Govt makes more money on US-64 than investors

As scheme is closed, investors end up with Rs8,000 crore, govt Rs10,000 crore

MUMBAI: The law of intended consequences states that actions of government often have unanticipated consequences. Unit Trust of India’s Unit Scheme-64 fiasco fits the bill completely.

Around early 2003, US-64, which was India’s largest mutual fund scheme then, was in a bad shape. Rather than face the wrath of the public in a pre-election year, the government of India came up with a rescue scheme. In May 2003, UTI offered to buy back the first 5,000 units of US-64 at Rs12 and the remaining at Rs10. Alternatively, investors had the option of taking 6.75% tax-free bonds in lieu of their investments. These bonds matured on May 31, 2008. Around Rs8,000 crore would be needed to redeem these bonds.

Around the same time, the government handed over the equity holdings of US-64 to the Specified Undertaking of UTI (SU-UTI) that was to handle its dud investments.
Nobody, though, thought then that SU-UTI will make a killing from these equity investments. But that’s exactly what has happened. “Over the last five years, this portfolio has seen gains far in excess of the government’s liabilities on the tax-free bonds.

While the latest figures are not yet available, a rough estimate would put the government’s profits at not less than Rs18,000 crore,” says Dhirendra Kumar, chief executive of Value Research, a mutual fund rating agency.

What this means is that after paying the Rs8,000 crore needed to redeem the bonds,    Rs10, 000 crore is still left as profit.

“To make the scale clearer, consider an investor who started with Rs1 lakh in these bonds. Over these years, he would have received Rs38,000 as interest and now he will get back Rs1 lakh back as redemption money. However, even after redemption, the government would still get to keep at least another Rs1 lakh that it has earned out of investing his money. And this is a conservative estimate; I think the government’s real profit on the deal could actually be higher”, says Kumar.

The question is: should SU-UTI (proxy for the government of India) be making a profit out of the entire exercise? “The bonds were issued in lieu of the value of US-64 units. By exchanging what was essentially a quasi-equity instrument for a fixed income one, the government undertook the entire risk of the US-64 equity portfolio. Therefore, strictly from a legal viewpoint, the government may well be within its rights to not distribute the portfolio profits. Also, as they are used to receiving the regular 6.75% interest, investors will not be expecting any largesse,” says Sandeep Shanbhag, director, Wonderland, an investment and tax advisory firm.

“Legally, the government is well within its rights to keep the money. If the government was just another money manager which was in this business for profits, its logic for keeping the money would be strong — it took the risk, so it should get the profits. However, the government is not just another money manager. US-64 investors have lost a lot because of the incompetence and malfeasance of various managements appointed and overseen by the government. It is utterly unethical for the government to profit out of this whole affair. It’s really as simple as that,” says Kumar

In fact, SU-UTI has major holdings in stocks like Axis Bank, L&T and ITC, as the accompanying table clearly shows. Selling its holdings in just one of the three stocks would be enough to redeem the Rs8,000 crore of US-64 bonds.

Given this, shouldn’t SU-UTI be sharing these profits with the original unitholders of US-64? “The money that was used to generate these profits once belonged to the old UTI’s unit-holders. I think it only fair and ethical that a share of the returns generated in the wonderful boom-time on the Indian stock markets should be shared with the all unit-holders,” says Kumar.

“The ethical, and smart thing to do in a pre-election year, would be to distribute the profits. The average US-64 investor was the common man. Such a move would not only be ethical but also go a long way in assuaging his angst suffered five years ago. After all, this is the legacy of US-64,” says Shanbhag.