Here's why the trade unions are wrong about EPFO investment in equities

The government recently allowed the Employees Provident Fund Organisation (EPFO) to invest in the equity markets. As expected the trade unions are up in arms. The general grouse of the Unions are well known - money will be gambled away or the fund will suffer losses in the event of a market crash.

Nothing can be more further from the truth. But first let’s try to look at the opportunity for the markets before addressing the issue of equity investments being a gambling exercise.

India's EPFO is one of the largest funds in the world with a corpus of $100 billion or Rs 6.5 lakh crore and a membership of 80 million subscribers. Annual addition to the fund is around Rs 80,000 crore. As per Labour Minister Bandaru Dattatreya's statement, EPFO investment will start from July by investing 1% of the corpus which will be increased to 5% by March 2016.

As far as the markets are concerned, 5% investment of incremental money of Rs 80,000 crore being invested in the market is nothing to celebrate. LIC invests around Rs 45,000-50,000 crore in the market every year. Even 5% of the overall corpus of EPFO amounts to only Rs 32,500 crore or less than $5 billion and this is a one time investment.

Coming to the objection of the trade unions, the amount likely to go into equity, in percentage terms  is not big enough to have a meaningful impact even if the fund performs poorly.

Further, just like pension funds and insurance funds, EPFO’s investment in the equity market will be restricted to only the top companies and governed by strict rules and accountablity. These are companies which are profitable and have a dividend paying track record. 

Reports say that EPFO will be restricted to invest in public sector enterprises (PSE) or take part in divestment of PSEs. Central PSE or CPSE ETF has performed well in the market and has given a return of 34 per cent since its launch in March 2014. In the first year of its launch, the fund managed by Goldman Sachs achieved a return of 21 per cent.

Thus assuming that only 5% of the EPFO corpus was invested in the CPSE fund and the remaining 95% in its existing debt instrument which yielded 8.6%, the net return would have been 9.22%.

EPFO is itself not too happy with the returns they are delivering over the years and have been considering investment in alternate asset class like real estate, infrastructure and equities. In an internal presentation, EPFO has pointed out that provident fund returns are not enough to even cover for inflation.

As for the point of equating investing with gambling, it is taking things a bit too far. Investment in equities has yielded a better return than other financial assets over the long term. Since its inception in 1979, BSE Sensex has given a return of 16.94 per cent CAGR, almost twice that of investments in debt.

Agreed, there have been periods of negative returns but we are talking of returns over the long run and that too in good quality companies. An amount of Rs 1,000 invested in 1979 would have become Rs 22,251 if it was invested at 9% interest in a debt instrument. But if the same amount was invested in the BSE Sensex, the investor would have made around Rs 2.8 lakh, nearly ten times the amount invested in debt.

Perhaps the trade unions should have a look at equity returns before complaining. Or better still, they should invest in equities and experience the returns before rubbishing it.