Monday, 8 April 2013

Forced saving in equities good for retirement corpus

There is many a slip between the cup and the lip. This adage is apt for the New Pension Scheme (NPS), which was rolled out a few years ago. The objective behind the NPS is noble indeed. The provision of post-retirement income in the form of pension to any Indian citizen. While Central Government employees were the first to sign on (albeit compulsorily), the initial proponents of the scheme also sought to make it popular among those who were not covered by any formal pension
program. It is also the only pension scheme so far, to offer its subscribers an opportunity to participate in the equity markets during the accumulation stage.

Despite the stated lofty intentions, the NPS has been beset with a slew of procedural and regulatory hurdles. A few of these are:

  •     Lack of parliamentary ratification of the Pension Fund Regulatory Development Authority (PFRDA) Bill.
  •     The lack of interest displayed by the marketing agencies, owing to the poor incentive structure.
  •     The ostensible lack of focus on the part of the fund managers, owing to the abysmally low fund management fees (0.009% until recently).
  •     The seemingly complicated structure, involving Tier I and Tier II accounts, with compulsory annuitisation on attaining the age of sixty.

While the average subscriber is not too concerned about the delays in parliamentary recognition, they have been generally apprehensive about the scheme's exposure to equities. This could be due to two reasons :

  1.     There is a legacy of choosing Government guaranteed schemes such as Public Provident Fund (PPF) and Employee Provident Fund (EPF), where safety of capital is accompanied by high visibility of returns.
  2.     The prevailing belief among many individuals is that equity markets are unpredictable (and consequently risky) and, therefore, it is not prudent to entrust one's retirement related investments to the stock market.

The PFRDA had foreseen such resistance. Hence, they offered three asset classes to their subscribers :

    E Class: Investment in Index funds that replicate the portfolio of either BSE Sensitive index or NSE Nifty 50 index.
    G Class: Investment would be in Central and State Government Securities..
    C Class: Investment would be in fixed income securities other than Government Securities.

Subscribers could choose investment portfolios which contained different proportions of these three asset classes, based on their comfort level. Also, since investment in equities was restricted only to index funds, it accorded a (psychological) veneer of safety to the entire exercise.

However, last week, the PFRDA expanded the basket of eligible equities by permitting the designated NPS fund managers to invest in any stock listed in the derivatives segment. In other words, the eligible universe of stocks has risen from around 50 to 149. Also, fund managers are free to decide the weightage of individual stocks in their portfolio.

Several industry experts have denounced this latitude accorded by PFRDA on two grounds :

  1.     The whole exercise was conducted in a surreptitious manner, with not enough opportunity having been provided for discussion and deliberations
  2.     The free rein given to fund managers will induce them to adopt a cavalier approach with respect to subscribers' monies and may also encourage corrupt practices.

But there are arguments to be made in favour of PFRDA's move. Some of them are as follows:

  1.     The current list of designated NPS fund managers, comprises reputable public and private sector institutions. All of them have extensive fund management experience and, therefore, they are aware of their fiduciary responsibilities.
  2.     It is a myth that index funds are 'safe' and non-index stocks are not. Volatility is part and parcel of equity investing and merely investing in an index fund does not shield you from the inherent vagaries of the stockmarket. In fact, this myth has been the cause of disillusionment among many mutual fund investors, in the past.
  3.     Today, NPS fund managers are adequately compensated for their efforts (at 0.25% of the assets managed). Hence, there is less incentive for shenanigans as they would not like to be rendered ineligible, due to any scandal. Sure, a rogue employee may pop-up periodically, but that may happen even in today's regime.
  4.     The internal prudential guidelines of the fund management companies, will ensure that the lion's share of the portfolio will comprise the same index stocks that they used to invest in earlier. In fact, fund managers may now be susceptible to the charge of being called 'Index-Huggers,' as the other stocks could comprise only a minuscule proportion. This is often seen even in the mutual fund schemes being managed by many of these same managers.
  5.     Every fund manager knows that they are under the glare of the Regulator and the media. Hence, they will not be unduly adventurous.

We should welcome this freedom being accorded to the managers. Over the past one year, the PFRDA has taken several pragmatic steps to incentivise their stakeholders and popularise the scheme. Therefore, this latest move should not be seen as regressive in any manner.


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