Secure your retirement- NPS

Pension regulations have been long awaited for the Indian populace. With the setting up of the PFRDA (Pension Fund Regulatory and Development Authority) and the New Pension Scheme, this has now become a reality. The major aim that NPS seeks to achieve is to bring people from the unorganised sector into the pension fold. Pension space in India has been dominated by employer-sponsored plans with contribution from the employee to a certain extent. In addition to the superannuation plans offered by employers, mutual funds and insurance companies also offer voluntary pension schemes. With the NPS, the government is able to offer flexible, growth-oriented scheme that has the potential to generate by far the best returns compared with the products that are available in the market today. The NPS the most effective tool to accumulate wealth for the life post retirement.

Why do you need NPS?

The conventional retirement options like the Employee Provident Fund (EPF) and the EPS (Employee Pension Scheme) give fixed returns but do not offer sufficient flexibility to the employees during their working and post-retirement years. In these schemes, the neither the subscriber nor the employee can choose how his or her money is invested. Also, the amount collected through all schemes administered by the Employees' Provident Fund Organisation including the two mentioned above may not be adequate for individuals' future. The major change that the NPS brings in is the shift from a defined benefit to a defined contribution regime for the government employees.

Structure

The unique option that the NPS gives to subscribers is a selection of fund managers with whom they wish to entrust their funds' management. Thus, this flexibility and a competitive environment would push the PFMs (pension fund managers) to work for better returns. The scheme currently has six pension fund managers:

*ICICI Prudential Pension Funds Management Company

*IDFC Pension Fund Management Company

*Kotak Mahindra Pension Fund

*Reliance Capital Pension Fund

*SBI Pension Funds Private

*UTI Retirement Solutions

Subscription types

To apply for the voluntary pension scheme, there are two types of accounts:

Non-Withdraw-able account: The tier 1 account is the basic NPS account that is non-withdrawable till retirement or in the case of death of the subscriber. In this type of account, the total corpus at the retirement age is split, whereby a minimum of 40 per cent of the final corpus has to be compulsorily used to buy an annuity while the subscriber is free to withdraw the remaining 60 per cent as a lump sum or in installments.

Withdraw-able Account: A tier 2 account is available to only those who are existing subscribers of the tier 1 account. The unique selling point of the tier 2 account is that money contributed into this account can be freely withdrawn as and when the subscriber wishes except for a minimum balance that needs to be maintained at the end of each financial year.

Investment options

In NPS, there are two types of fund management options available and the contributions can be invested in various ways. The investment decision should be guided by two factors -risk appetite and ability to actively manage money. This makes NPS flexible for the subscribers whereby they can customise returns.

Auto choice - lifecycle fund. Under this option, contributions made by the subscriber are pooled into a lifecycle fund and then invested as per pre-defined asset allocations that change over the life cycle of the subscriber. Up to 35 years of age of the investor, 50 per cent of the assets will be invested in equity index funds and the rest will be in debt instruments. As the person gets older, investment in equities will taper off by a certain percentage every year and get diverted to debt instruments. By the time the investor turns 55, his assets in equity instruments will be contained to 10 per cent and a major chunk (around 80 per cent) will be invested in government securities.

Active choice. Under this facility, investors have the right to choose the investment pattern as well as the pension fund manager. Investors are also allowed to revise their choices once every year in May.

Asset allocation class options:

Asset Class E. Growth option under the NPS that invests in equity (index funds). The cap for equity investment is 50% of the investment corpus.

Asset Class C. Medium-risk option with investments in fixed-income instruments but not necessarily in government securities.

Asset Class G. Low-risk option whereby investments are made only in government securities.

NPS - The cheaper option

Our calculations show that an investment of Rs 1 lakh per annum over the next 30 years yields the maximum returns if invested in NPS when compared with a unit-linked pension plan or pension plan offered by a mutual fund company. This is considering that all three options give similar returns at the rate of 10 per cent per annum. For the sake of this projection, we have considered funds that would match the asset allocation pattern followed by the aggressive portfolio under NPS.

