With ₹1.44 lakh crore in its kitty, the National Pension System, which the Centre is positioning as the default market-linked pension system for all Indian citizens, is growing in both popularity and size. It is, therefore, good to see the Pension Fund Regulatory and Development Authority (PFRDA) focusing on improving the scheme’s architecture to render it more effective and investor-friendly. The PFRDA is now seeking to appoint ten pension fund managers to manage NPS assets in place of the present eight, and plans to change the selection process to give greater weightage to technical skills and less to costs. These are welcome changes indeed.
To start with, expanding the number of pension fund managers (PFMs) available on the NPS menu will result in more choices to investors, and foster greater competition. NPS investors currently have the flexibility to choose from a menu of eight PFMs; based on their portfolio disclosures and returns, they can also switch freely between them, thus keeping them on their toes. While the present crop of PFMs have delivered healthy returns, return differentials between them have been quite narrow and new managers may bring differentiated strategies to the table. Two, it is also good to see the regulator abandon the obsession with low costs and lay greater store by capabilities in selecting its PFMs. In the new round of bidding, sponsors will have to meet basic eligibility criteria (such as a five-year track record in fund management and a ₹50 crore networth) and score over 70 per cent in technical capabilities (investment experience, team and performance) before their commercial bids (on fees) will even be considered. On fees, instead of selecting the lowest bid and forcing all PFMs to match it, prospective bidders have been allowed to bid realistic fees subject to a ceiling of 0.10 per cent (of assets). While this represents a tenfold rise in charges for investors, it is likely to pay off in the form of more skilled players entering the fray and hopefully delivering better results through more active portfolio management. A 10-basis points fee is certainly not steep when compared to the 225-300 basis points charged by the active mutual fund industry. The 1-basis point fee accepted in the last round kept away some serious players and may prevent PFMs from deploying their best talent in managing NPS assets.
Though prospective bidders are clamouring for even higher fees, the PFRDA should look to sweeten the deal by appointing the eligible PFMs for a longer term (maybe even perpetuity), with a provision to replace laggards. Investors decide to invest in any market-linked product based on its track record over two market cycles (typically 10 years). But the NPS’ system of reshuffling its PFMs every five years is unsettling and effectively renders a PFM’s track record irrelevant. A longer tenure will also ensure that prospective bidders take this mandate seriously and invest long-term capital and talent in order to deliver a better experience to investors.