While stocks exposure may
increase returns, current limit of up to 5% is too small to have a significant
effect
The Employees’ Provident Fund
Organization (EPFO) has started investing in the stock market through the
exchange-traded fund (ETF) route from Thursday.
An ETF is a basket of securities
that tracks the stock prices of the companies on an underlying index, and is
traded on the exchanges. Being a passive fund, it not only comes with a much
lower expense ratio but also obviates the fund manager risk.
The labour ministry has allowed
for 5-15% of Employees’ Provident Fund (EPF) money to be invested in equities.
But, to begin with, EPFO has decided to take an exposure of up to 5% of the
incremental corpus through ETFs. “We have decided to take it slow and see how
it goes. So, we will start with an investment of up to 5% of the incremental
corpus in ETFs,” said K.K. Jalan, central provident fund commissioner, EPFO.
The Organisation will allocate `5,000 crore by March 2016 in ETF and could
increase it to as much as `7,000-8,000 crore, said Jalan.
For now, the Organisation will
invest in two schemes of SBI Mutual Fund—SBI-ETF Nifty and SBI Sensex ETF. Jalan
said that out of the total investable corpus in equity asset class through
ETFs, 75% will go into SBI-ETF Nifty and the remaining 25% in SBI Sensex ETF.
“SBI is our sole banker, so we
have decided to go ahead with SBI Mutual Fund for now. Also, we didn’t have
time to come out with a tender and spend another year finalizing the asset
management company. In future, though, we will consider looking at others as
well,” he added.
Before understanding what an
equity exposure would mean to the money that you invest in your EPF account,
let’s start with a quick look at how EPF works.
How EPF works
Every month, a salaried
individual contributes 12% of her salary in the EPF account and the employer
matches the contribution. A part of the employer’s contribution goes to the
Employees’ Pension Scheme. The contributions made to EPF then compound at a
rate declared by the EPFO every year. Currently, the rate of interest on your
EPF money is 8.75% p.a.
Contribution by the employee up
to `1.5 lakh qualify for a tax deduction under section 80C of the Income-tax
Act, 1961. A deduction reduces your taxable income. The interest that your fund
accumulates along with the contributions made are tax-free on withdrawal if you
withdraw the money after five years of continuous service.
In terms of withdrawing your
money, the rules allow EPF withdrawal only at the time of retirement, medical
contingency or an unemployment period of two months. Given that EPF has
exempt-exempt-exempt treatment of taxation—which means that your contribution
and interest are both tax-free—it’s one of the top recommendations by financial
planners for a person’s debt investment portfolio.
It is with the aim to improve
returns further that EPFO has decided to enter the stock market. “If we remain
invested in fixed income alone, then the interest rate is likely to remain
subdued and see further downward trend in coming years. If we hadn’t changed
our investment philosophy, then it would be difficult to give good rate of
returns to subscribers. So, it was considered appropriate to a bring change in
the methods of management of funds cautiously and carefully” said Bandaru
Dattatreya, Minister of State for Labour and Employment (independent charge).
With equity investments the
expectation is that EPF will offer a meaningful real rate of return. “There is
no proper social security net for an Indian household. So, they end up putting
their money in bank FDs (fixed deposits). In a way this is good for banks but
does not do much for the savers,” said Arundhati Bhattacharya, chairperson,
State Bank of India. “When inflation is high, bank interest can’t keep pace and
doesn’t beat inflation. Hence, despite saving, savers lose money. If you take a
longer-term view, equity gives superior returns,” she added.
Equity support for EPF
Currently, EPF invests largely in
government securities with the help of five fund managers, namely SBI, ICICI
Securities Primary Dealership Ltd, HSBC Asset Management (India) Pvt. Ltd,
Reliance Mutual Fund and UTI Asset Management Co. Ltd.
“Currently, we invest around 65%
in government securities and the remaining in public sector and private sector
bonds. In private sector bonds, our exposure is less than 5%. Since our
portfolio is held to maturity, the role of fund managers is not much and so the
fund management is very less, of around 0.00005%, which is deducted from the
fund,” said Jalan.
Considering that even the equity
investments will be managed passively, there will not be a fund manager, but
even ETFs come with an expense ratio that will be borne by the investor.
“SBI Mutual Fund has given us a
discount on the expense ratio as we will pay only 0.07%. The expense ratio will
be deducted from the fund value,” said Jalan. Given that mutual funds are not
allowed to offer differential pricing, this discount benefits even individual
retail investors.
“We are already seeing the
spill-off as the race to the bottom has begun. Reliance and ICICI Pru mutual
funds have reduced their expense ratios from 0.5% to 0.03% on their Sensex and
Nifty ETFs in the hope to get a share of the EPF money. For retail investors,
this is certainly good news as it will reduce tracking error of the funds,”
said Manoj Nagpal, chief executive officer, Outlook Asia Pvt. Ltd.
Returns kicker missing
What will equity investment mean
for your EPF money? It’s too early to say, feel most financial planners. “This
move will help create a buzz around EPFO and people may start watching this
asset class. However, we don’t expect interest rates to improve as of now since
the exposure (to equity) is very small and won’t have such a big effect on the
overall investments,” said Surya Bhatia, a Delhi-based financial planner.
Others agree that the 5% limit
imposed is very small. “The amount that will be exposed to ETF is minuscule. It
is difficult to say if it will give better returns since it is only 5% of the
overall corpus,” said Suresh Sadagopan, a Mumbai-based financial planner. This
means that you may not really see a significant improvement in your returns.
“Investing 5% of the incremental
corpus may mean that the returns improve by about 10 basis points. For equities
to have a significant impact, they (EPFO) will need to increase the investment
to 10-12% of the incremental corpus,” added Nagpal. One basis point is
one-hundredth of a percentage point.
However, unlike mutual fund
investments, which show the net asset value (NAV) of your investment on any
given day to help you track the performance of the fund, the EPF money going
into ETFs will for now continue with the same system of declaring a rate of
interest on your overall portfolio.
EPFO declares a rate of interest
at the beginning of the year, which is the rate at which your money will
compound for the year. In future, this rate will also reflect the returns made
from the equity market, and EPFO is working towards making the system more
transparent. “We are studying the various pension systems around the world and
will come with an accounting methodology soon. In some cases, a part of equity
returns are distributed whereas a part is kept as reserves which can be dipped
into if the markets turn volatile. We are looking at various ways and should be
able to finalize soon,” said Jalan.
For the stock markets, too, the
move is good news as it will bring in long-term money, which lends to
stability.
“Given that EPFO will invest in
equities on a regular basis, it’s like having an SIP (systematic investment
plan). The current SIP book is about `2,000 crore and I see this book doubling
with EPF money in the coming years. This will reduce volatility,” said Nagpal.
For you, the good news is that
EPF has finally entered the stock market and as contributions begin to increase
over the long term, it may mean better returns on your investments.
Source: http://www.livemint.com/Money/nYf04GWyTbEYtdY3EPkNVK/EPFOs-equity-turn-what-it-means-for-you.html