NPS has the lowest set of charges and therefore delivers the highest returns. The table (Your retirement kitty) shows how the progression of the invested amount happens over 30 years. From the initial period, wealth under the new pension scheme grows faster and owing to the low charges levied, the difference between NPS and other products is almost to the tune of Rs 50 lakh towards the end of the 30-year period. For retail investors looking to invest around Rs 1,000 or so monthly, NPS is clearly a better option because it comes with low charges and flexible fund management options. Due to higher charges levied in ulip-based pension plans during the initial years, the difference in the corpus at the end of the tenure is also substantial. In case of maximum allowable lump sum to a pensioner, the mutual fund pension plan would pay out less in comparison to insurance-based plans as they have the advantage of tax-free lump sum. The mutual fund pension plan is taxed at the rate of 20 per cent (without indexation) and 10 per cent (with indexation).

Taxation

NPS allows subscribers to grow their retirement corpus in the most cost effective way possible. However, NPS is taxed under the EET (Exempt-Exempt-Tax) regime. This means that the investment gets tax exemption and so do the returns on investment. However, all withdrawals are taxed under the applicable tax slabs and so is the annuity interest. Even under the current scenario, i.e. the EET regime, NPS competes on an even field with other instruments. With ULIP based schemes there is the advantage that the withdrawn lump sum is tax-free. Even taking into account this loss of money to tax, NPS returns are higher.

When the Direct Tax Code is introduced it would be interesting to see how it changes the game for the NPS. It could well make or break the market for NPS.

Challenges

The major challenge for the NPS remains its distribution. When the NPS was opened for the unorganised sector, it was expected to be profitable to its fund managers by cornering high volumes of subscribers. However, with not so many distributors and barely 4,000 odd subscribers, in the voluntary (non-government) sector, it has been a major disappointment.

The largest pie of investments in this space is cornered by unit-linked retirement plans offered by insurance companies. Comparing insurance based retirement solutions to NPS shows one major point where the NPS scores. The NPS is a savings and retirement security product and as such, it does not burn a hole in the pockets of the subscribers by the charges it levies. ULIP based pension schemes, on the other hand, are in between, they are inefficient routes for buying insurance and as investment. The investment corpus in ULIP based pension schemes takes a major hit especially in the early years with high charges of around 10 per cent in the first five years. There are and have been ULIP based plans with low charges but distributors have not actively promoted them because of lower commissions.

Conclusion

NPS is a safe and effective post-retirement tool. With its lowest charges, it also is the cheapest way to get an exposure to the market. For thousands and lakhs of employees in the unorganised sector, who have negligible or no postretirement social security benefits, NPS is a boon and greater awareness and marketing will not only increase NPS accounts but also make them available to this immense market, this new and yet ignored tool called the NPS.

Source: http://in.biz.yahoo.com/100524/50/bavngz.html

‘Very few fund managers can consistently beat the index'

We all assume that investors come to us so that we shoot the lights out! But a vast majority ofinvestors want just a bread-and-butter return that is substantially higher than other fixed-income options. Everyone wants to drive a Ferrari, but when it comes to driving on Indian roads, we all plump for a Maruti.

In an interview with Business Line, Mr Krishnamurthy Vijayan, IDBI Mutual's Managing Director and CEO makes a cast-iron case for why Indian investors should choose an index fund over so-called actively managed ones. He argues that beating the index is getting more difficult even for seasoned managers. The high churn in the mutual fund industry and the difficulty of predicting who will win make index funds the simplest solution for investors.

Excerpts from the interview:

Why has IDBI Mutual Fund started out with an index fund instead of an actively managed one? You were talking about the feasibility of having a wholly index-based fund house in India. Can you explain that?

It is my view that today, very very few fund managers are able to consistently add value to the index. A good number of fund houses have shut shop, moved on. Then, as the Indian market has become more and more efficient, the number of active funds outperforming the index is declining. The margin of outperformance too is diminishing.

We wanted to start off with a flagship Nifty fund because Nifty stocks account for around 60 per cent of the traded volumes. It provides sufficient diversification to investors, covering 50 stocks from 22 sectors. And the index itself is actively managed by competent people who apply liquidity and quality parameters to select the best of breed stocks.

