difference of Rs 65 billion between the current market value of the US-64 portfolio and the net asset value of its units.

Essentially, while the market value of US-64's investments as on December 28, 2001 was pegged at Rs 138.95 billion, the asset value based on the NAV of Rs 5.81 per unit as on the same date works out to Rs 74.24 billion. That is, the total asset base is funded out of unit holders' capital of Rs 74.24 billion and borrowings of Rs 64.71 billion.

This is typically how hedge funds, or more specifically leveraged funds operate. Based on a small pool of units holders' funds, these funds borrow in the market to fund a bigger pool of investments. The returns on this larger pool of investments, after deducting the fixed interest to be paid to the lenders, are then distributed to the small pool of unit holders.

In effect, the fund is able is generate revenues and profits for its unit holders out of proportion with their invested capital. In the US-64 case, borrowings account for almost 50 per cent of the total asset base.

However, UTI chairman M Damodaran denied US-64 is operating as a hedge fund. "We are not borrowing from the market to build assets. We have resorted to borrowing only once in April-May 2001 to meet the redemption pressure," he said.

Damodaran also pointed out that even though UTI borrowed Rs 69 billion to meet the redemption pressure (in April-May 2001), only Rs 25 billion was borrowed from banks and the rest came from UTI's internal liquidity pool.

"There was no borrowing after July 2001. And please also note the fact that we have been able to reduce the liability ('negative liquidity') substantially by Rs 29 billion. The liability has come down from Rs 69 billion to Rs 40 billion now," Damodaran said.

However, it is clear that the money raised to fund redemptions is in effect funding the asset base. Cash raised to meet redemptions is just another way of saying that the scheme did not sell assets to raise cash. Ideally, a mutual fund should be sellings its assets (investments) to match unit holders' equity capital, rupee for rupee.

Sebi regulations for mutual funds prohibit mutual funds from leveraging or borrowing funds in order to invest in the market. Investments have to be necessarily made out of the corpus provided from the investor pool. However funds can borrow up to 20 per cent of their net asset to fund redemptions. And, this applies to UTI, too.

According to P K Nagpal, Sebi division chief in mutual funds department, "though UTI does not come under the purview of Sebi, the same regulations apply to investments of the Trust too."

The scheme, however, has not benefited by not selling its part of the holding in the market when it faced a redemption pressure in April and May 2001.

The current equity portfolio of shows that the market value of technology stocks in its portfolio has depreciated substantially between April-May and December 2001.

The value depreciation in the US-64 over the average market price of May 2001 has been estimated around Rs 16 billion. UTI could have saved this money and the interest on borrowings if they had funded the redemption by selling the stocks.

The big holdings in the scheme have underperformed the BSE Sensex which has declined 10.2 per cent between April and December. For instance, Reliance Industries, which makes up the single biggest chunk of the US-64 portfolio at 13.84 per cent with 62 million shares, is 17.6 per cent lower on January 1 than the average market price of Rs 370.20 in the month of May 2001.

Similarly, the market value of ITC shares is down 14.9 per cent, Reliance Petroleum (down 42.8 per cent), State Bank of India (down 20.8 per cent), ICICI (down 48.4 per cent) Tisco (down 36.9 per cent) and Hindalco (down 26.9 per cent).

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