Market experts, however, do not subscribe to the view. "The NAV of the mutual fund represents nothing but the current market value of the portfolio. Thus, the first reason cited in the report is totally baseless."

The unit capital (asset base) of US-64s investments as on 28 December 2001 was pegged at Rs 13,895 crore. The NAV at Rs 5.81 per unit as on the same date works out to Rs 7,424 crore. That means, the total asset base is funded out of unit-holders capital of Rs 7,424 crore and borrowings of Rs 6,471 crore.

Let us understand how the mutual fund operates. When the value of assets goes into a tailspin, the mutual funds borrow amounts to the extent of the shortfall between the outstanding unit capital and the market value of the portfolio. The shortfall have to be funded through either borrowings or internal accruals, so that in case of redemptions the fund is able to repay without further depletion in the market value of the portfolio.

US-64 has done exactly this borrowed funds to meet redemptions. Since the US-64 portfolio has depreciated due to lower stock prices, the difference between the unit value and the portfolio value is glaring. Another important point to be noted is that US-64 has become NAV-based only for the past two days. Till July 2001, when the sales and repurchase activites were suspended, the repurchase price was broadly considered as the NAV of the scheme.

US-64 is continuing with the repurchase price till May 2003 for retail investors up to 5,000 units concurrently with the NAV-based pricing mechanism for larger investors. This means that US-64 will face redemption pressure for another 17 months, as the repurchase price ranging between Rs 10.50 to Rs 12 is higher than the NAV-based price.

Now let us look at how hedge funds, or more specifically leveraged funds, operate. Based on a small pool of unit-holders funds, these funds borrow from 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.

Here is where the difference is. The leveraged funds borrow money to invest more in financial instruments with the objective of earning higher returns, while regular mutual funds like the US-64 borrow money to meet redemptions.

UTI chairman M Damodaran has denied that US-64 is being operated 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 says.

Damodaran also says that even though UTI borrowed Rs 6,900 crore to meet the redemption pressure (in April-May 2001), only Rs 2,500 crore was borrowed from banks and the rest came from UTIs 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 2,900 crore. The liability has come down from Rs 6,900 crore to Rs 4,000 crore now," he says.

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. And funds can borrow up to 20 per cent of their net asset to fund redemptions. This also applies to UTI.

The scheme, however, has not benefited by not selling part of its holding in the market when it faced a redemption pressure in April and May 2001. The current equity portfolio shows that the market value of technology stocks in its portfolio had depreciated substantially between April-May and December 2001, making it all the more difficult to sell portfolio and fund redemptions.

The big holdings in the scheme have under-performed the BSE Sensex, which 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 6.20 crore shares, is 17.6 per cent lower today 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), SBI (down 20.8 per cent), ICICI (down 48.4 per cent) Tisco (down 36.9 per cent) and Hindalco (down 26.9 per cent). The top holding of the scheme is the 11.24-per cent 2004 G-sec with a market value of Rs 3,569.75 crore. While ITC is at the third position with a value of Rs 804.23 crore, Reliance Petro is at fourth with a value of Rs 641.24 crore.

The other major counters where the fund took exposures are Infosys Technologies (investment: Rs 311.70 crore), Hindustan Lever (Rs 310.81 crore), HDFC (Rs 309.04 crore), Bharat Petroleum Corporation (Rs 191.55 crore), SBI (Rs 184.03 crore) and MTNL (Rs 173.66 crore).

The fund had also invested Rs 286.92 crore in the non-convertible debenture (NCD) of Jindal Iron and Steel Company. It has invested Rs 80.48 crore and Rs 78.75 crore in the NCD of IDBI and Jet Airways respectively. The fund still has investments of Rs 71.33 crore in Zee Telefilms and Rs 35.36 crore in Himachal Futuristic Communication.

UTI, meanwhile, has ruled out any distress sale of equities in the open market and has made it clear that over Rs 2,500 crore has been tied up with banks and financial institutions to tide over the crisis.