Rate cloud blurs PFs' investment outlook

Fund managers and provident fund (PF) trustees despite sharing similar views on the interest rate seem to be pursuing diverging investment strategies.

Gratuity, superannuation funds and excluded provident funds are parking company contributions in short-term treasury bills of six to nine months maturity. In contrast, trustees of exempted provident funds are investing in long tenure government securities, where yields are ruling the highest.

"We expect interest rates to rise, but the uncertainty over what would ultimately be the declared assured rate of return on provident funds, forces us to invest in long-term bonds where yields are highest," said a fund manager of a Bangalore-based multinational company.

"There is a clear divergence in the investment pattern of these funds, perhaps for the first time," said Amit Gopal, vice-president, India Life, which manages over 150 provident funds.

Some trusts are taking bets that rates will move further and are buying short-term treasury bills. Another major difference in their investment pattern is the fact that superannuation and gratuity funds make allocations once a year and, hence, would like to maximise gains.

In contrast, provident funds invest every month and, hence, hedge interest rate exposure as they, in effect, become systematic monthly investors.

At the same time, there is a bright side to the issue. With bond yields moving up, the differential between payout rate and earnings is declining.

The differential today stands reduced at about 200 basis points from 250-300 basis points in March 2005. This is the difference between the actual yield on investment as opposed to the administrative rate of assured return of 9.5 per cent.

"The payout rate for 2005-06 remains a huge confusion for PFs," said Gopal. It has been reported that the finance ministry has asked the Employees Provident Fund Organisation (EPFO) to pay an interest that is in line with the income the fund will be able to generate.

This accordingly is expected to be around 8 per cent, stated sources. "Even if the payout rate is retained at 9.5 per cent for 2005-06, trusts will be better off this year on account of rising yields," pointed out a senior trustee of a public sector enterprise provident fund.

This takes off from the fact that the cut-off yield for the 8.07 per cent Government of India 2017 security auctioned was at 7.48 per cent, close to market expectation of 7.94 per cent.

The breather in interest rates may make companies review plans to wind up trusts and go back to the EPFO. However, the downside is that a significant segment of the PF investment allocation "" PSU bonds and state loans "" have not yet reacted adequately to the rise in yields.

"PF trusts have changed investment strategy this year and have bought Central government securities in April instead of the usual practice of picking up PSU and state government papers," said Gopal.