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Pavagada Subramanyam |
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No respite seems in sight for India’s equity markets. Reeling from a share price rigging scam in March and brokers’ protests against new trading rules, the markets were felled once again last month by news of trouble at India’s largest manager of mutual fund assets, the Unit Trust of India (UTI).
On July 20, Pavagada Subramanyam, former chairman of the government-controlled UTI, which manages assets worth around $12.3 billion owned by 40 million investors, was arrested, along with two senior UTI officials, on charges of criminal conspiracy and abuse of public office. The trio are accused of privately buying shares in a software company last year, resulting in losses of about Rs320 million ($6.8 million).
Subramanyam was sacked by the government in early July, a day after UTI’s biggest fund, the $2.7 billion open-ended US 64, froze sales and purchases of its units until January next year. A falling stock market and large numbers of redemptions by investors forced the fund to take that extreme step. Faced with around 20 million angry investors, finance minister Yashwant Sinha said UTI’s managers had kept him in the dark about the troubled fund and promised a partial bailout for small investors, the second rescue in three years.
The bailout announced on July 15 allows investors to sell up to 3,000 units to the fund from August 1 at a small capital loss. Over the next two years, the fixed price of units will rise each month, encouraging investors to stay in the fund to keep their losses down.
The government fears that if all investors rush for the exit at once, the stock market will crash because around two-thirds of the fund is invested in shares. UTI says it will sell those shares privately, not in the open market. The government has openly urged state banks and insurance companies to come to UTI’s aid by way of loans or buying its shares.
Sinha is under mounting pressure from his political opponents. A parliamentary probe into the stock market crisis in March is on. The main opposition Congress party is threatening to raise a stink in parliament over US 64. Kirit Parikh, an MP who heads an association of small investors, alleges that large corporate investors were tipped off about UTI’s plan to freeze sales and pulled out $883 million from US 64 in April and May this year. Sinha hopes that by acting tough (ordering an independent probe into UTI’s past investments and prosecuting UTI’s top managers) some of that criticism will be subdued.
| Net assets of Indian mutual funds as of 30 June 2001 | ||
| (Rs Bn) | ||
| Total assets | 979.5 | |
| Private sector | 346.2 | -35% |
| Public sector | 74 | -7% |
| UTI | 559.2 | -57% |
| Source: Securities Exchange Board of India | ||
UTI’s troubles can be traced to the cosy relationship it enjoyed with the government. After a run on US 64 forced a government bailout three years ago, an expert panel pointed out that the fund had invested heavily in illiquid privatization shares of state companies and banks. As part of the Rs30 billion bailout, the government bought back those shares at nearly twice the market price through a debt-equity swap. The fund was given three years to restructure itself into a bond fund in line with the fixed income its investors expect and start selling its units at market prices (their net asset value) rather than fixed prices.
Yet about two-thirds of US 64’s investments today are still in shares. The fund bought heavily into technology stocks and over a fifth of its equity investments in June last year were in the IT sector. By June, equity investments had climbed to 73% from 68% in the previous year. One manager of an American fund says: “That should have been the time to move to market pricing of its units but US 64’s managers continued to sell them at fixed prices. It made no sense to let investors believe that there would be no loss of capital in an equity fund.” Technology stocks nosedived soon after, and a stock market scam in March this year nailed the fund’s fortunes.
| Yashwant Sinha | ||||||
The absence of regulation encouraged its managers to take those risks. US 64 is not subject to the scrutiny of the Securities Exchange Board of India and, unlike other mutual funds, does not disclose all its investments or the market value of its assets. UTI’s new chairman, M Damodaran, a bureaucrat from the Ministry of Finance, says US 64 will reveal the market value of its assets from January next year, but admits that it is currently lower than the government’s bailout price. Many fear that the criminal prosecution of the former UTI chairman and top managers might spark an exodus from all of UTI’s equity funds.
The US 64 rescue reinforces investors’ perception that government ownership or control over India’s biggest financial institutions guarantees them protection. Several mutual funds managed by state banks or insurance companies made the same mistakes that UTI did and were bailed out. N Vaghul, the non-executive chairman of ICICI, a large private bank, says: “There is a danger that this implicit guarantee will be invoked in all government-run institutions. The government must get out and professionalise them fast.”
UTI’s problems could hurt all mutual funds, including privately managed funds that have cut its market share down to 57% today. The largest among them are managed by Alliance, Sun Life, Prudential and Templeton.
One such private manager says: “UTI’s breach of trust will make all mutual funds seem suspect, particularly to investors in smaller towns where we expected to grow our reach next. They could turn to bank deposits to protect their capital.”
Currently bank deposits total $215 billion, over 10 times the total assets managed by mutual funds. That brings little cheer for India’s equity markets. The big banks are state-owned and the government is their biggest borrower.
