Don't change your pension fund manager unless investment lags others

Currently, variability in performance for investor portfolios over five-year horizon is low

September 19 was the day when the PFRDA (Pension Fund Regulatory and Development Authority) Act was passed. On this occasion, let us review the performance of the various pension fund managers (PFMs) in the National Pension System (NPS), and also examine how various developments (including regulatory changes) within this retirement product could affect you, the investor, and how you should respond to them.

Past performance

How an investor fares in NPS depends on two factors. One is the asset mix she chooses and the second is the fund manager.

While choosing the asset mix, she can go for the active choice option where she gets to decide the asset allocation. The other option is to go for the auto choice option where the asset allocation is determined by age.

Suppose that the investor is 30 years old. She opts for a portfolio that has a 75 per cent allocation to equities, 12.5 per cent to corporate bonds, and another 12.5 per cent to government bonds. (We have not included alternative investment funds, or category A, since investors can take only up to 5 per cent exposure to them).

The returns data used here was taken from the NPS Trust website (dated September 9, 2022). Applying the 75:12.5:12.5 weightage to the three asset classes, we got the following returns. For five-year and three-year returns, HDFC is the best performer with returns of 11.7 per cent and 15.8 per cent respectively. For one-year return, LIC is the best performer.

Suppose that there is another investor who is older and hence chooses to have a more conservative portfolio. She allocates 50 per cent to equities, 25 per cent to corporate bonds, and another 25 per cent to government bonds. Even with this allocation, the results are the same. HDFC remains the best performer over the three- and five-year horizons, while LIC remains the best over the one-year horizon.

“Since retirement is a long-term portfolio, investors should give higher weightage to longer-term performance while selecting a PFM,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers.

Financial planners say you should not hop from one scheme to another immediately if your PFM is underperforming slightly. “The weighted average return numbers over the five-year period show that the variability in the returns of various PFMs is small,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.

Besides, in the NPS space, fund managers have been allowed to pursue active fund management. However, according to financial planners, given the low fee, most are in all likelihood pursuing a closet indexing strategy (which may account for the similarity in returns). And even if they pursue an active management strategy, investing based on past returns would still remain a gamble, because the outperforming PFM would keep changing.

According to Raghaw, investors should choose a PFM that is a large and reputed player in the fund management space, and for whom the reputational risk is great. “Once you have chosen a PFM, stick to it. Switch only if it lags behind by a large margin over the long term compared to peers,” he says.

Some financial advisers suggest avoiding PFMs whose investment decisions can be swayed by government pressure.

Defined benefit or defined contribution?

During the past year, the Rajasthan state government announced that it would opt out of the NPS and revert to the old pension system. While NPS is a defined contribution scheme, the old pension system was a defined benefit scheme.

“For anyone who manages long-term money, it is very difficult to promise a particular rate of return, given the fact that interest rates tend to witness a secular decline,” says Dhawan.

A quarter of a century earlier, in 1997, the Public Provident Fund (PPF) offered a return of 12 per cent. Currently it offers 7.1 per cent. Fixed deposit rates of banks have seen a similar decline.

Due to this inability to predict long-term returns, there is a very real risk that a government could renege on its promise to offer the promised rate of return. “While a defined benefit scheme offers greater mental comfort, there is a very real risk that the promised return may not materialise because the returns generated fall short of what was promised,” says Dhawan. Globally many governments have failed to offer pensioners the promised rate of return. There has been a large shift towards defined contribution schemes.

In a defined contribution scheme, you and your employer contribute upfront in an account that is marked in your name. Even if the government’s finances take a turn for the worse, you are not at risk since money has already been contributed into your account and can’t be clawed back. Here, the outcome depends on how the investments perform.

“In a defined contribution scheme, there is the potential for variability in outcome (the corpus generated at the time of retirement). Therefore, in addition to investing for retirement via NPS, ideally people should also invest via other instruments so that their retirement planning doesn’t get jeopardised if returns from NPS are on the lower side,” says Dhawan.

Guaranteed return scheme

The PFRDA will soon launch a guaranteed return scheme, which the PFRDA Act requires it to do.

“Investors should look at the exact nature of the guarantee before opting for this scheme. Will the guarantee be on an annual basis, as is currently the case for products like Employees Provident Fund, or will it be on a terminal basis, meaning that the guaranteed rate will remain the same for the entire period until a person’s retirement?” says Dhawan.

Generally, when fund managers offer guaranteed returns, they prefer to invest in instruments (such as G-Secs) where the variability in return gets minimised. And they avoid high exposure to equities, which have the potential to generate higher returns, but come with a lot of variability. Therefore, investors must also examine the exact quantum of return that is promised in the guaranteed return scheme, and then take a call whether they will be better off going with the guaranteed return scheme or with a market-linked scheme. “Younger investors in particular run the risk of giving up on potential upside if they opt for a guaranteed return scheme,” says Dhawan.

Salaried workers who have an EPF account already have one pension scheme that offers a guaranteed (on an annual basis) return. So, they may perhaps (risk appetite permitting) opt for market-linked funds within NPS in the hope of generating higher returns from it.

Three new fund managers

Investors in NPS will soon have three more fund managers to choose from—Axis, Max Life, and Tata—in addition to the existing seven.

“Several PFMs are today there who have developed decent long-term track records. Therefore, wait for the new ones to develop a track record before you switch to one of them,” says Dhawan.