by Mr. Dhirendra
Kumar, Value Research
The Employees' Provident Fund Organisation (EPFO) will start
investing a tiny incremental amount in equity ETFs this month. Yawn.
Soon, within this
month in fact, the EPFO could begin
investing in equity assets. This should be a turning point for EPFO.
If implemented
properly , equity returns could be the change from dooming EPFO beneficiaries
to old age poverty to enabling decent returns on retirement savings.
According to what
the labour ministry has said, equity investments will commence in July and the
equity exposure will go up to 5% by the end of the financial year.
According to the
finance ministry's new norms, 5% is the minimum equity exposure that EPFO must
have. This can go up to a maximum of 15%.
There is no shortage
of people who are proclaiming that the government is forcing EPFO to gamble
away the hard-earned savings of employees. I'm surprised at how widespread the
underlying sentiment is.
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| Dhirendra Kumar, Value Research. |
From the fear
mongering that is going on, one would think that the EPFO will immediately
deploy its corpus to leveraged day trading in derivatives. In fact, I came
across an article on this issue from an otherwise balanced publication with the
hashtag # financial derivatives!
That's misleading
misinformation. The small amount of equity exposure that EPFO funds will have
are limited to ETFs. ETFs share none of the high-risk characteristics of
derivatives.
In any case, this
name-calling always avoids the main point of the logic of equity investing for
PF funds.
The return offered
by EPFO is too low to give any kind of realistic re turn over and above the
inflation rate.
Constrained by the
fixed income investment mandate, the returns have barely kept pace with
inflation. When you take rising prices into account, fixed income returns are
the worst form of retirement savings.
They ensure,
without any doubt whatsoever, that the saver will just get back the actual
value that he or she invested, without any gains whatsoever.
The risk that
critics talk about are based on the casual impression of volatility . Equities
may be volatile, but over any investment over a few years, the volatility gets
more than compensated for by returns. Take the last ten years, for example.
One lakh rupees in
EPF have increased Rs. 2.48 lakh.to However, Rs. 1 lakh in a Nifty ETF would have
been Rs. 3.9 lakh. Do note that these ten years have seen the worst financial
crisis in a generation as well as a long period of stagnation.
This kind of a
difference between returns would make the difference between a saver starting
retired life in prosperity versus always struggling to make ends meet.
But, of course,
this is not going to happen. The actual quantum of equity exposure is useless.
The norms say that
the EPFO must invest between 5% and 15% of incremental investment in equity
ETFs. No assets will be taken out of fixed income and then redeployed into
equity.
At this rate, it
could take a decade or more for the equity exposure to reach 5% or more. And,
even then, a 5% exposure is the worst of both worlds.
When equity markets
drop, the usual suspects will cry themselves hoarse about the losses, but when
the markets rise, the tiny exposure to equity means that gains that are
meaningful to savers will be hard to come by .
Equity exposure will not serve
the purpose unless it is in the 30% to 50% range.
That might sound
like sacrilege in the context of EPFO, but equity exposure of that scale is
already available in some of the plans of the National Pension System (NPS).
And that actually
points to the logical solution to India's retirement savings mess -dissolve the
EPFO and merge it into the NPS.
About the author
Mr. Dhirendra Kumar is CEO at Value Research.
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