Why should the investor settle for index returns, when some equity funds do much better?

Let's look at it this way. There are 64 fund houses that have, at various times, obtained mutual fund licences in India. Of those, about 22 have, in one way or another, exited the business. And of these, I would say only 4-5 funds have consistently delivered good returns. The rest have been mainly flashes in the pan — one good year, a couple of bad ones, and so on.

For the investor, this causes a lot of post-purchase dissonance. He buys a fund and sees the market going up, but his fund's NAV remains below Rs 10, sometimes for years. When the Indian market was in its early stages, a select club of individuals could make outsized returns based on information not generally available to the public.

As markets became more efficient, information came into the public domain, the disclosure rules also became more stringent. That still allowed room for professional managers to do better. But today, when there is a large mass of humanity armed with information, outperformance becomes very difficult.

For the investor, the dilemma is who is this person who is good enough to outperform that market? And am I willing to take the incremental risk required to get that outperformance? The average investor's answer would be ‘No'. When you can get a good average return that is superior to other options in the market such as debt instruments, that should be enough. Given that the index in India is consistently delivering a 20-25 per cent return, it thus makes sense to pick up an index fund.

Over the past few years, the proportion of active funds doing better than the index has been at 70-80 per cent. Only in 2009 did that drop to 60 per cent. Will active funds really find it difficult to do better than the index over the next few years?

My view is that not only will the incidence of underperformance continue, but that it will increase! First of all, even 60 per cent is not a great proportion. Two, these numbers are influenced by a survivorship bias, where funds that disappeared or have languished are simply not taken into account.

Three, research shows that, in any given year, the fund that gets the maximum fresh money is the top performing fund for the preceding year. Surprisingly, that fund is never the top performer over the next few years. Funds are typically able to make it to the top when they are tiny, but revert to mean when they become larger!

The category average returns that you see for equity funds are also misleading. Divide funds into quartiles based on returns and you will find that the index is looking much better than a good number of the active funds. Above all, we should look at what the investor wants. We always assume that the investor comes to us so that we shoot the lights out! But the fact is a vast majority of investors want just a bread-and-butter return that is substantially higher than prevailing fixed interest options. Everyone wants to drive a Ferrari, but who really buys one? When it comes to actually driving on Indian roads, we all plump for a Maruti!

I think the core portfolio of an investor only needs to be in bluechip stocks built up over a period of time. That is where an index comes into play. That is why every pension fund making a foray into a new market only takes an index exposure. Thirty or 40 years down the line, fund houses of today may not be around and neither will the fund managers, but the indices will still be around.

With SEBI trying to reduce the cost structure in the mutual fund business, there appears to be a shift to low-cost products. Are index funds also in line with this objective?

When there is very low premium to active management, the only way to deliver good returns to the investor is by reducing the management fee. By reducing the fee from 2.5 per cent (for active funds) to 1.5 per cent (for index funds), the investor gets an effective 40 per cent discount.

If you look at any diversified equity fund, about 70 per cent of the holdings are in index stocks. Where holdings are substantially outside the index, the funds don't weather market declines very well.

If investors need to buy the index, why not Exchange Traded Funds? Why have you used the open-end structure instead? Open-end index funds in India seem to have a very high tracking error.

The tracking error on Indian index funds has arisen largely because they either take cash calls or derivative calls and not because of their structure. You see, fund houses in India are psychologically active managers of money. The moment you take the leeway to be active, you tend to take on these calls.

To be completely passive, you need a lot of discipline. ETFs have a few disadvantages. One, today, the market for ETFs is quite small, as people like to buy from the issuer. The impact cost of buying an ETF (from the market) is high. Two, for a retail investor it is best to invest in the markets through a SIP, you can't do this in an ETF.

Three, upfront loads have been banned on mutual fund products. Yet while buying an ETF you will be paying an upfront brokerage. Internally, we have set a guideline that the tracking error on the IDBI Nifty Index Fund should be less than 1 per cent on the Nifty. We are also consciously adopting the Nifty Total Returns index as our official benchmark to factor in dividends.

