The primary purpose of a retirement fund is to compensate investors for inflation, to assure them a reasonable lifestyle after they stop working. On this score, there is no doubt that India’s default pension manager for private sector employees — the Employees Provident Fund Organisation (EPFO) — has been ineffectual in recent years. Even as consumer price inflation has climbed from 9.5 to 11.5 per cent in the last three years, the interest paid by the EPF has stayed put at 8.5-8.75 per cent, earning a negative real return for its subscribers. This state of affairs cannot continue and if it is to provide employees with a genuine social security net, the EPFO has to manage its funds far more efficiently to deliver inflation-beating returns. But the finance ministry’s proposal that the EPFO raise its equity allocations to 30 per cent is too drastic a measure to address this problem.
Diverting a part of employees’ retirement contributions to equities may be good for the Indian stock market, which badly needs domestic money to counter-balance foreign investor flows. But using the EPFO as a vehicle to achieve this may work against the interests of its subscribers. For one, managing an equity portfolio, even one that passively mirrors an index, requires a good sense of timing and a hands-on approach to money management, which the EPFO has not demonstrated so far. The bulk of EPFO money is parked in public sector bank deposits and Central or state government bonds as mandated. Forget equities, the organisation has so far shown no inclination to invest even in the triple-A rated corporate bonds or the gilt mutual funds that its restrictive mandate permits. Actively managing these debt instruments for a better return should be the first step in transitioning the EPFO to a more dynamic regime. Two, given the risks involved in a fund such as this, any equity allocation should be accompanied by regular benchmarking of returns and accountability on the part of the fund managers. Today, such accountability is missing. The EPFO’s private sector fund managers are replaced every three years and are selected mainly for their ability to bid the lowest fee. Ironically the fund manager who generated the best return from 2008 to 2011 (ICICI Prudential) was replaced in the last round of bidding. Before embarking on riskier investments, it is imperative for the EPFO to overhaul its selection process to ensure the longevity of managers with good track records.
As for the flow of domestic money into the stock market, this is better achieved by popularising the market-linked National Pension Scheme (NPS). The NPS already has the mandate to invest up to 50 per cent of its funds in equities and has accumulated a track record in this asset class. By offering a menu of choices, it also allows the investor to make the risk-return trade-off necessary to add equities to his retirement portfolio.