EPF must invest in equity to grow fast enough: Expert View
Posted by: Uma Shashikant on Mar 20, 2017, 06.30 AM IST
By Uma Shashikant
Some arguments simply fail to die. We are again hearing about the Employees' Provident Fund Organisation's (EPFO) plans to invest up to 15% of its corpus in equity. We can also hear the alarm bells ringing about risking the hard-earned money of workers in stock markets.
On the one hand, we have an equity market in which international pension funds invest so that their investors can get a better risk-adjusted return. And then we have our own retirement corpus of the working and salaried class that is steeped in ideas of the 1950s. Our labour unions demand a fruiting tree that will sprout one leaf a day, so they can be sure it would be good enough.
International managers take the risk of putting the retirement savings of ordinary folks in distant emerging markets like India. They are required by the law of their land to act in fiduciary capacity. The penalties for wrongdoing is high. The processes and procedures for deciding how the money will be managed is far more stringent than what we have in India.
The investment advisers and managers are paid based on the performance of their portfolios, and they would be very unwilling to take risks. Their response is: We would be failing in our fiduciary duty if we bypassed an asset class like emerging markets that offer better returns while reducing the overall risk of the portfolio.
That is the question one should ask the Ministry of Labour and Employment. Is it failing in its fiduciary duty of enabling a large number (17.14 crore members as of 31 March 2016) of simple wage earning employees from retiring with a larger corpus?
Is it allowing its unwillingness to consider the benefits of diversification and the merits of asset allocation to affect the lives of trusting EPF members? Is it unwilling to counter uninformed arguments with facts, data, research, international experience and practice? Why cling to the world of the 1950s when the EPF Act was promulgated?
The answer lies in the design of the EPF. Look at the annual reports of the EPFO and you will find page after page of data and information about contributions, service and compliance.
Search for information on the website, you will find the tremendous advances that have been made in enabling the transfer, withdrawal, consolidation, access, querying and all such service aspects. Then there is detailed information about defaulting companies and steps being taken to go after them.
The EPF sees itself as the central government agency that strives for the right of the subscribers to know what the balance in their account is, take loans and advances against it, draw it on retirement, and ensure that the employer has contributed their share as promised. Pursue the long list of case laws, and most are about errant employers, penalties for not contributing, and lack of service.
It is very difficult to find evidence for an organisation that sees itself as an institutional investor managing nearly Rs 8 lakh crore of small investor's money, acting on behalf of its subscribers. There is only a safe-keeping, service and compliance orientation.
There is also another problem. Since the scheme was formulated in the 1950s, the treatment of contributions is as if they were only entitled to simple interest. The idea is to hold the money on behalf of the subscriber and pay an annual interest. The law requires controls on administrative expenses, and asks that all incomes be taken into the “interest suspense account.”
At the end of each year, the Central Board of Trustees (CBoT) who are responsible for managing the money would recommend to the Ministry a rate of interest to be paid for the year. After the approval of the Finance Ministry, this rate would be announced and credited to the subscriber accounts.
If the CBoT decides to invest in equity markets, it should be able to earn an annual income (dividend yield won’t match the targetted 8.5%) and earn positive returns each year, so that it can be credited to members. This is the steady leaf-sprouting fruit tree I was alluding to earlier. The design just asks for an annual crop of grains that will be sown and harvested to a season.
The design has no scope for fruiting trees that can be grown with lesser effort, over a longer period, to yield good harvests. Only provided the authorities saw that falling leaves of the winter as a precursor to the fruiting abundance of the summer.
There is no scope to invest in a growth asset that will appreciate over time. There is no harvesting the benefit of diversification, using a small portion in equity to enhance return while reducing risks. There is also no concept of marking to market, declaring the current value of the investments, or allowing subscribers to know the appreciation in their portfolio.
Only pure realised interest income matters, nothing else. Not even the fact that bonds and debt securities also carry credit risk, and would also require stringent supervision and management.
The choice of managers to make the investment decisions is not based on performance, but on low cost. The mandate for the managers is for three-year periods, even as one of them has been embroiled in controversy in their home markets. But if an annual rate of return is declared, everyone assumes that all is well.
Retirement planning is not about earning a constant rate each year. It is about being able to set aside money for a long period, allowing it to grow so that it gets an opportunity to appreciate in value. The investment objective is growth, but the EPF’s investment portfolio is in income assets.
A classic case of asset allocation that is not aligned to the need of the investor. Which is why the 15% equity allocation is something the Ministry should push for, in the interest of delivering some growth in the portfolio. Investing in a large-cap index as the CBoT currently does with the 5% equity allocation, is a good start to introduce the benefit of equity to the subscribers.
Slowly the orientation should change away from income to growth.It is extremely helpful to see the PF balance on the mobile phone and transfer the balances with a UAN. But what matters is the value of the money that is being squirreled away.
Managing others’ money in trust needs strategic portfolio management and diversification. These insights got the Nobel prize in 1990, but the core ideas do not seem to have washed ashore the holy Jamuna, yet.
(The author is Chairperson, Centre for Investment Education and Learning.) This article appeared in Economic Times dated Mar 20, 2017, 06.30 AM IST