Source: http://www.thehindubusinessline.com/iw/2010/05/23/stories/2010052350600700.htm

Rally in G-secs has positive impact on MF income schemes

The rally in the Government securities market over the last one month has had a positive impact on the income schemes of mutual funds. These schemes have given investors attractive annualised returns of 15-20 per cent the one-month period.

Bond market

A host of factors including global economic uncertainty, receding probability of the Reserve Bank of India going in for rapid increase in interest rates when major central banks were persisting with an easy monetary policy, a thaw in global commodity and oil prices, and volatility in stock markets have triggered a rally in the bond market, which in turn has boosted the net asset values of income schemes, say market players.

Following the 40-odd basis points softening in the yield of the benchmark 10-year Government security over the last one month or so, the net asset values of income schemes has gone up, according to Mr K. Ramanathan, Chief Investment Officer, ING Vysya Investment Management.

annualised returns

As a result, investors in income schemes have earned higher annualised returns of 15-20 per cent over a one-month period up to May 21. The annualised returns in the preceding month were in the 6-9 per cent range.

Income schemes of mutual funds typically invest 80-100 per cent of their corpus in debt instruments including the Central Government securities, State Government securities, and debt securities issued by public and private sector companies and up to 20 per cent in money instruments such as treasury bills, certificate of deposits, commercial papers, etc.

long-term G-secs

“The long-term government securities have done well with select securities have moving up by 4-5 per cent since April 16.

The net asset values of some of our duration funds (which invest in long-term G-Secs) have gone up by 4.5-5 per cent in the last month and a half,” said Mr Maneesh Dangi, Head - Fixed Income, Birla Sun Life Mutual Fund

For Birla Sun Life MF, its long term funds, such as income fund and gilt fund, have given a 5 per cent return in the last three months, which works out to an annualised return of 20 per cent.

According to the Association of Mutual Funds of India's data, income schemes of mutual funds saw robust inflows of Rs 1,18,942 crore in April 2010.

The outstanding aggregate corpus in the 345 income schemes as of April-end 2010 was Rs 4,21,063 crore.

These schemes accounted for 39 per cent of the mutual fund industry's total assets under management of Rs 10,87,584 crore.

With the Euro zone crisis casting its long shadow on the stock markets, the Government's coffers swelling on account of good inflows from 3G auction, and reports of possible doubling of the FII investment limit in Government securities coming in, the bond market should be buoyant, said Mr S. Srinivasaraghavan, Vice-President and Head of Treasury, IDBI Gilts Ltd.

This could in turn give a leg up to the returns on the income schemes.

Source: http://www.thehindubusinessline.com/2010/05/24/stories/2010052451920300.htm

Gaining the Gilt Edge

Investors are surprised when gilt funds lose money, finds Ravi Samalad. But the difference between the top and bottom performers of gilt funds is huge

A few weeks ago, one of our readers wrote to us about the performance of a gilt fund he had invested in. He had invested Rs6 lakh in a long-term gilt fund at an average NAV (net asset value) of Rs20.39 in 2008. When he wrote to us, its NAV had fallen to Rs19.13—down 6%. The investor was surprised. How can one lose money in a gilt fund, he complained. If you think that the word ‘gilt’ is synonymous with ‘risk-free’ over all periods of time, it is not.

Gilt funds primarily invest in government securities (G-Secs) issued by the Reserve Bank of India. These funds also invest in corporate bonds, zero-coupon bonds and treasury bills, certificates of deposit, commercial paper and usance bills, as well as derivative instruments like exchange-traded interest rate futures and interest rate swaps. As you know, the NAV of any fund fluctuates on a daily basis just like share prices because the underlying asset—whether bonds or shares—fluctuate on a daily basis. The fact is: anything that is interest-bearing will go up and down with the market. The value of bonds of any kind is primarily influenced by the prevailing interest rates. If interest rates go down, the value of bonds goes up. The daily NAV of a gilt fund is calculated by valuing a variety of government bonds, which a fund has invested in, that are traded in the market. As interest rates change, the value of the securities in which the scheme has invested, fluctuates as well. This, in turn, will be reflected in the changing value of the fund and its NAV.

