It is strange how any debate about India’s pension sector often gets bogged down on details even as the big picture is completely ignored. The Employees Provident Fund Organisation’s (EPFO) recent decision to set its interest rates at 8.75 per cent for this fiscal was the cue for a raging debate on whether or not it should invest in the stock market. The recent passage of the Pension Fund Regulatory and Development Authority Act (PFRDA) generated a lot of heat about foreign investors being allowed to manage India’s retirement savings.
Yet, the basic truth is this: a majority of the workforce today lacks any form of retirement security. Though India is likely to see its 60-plus population swell from 80 million to nearly 200 million over the next 15 years, nearly 90 per cent of these people are not covered by any formal pension scheme.
Then there is the fact that even those who are supposedly covered by formal pension schemes aren’t really assured of a reasonable retirement kitty. Take the over 8 crore subscribers of the EPFO. Though their monthly contributions to the EPF are well-defined, the returns they can hope to earn from this fund aren’t. The rate at which one’s retirement savings grows under the scheme is determined by the interest rates announced by the EPFO trustees each year. The primary purpose of any retirement fund is to generate inflation-beating returns. Even as consumer price inflation (CPI) has accelerated in the last three years, the returns declared by the EPFO have declined. Against the CPI inflation of 8.4 per cent, 10.2 per cent and 9.5 per cent, respectively, over 2011-12, 2012-13 and 2013-14, the EPFO declared interest rates of 8.25 per cent, 8.50 per cent and 8.75 per cent, respectively, for these three years. These are much lower than the 9.5 per cent declared in 2010-11.
Returns this year may prove higher than inflation but that is more due to the latter moderating than because of the EPFO getting its act together.
Over the long-term, the fund’s inability to deliver over inflation can cost its subscribers dear. They may be left with much lower purchasing power than they expected when they retire.
The usual solution offered to this problem is to let the EPFO invest, say, 10-15 per cent of its corpus in equities. But investing in equities requires hands-on portfolio management, a good sense of market timing, and an ability to actively churn the portfolio in tune with shifting macro indicators. The organisation has so far demonstrated very little ability on these.
For one, its current investment strategy, if one can call it that, is restricted mainly to buying and holding Government securities (about 40 per cent of the assets), and parking funds in deposits and bonds of public sector institutions (32 per cent of assets) and the special deposit scheme of the Government (about 11 per cent).
Not only are its investments subject to rigid and archaic guidelines but they are also further moderated by its Board of Trustees. As a result, the EPFO hasn’t even explored triple-A rated corporate bonds or debt mutual funds, which are allowed under its restrictive mandate. More active management of the debt portfolio is the need of the hour, before the fund can jump headlong into equities.
Two, the decision (since 2008) to appoint private fund managers to manage the EPFO’s Rs.5-lakh crore-plus corpus hasn’t generated material benefits for its subscribers either. The restrictive investment rules do not allow these managers to manage the portfolio for the best results. The inexplicable decision to appoint these fund managers only for three years at a time has also made for low interest as well as accountability from the chosen managers.
And to top it all, fund managers are selected not mainly for their track record or governance but on the basis of who bids the lowest management fee. In the previous round of auctions in 2011, ICICI Prudential AMC, the best performing manager in the preceding three years was dropped. The term of the current managers is expiring this month and it is critical for the EPFO to review both the term and the selection criteria.
NPS’ woes
Subscribers to the National Pension Scheme (NPS) are luckier than those in the EPFO when it comes to returns. The NPS is the default pension manager for all Government employees since 2003 and is also open to private and informal sector workers.
Given that this scheme offers a wide menu of asset classes (equities, private and Government bonds and money market instruments) to its managers, most plans have managed to generate a double-digit or at least inflation-beating return. The scheme also allows the employee to choose between managers based on their individual return record and freely switch between them. This has led to better accountability and performance.
But the NPS too is not without its share of problems. Fund managers are appointed for five-year terms after which they may be changed or replaced. The managers are again selected primarily based on the fee they bid to manage the assets; Reliance Capital bid 1 basis point or 1 paisa per Rs100 in the recent auctions.
Given that a 200-300 basis point fee is the norm to manage mutual fund or insurance assets, the question is whether such rock-bottom fees will encourage private managers to deploy their best resources or skills in managing NPS funds.
If you ask the lay investor what is the one quality that he would like from the manager of his retirement savings, his answer would undoubtedly be ‘stability’. Therefore, it is critical for the NPS to re-examine how it can grant its top performing portfolio managers a longer tenure so that they can manage the corpus with a long-term orientation.
Provided these glitches are ironed out, the NPS, with its voluntary subscriptions and transparent and flexible plans, can, in fact, emerge as the default retirement solution for most Indians.
Of course, this cannot be accomplished on a shoe-string budget. It would require active marketing effort by the Centre and distribution incentives that prompt banks, post offices, and other financial intermediaries to actively showcase the scheme as a good retirement option for the lakhs of Indian workers who today have no retirement benefits at all.
(This article first appeared in The Hindu dated Sept 8.)