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US-64: Assured Returns, Finally!

When US-64's tenure ends, it will turn into a 5-year tax-free bond with a 6.75 per cent coupon. To enhance liquidity, UTI has also taken certain measures to encourage secondary market trading. What does this mean for the investor?

If you have been an US-64 investor, the last few years undoubtedly would have been tough on you. However, the scheme's parent, the Unit Trust of India (UTI) has provided some relief to US-64 unit holders--especially those who held over 5,000 units—by encouraging secondary market trading. That apart, UTI has also proposed to convert US-64 into a 5-year tax-free tradable bond. So, what does this mean for the investor?

As per UTI's earlier package, if you held upto 5,000 units, you could a) sell the units back to UTI at a price, which increases by 10 paise every month, or b) redeem units at Rs 12 or NAV (whichever is higher) on May 31, 2003. However, if you held over 5,000 units, then your only hope was that UTI would repurchase these units in May 2003 at Rs 10 or NAV, whichever is higher.

In case of a distress sale, the investor had two options: either to sell in the secondary market at a discount to the NAV or sell it back to UTI at NAV. Both these options would have meant heavy losses for investors.

What's New
According to the new package, investors who want to sell units in the secondary market are required to send their unit certificates along with a Form for Classification of Units (FCU) to UTI, which will classify the units in three categories. An investor having upto 5,000 units will get units in category A. An investor with over 5,000 units will fall in category B. So, an investor with 7,000 units will get 5,000 category A units and 2,000 category B units. Category A will be redeemed at Rs 12 or NAV, whichever is higher, and category B units will be redeemed at Rs 10 or NAV, whichever is higher on May 31, 2003. With the current low NAV levels, investors purchasing US-64 units from the secondary market should end up with an assured price of Rs 12 or Rs 10.

Existing Option for US-64 Unit Holders
  Category A   Category B  Category C
  "(Upto 5,000 units)"  "(Above 5,000 units)"  Units bought during
      15/11/02 and 22/01/03
February 2003 Rs 11.70 or MP (A) MP (B) or NAV MP (C) or NAV
March 2003 Rs 11.80 or MP (A) MP (B) or NAV MP (C) or NAV
April 2003 Rs 11.90 or MP (A) MP (B) or NAV MP (C) or NAV
"Upto May 30, 2003" Rs 12 or MP (A) MP (B) or NAV MP (C) or NAV
"On May 31, 2003" Rs 12 or NAV $ Rs 10 or NAV $ MP (C) or NAV
"June 01, 2003 Onwards" "Will be Converted to 5-year, tax-free, tradable bond"
MP: Market Price in the secondary market
$: whichever is higher

This move has already resulted in better price realisation for investors selling in the secondary market. The market price of units has already moved towards the assured price of Rs 12 or Rs 10 depending on the category.

Category C units are for those investors who bought US-64 in the secondary market between November 15, 2002 and January 22, 2003. These investors will not benefit from the new package and will have to sell at NAV-based price to UTI or at a discount in the secondary market. Investors who had bought US-64 units from the secondary market before November 15, 2002 have been transferred to Unit Scheme 2002, which is an open-ended NAV-based scheme. As far as the stock market is concerned, there are three different types of US-64 units trading at different prices.

Finally, an Assured Returns Product
From June 1, 2003, US-64 will be converted into a 5-year, tax-free tradable bond. Thus, those unit holders who will stay with the fund after May 31, 2003 will get a fixed return irrespective of the state of the stock market. Therefore, UTI has finally planned to convert US-64 as an assured return product, which has anyway been the common belief among its investors.

The coupon rate has been fixed at 6.75 per cent, which is tax-free in the hands of the investor. This means that for an investor in the 30 per cent tax-bracket, it is an effective return of around 9 per cent. Even for a small investor it is a good option as the interest is higher than the comparable 5-year GOI security. Therefore, if you don't have an immediate need or near-term requirement of money, staying with US-64 after May 2003 could be a good option. Moreover, as the bond will be traded on the stock market, one also has the option to sell but will depend on the kind of liquidity it attracts.

The biggest benefit to UTI from this exercise is that it hopes to ease the redemption pressure it would face in May 2003 when unit holders queue up. With unit holders, hopefully selling units in the secondary market in the run up to May 2003 or opting for the bond option, UTI won't have to sell the underlying stocks in the portfolio to meet redemption requirements. And this could be good news for the stock market as well, provided more unit holders opt for the bond option.