In the example we started with, the investor had entered the fund at a time when bond prices were high. When interest rates rose and bond prices fell, the NAV of the fund declined. There is nothing mysterious about a gilt fund declining 6% over two years. The same fund has posted decent returns of 7% since inception. In short, buying gilts does not save you from short-term risk of loss due to market fluctuations.

As TP Raman, managing director, Sundaram BNP Paribas Asset Management Company, explains: “The market risk of a debt instrument can be eliminated only in a situation where a security is held till its maturity. Since gilt funds are generally open-ended funds where investors are allowed to enter and exit at various points of time, the funds may be forced to honour the redemption commitment even if it involves booking losses. Further, as all securities are marked-to-market on a daily basis, the NAV of the fund at any point of time recognises the current fair/realisable value of all securities in the portfolio. This recognition leads to losses (principal erosion) or profits for different investors depending on their entry and exit, when analysed at short periods.”

When it comes to gilts, the usual route for an investor is mutual funds. Retail investors do not have access to government securities because these are dealt in large lots which only institutional players can afford to buy. But gilt funds can pool money from retail investors and buy government securities, offering an indirect route to retail investors. However, most investors invest in such funds without consulting a financial advisor and cry foul if the NAV falls.

When To Buy Gilts

“The right time to invest in a gilt fund is when interest rates in the economy are near their peak levels, inflation expectations are likely to go down, growth slowdown is seen in the months ahead and overcapacities get built up in the economy. An ideal time-frame should be two to four years, depending on the clues from broader indicators in the economy,” adds Mr Raman. The past one year has been a time of rising inflation and rising interest rates, leading to falling value of gilts and, therefore, the NAV of gilt funds.

The principal amount that you have invested may erode due to interest rate fluctuations and mark-to-market formula of securities valuation. Although there is no fixed timing for investing in gilt funds, financial advisors believe that one should ideally invest when interest rates are around 8%. Long-term securities react more in response to interest-rate changes than short-term securities.

Gilt funds are of two kinds—short term and long term. “There is no ideal time horizon for gilt funds; it is advisable to invest when interest rates are high but it is very difficult for a common investor to predict interest rates. The best way for an investor is to go for a short-term gilt fund, where the effect of interest rate changes will be nil, so the NAV will not give you nasty shocks,” says Bhavesh Gajiwala, a Surat-based independent financial advisor (IFA).

Of the 29 gilt funds available, 14 have recorded hugely varying compounded annual returns over five years. ICICI Prudential, JM G-Sec Regular Plan and Templeton India GSF have reported the highest returns of 9%. HSBC Gilt Fund and Taurus Gilt Fund have reported the worst performance of 2% and 1%, respectively, for the same period.

So, here again, you will have to time your buying and selling to avoid losing money in a supposedly loss-free product like gilt funds.

No Sheen on Gilt Funds?

Distributors don’t promote gilt funds aggressively due to the meagre commissions offered (usually 0.15% to 0.40%) compared to equity funds and unit-linked insurance plans (ULIPs) which give 30% of the premium plus trail commission of around 5%. Debt funds don’t offer such upfront brokerage. Gilt funds have remained low-profile because fund houses never promote them as aggressively as equity funds. According to data available with the Association of Mutual Funds in India, total assets under management (AUM) of gilt funds were just Rs3,171 crore, constituting 1% of all categories of mutual fund schemes, compared to equity funds which constituted 22% at Rs168,672 crore as of February 2010.

The performance of the scheme depends on a variety of factors affecting capital markets, such as interest rates, currency rates, foreign investment, government policy, etc.

“Volatility in gilt funds is far lower than that in equity. This, perhaps, makes it less glamorous and attractive. Retail participation in government securities has been a non-starter in India—both directly and through the mutual funds route. There are incentives aplenty for equity funds—right from tax-free dividends, low short-term gains and zero long-term gains. Similar incentives to gilt funds will go a long way in achieving the twin purpose of retail participation in government securities through mutual funds and bridging the demand-supply mismatch in government borrowings which the government is keen to address,” says Mr Raman of Sundaram BNP Paribas.

Source: http://www.moneylife.in/article/5294.html