India’s pension fund regulator has allowed fund managers of the National Pension System (NPS) to invest directly in stocks, in a move that seems to undermine the fundamental nature of a programme based on the principle of ensuring the safety of subscribers’ money.
This was done, without a debate or a public notification, through a 14 January internal circular sent by the Pension Fund Regulatory and Development Authority (PFRDA) to the five pension fund managers (PFMs) of NPS. These private sector fund managers thus were free to invest in stocks directly, instead of via index funds.
This dramatic shift was disclosed in a Mint investigation that was itself a follow-up to another change made by the regulator in February. PFRDA, in an emailed statement, defended the move on the grounds that it would allow fund managers to increase returns.
“By allowing active management, PFRDA intends to give freedom to each of the PFMs to enhance their performance and to optimize returns for the subscribers,” the statement said.
The new investment guidelines allow PFMs to invest in shares of companies listed on BSE and the National Stock Exchange and on which derivatives are available or are part of BSE Sensex or Nifty 50 index—a total of 149 stocks.
When NPS was set up in 2009, one of the three investment options offered equity exposure. Under this option, half the money would be invested in an index fund that would be created by the fund managers and half in debt for a mix of growth and safety.
But due to the slow uptake of NPS, PFMs weren’t able to raise enough money from subscribers to start their own index funds. According to the data provided by the regulator, the total number of subscribers
in the private sector is around 1.7 million for a corpus of Rs.1,590 crore as of February this year.
As a solution to this, PFRDA allowed PFMs to invest in the existing index funds offered by mutual fund companies (that have an expense ratio or an annual cost up to 1.5%). To this, PFMs were allowed to add a further fund management cost of 0.0009% until November last year and, subsequently, up to 0.25% annually, making NPS an expensive investment vehicle instead of the cheapest, as envisaged in the original design.
But this was an interim arrangement and PFMs are no longer allowed to invest in mutual fund companies. The change that was made in January will actually result in lower costs for investors, PFRDA said.
“Direct investment in stocks would entail reduction in cost of investment when compared to the cost of investment in an index fund,” the statement said.
The changes that have been made should also be seen in the context of another shift that took place over last year, allowing the entry of more PFMs.
A fund manager who did not want to be identified said PFRDA had opened up investment norms in January to include direct stock investing in order to accommodate the new fund managers who would set up shop and would struggle to garner funds to invest in the index.
The purpose for which NPS was set up has been defeated, said Dhirendra Swarup, former PFRDA chairman and one of those instrumental in its establishment.
“An actively managed equity portfolio is not the best way to go about for pure retirement plans, where safety is a very important consideration,” he said. “Those looking for higher rewards should invest through MFs (mutual funds) or directly in equities. A balanced risk-reward approach is better suited for NPS.”
Index funds eliminate the so-called fund manager risk since they mirror an index and also help in maintaining costs at the bare minimum.
By changing the investment guidelines from passive management of stocks to active management, NPS will place a greater risk on investors opting for equity. As mentioned above, an investor can invest up to 50% in the equity scheme.
While the decision raises questions about where NPS is headed, the manner in which the notification was issued is disquieting.
The change in the investment guidelines has not been followed by any public notification, although the product is meant to provide pensions to more than 300 million workers who currently don’t have a retirement product to put their money in.
PFRDA says it’s in the process of notifying these changes.
Mint spoke to at least three fund managers out of the five, who confirmed that PFRDA had made the change, although they declined to share the notification on the grounds that it was a sensitive matter. PFRDA, however, sent Mint the operative part of the investment changes. Mint also had access to a copy of the relevant communication in its entirety.
Given that a subscriber is required to lock in the investment until the age of 60, any modification to the investment pattern should have been brought to investors’ notice immediately, Swarup said.
“In all fairness, and for the sake of transparency, the change should have been preceded by consultations with all stakeholders,” he said. “Investment policy modification impacts the NPS subscribers. They should have been consulted by putting it in public domain and their feedback taken into account.”
The consultative process has become the norm with other financial sector regulators. For instance, the Insurance Regulatory and Development Authority recently issued a draft circular on the standardization of terms in health insurance before coming out with the final notification.
The Securities and Exchange Board of India circulated a draft on adviser regulations in August before issuing final guidelines in January. Likewise with the Reserve Bank of India, which seeks public opinion on draft guidelines before finalizing them.
“Transparency and objectivity should be the fulcrum of any regulatory decision. Ninety per cent of the investors don’t know what’s happening to their money. This is an individual account-based scheme where people should be able to decide. NPS needs greater transparency,” said Gautam Bhardwaj, director at Invest India Economic Foundation, one of those responsible for drawing up the blueprint for NPS.