Friday, 29 March 2013

Should changes in the New Pension Scheme worry you?

What is NPS? Most people can be pardoned if that is their response to a question about their views on the recent changes in the New Pension Scheme, which is more popularly known as NPS. This is despite the fact that NPS has been available for the general public since the last four years.

Let's take a quick look at what is NPS. Any Individual can start a NPS account by contributing money regularly and if the individual is employed, his employer can also contribute money up to a certain limit. The account holder can choose the proportion of money that will be invested between equities, securities and other debts with a maximum allocation of 50 per cent allowed for equities.

There is a default proportion between equity, debt and government securities depending on the account holder's age if he does not or cannot make a choice.

The account holder can choose from among several fund managers and keep changing his choice of fund manager periodically. As far as equity investment is concerned the fund manager was allowed to invest only in nifty or sensex index funds or was allowed to re-create either of these indexes.

What has changed?

In a recent amendment, PFRDA, which regulates NPS, allowed fund managers to invest specifically in equity shares that meet a certain criteria and not necessarily recreate the Nifty or the Sensex. They have also been prohibited from investing in index mutual funds though they can choose to continue to re-create the index rather than invest actively. An investment in an index fund is essentially a passive style where the fund manager just mechanically recreates an index whereas when he invests in specific equity shares he exercises judgment, which may go either ways. So the return on an index fund is likely to mimic the return on the underlying index whereas the returns on an actively managed equity fund can be widely different depending on the skills and luck of the fund manager.

Who will be impacted?

As of now, it affects about two lakh private sector NPS subscribers and about 15 lakh NPS Lite sector subscribers who have voluntarily opted for NPS. Most of the private sector NPS subscriber base has been added in the last 20 months after the Income tax act was amended by budget 2011 to allow a separate deduction without any upper limit in value terms in respect of contribution made by employer up to 10 per cent of the salary.

The whole structure of NPS was designed to reduce the inherent risks in any locked in long-term investment and keeping the costs to a minimum. It had assumed an actively involved subscriber base that would monitor the performance of various fund managers and switch actively from one fund manager to another depending on performance.

In practice, it is the most vulnerable NPS lite subscribers who could be most impacted. The biggest assumption of an actively involved subscriber base clearly isn't true for the NPS lite subscribers (or for that matter the grass root level entities that facilitated their NPS entry). Even if a subscriber wants to be active the availability of information and research/monitoring infrastructure (think companies such as valueresearch, etc.) that can support such activism is absent. In fact, even without allowing for active management, the equity schemes of different fund managers have varied quite significantly and despite avid research we could not find the data or information that would allow us to guess the reason for such significant variation among different index funds.

Think of it like this. Here is a scheme that locks in subscribers for long periods of time with an inert large subscriber base and very little infrastructure to support even the activists among the subscribers and then adds the risks of active fund management to the mix – it has the potential to become quite a serious issue.

I am sure safeguards will be added on in due course and an information and data infrastructure will be created to assist the subscribers or their representative bodies to take an informed decision on the choice of a fund manager. Till then please do worry if you are one of the two lakh people who has an NPS account or are running an organisation that facilitated opening of NPS Lite accounts. Please keep an eye out on the performance of the fund managers and switch if your fund manager is among the laggards.

Author is CEO,


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