The move will be risky since the finance ministry cannot give a guarantee on returns but experience indicates that this risk is compensated by higher returns.
D L Sachdeva
Member, CBT of the Employees Provident Fund
‘We feel that guaranteed returns, even if low, are preferable to non-guaranteed though higher returns from the stock market’
We are opposed to the investment of any component of provident fund in shares, whether we are talking on behalf of the trade unions or on behalf of the Central Board of Trustees (CBT). The proposal being made by the chairman of the Securities and Exchange Board of India (Sebi) is not new. It has been put before the Central Board of Trustees several times before. The CBT chairman, who is also the labour minister, has opposed it each time. Today we have investments only in public sector bonds; we have never gone to the stock market with our funds.
Usually, the demand is to put a limited portion of funds, say, five to ten per cent, in shares. But a five per cent investment would open the doors for such a pattern of investment in the future. That is a risk we cannot take. There was a long correspondence between the labour and finance ministries on this. The labour ministry even offered to put some funds in the market provided the finance ministry gave a guarantee — that is, if the returns were not on a par with the funds at the prevailing interest rates offered by EPFO then the finance ministry would reimburse the difference. But the finance ministry, which was so enthusiastic about pushing this proposal, refused to take this responsibility. P Chidambaram was finance minister when this proposal was made to the EPFO three or four times in the past few years.
We knew the finance ministry would not be able to give such a guarantee on returns or reimburse the difference in the EPF rates and the money received from the stock market. But we have stood by our decision of seeking guarantee on minimum returns.
In other countries, especially the developed ones, there is investment in stock market and there is no government guarantee either. But, then, they have been working towards curtailment of social security funds. Six months ago millions of people in Great Britain were on the streets protesting against these moves by the government to shirk its obligations.
Central and state government employees who are not subscribers of the EPFO have already been hit by the Centre’s shift to unguaranteed returns in the New Pension Scheme (NPS). Pensions for employees from 2004 would be given on the basis of the market value of the annuities handed to them at the time of retirement. So pensions would be dependent on market vagaries. In the EPFO, returns are guaranteed. The government wants that guaranteed component to go — that explains the constant harping on investments in the stock market. Having achieved this for government employees in the NPS, it slowly wants to bring these unguaranteed returns to non-government employees through the back door by pushing investments in stock market. But we feel that guaranteed returns, even if low, are preferable to non-guaranteed though higher returns from the stock market. The EPFO is the world’s largest social security scheme covering 40 million subscribers. It is the government’s duty to subsidise it or keep the funds in a special deposit scheme or SDS. Up to 2000 the funds were kept in an SDS at 12 per cent interest. Then this was discontinued. The money that remains in the SDS gets just eight per cent interest, on a par with the public provident fund.
Today there is a deficit of Rs 54,000 crore in the Employees Pension Scheme of the EPFO. This was because incomes and interest rates came down after 2000. The best way forward would be for the government to keep the provident fund investments in SDS and pay a minimum interest of 9.5 per cent.
D L Sachdeva is also National Secretary of the All India Trade Union Congress
As told to Sreelatha Menon
Vetri Subramaniam
Chief Investment Officer, Religare Mutual Fund
‘Equities are the best hedge against inflation. Return of capital is of no value when the value of that capital is itself eroded’
If I’d known that retirement was going to be this good I’d have done it the day after I left school…
Of course that holds true only when you have a pension that will see you through that period of your life when you cease to work for a living and for an income. In India,the ticket to a golden retirement was a job in the government or public sector where the pension benefits were guaranteed by the state. As participants or recipients of the scheme, one does not worry about the source of the pension payment because it was backed by the state. But the experience from the developed world suggests that this form of a defined benefit pension programme has proved ruinous for both governments and the private sector.
In an acknowledgment of this reality, the government established the Pension Fund Regulatory and Development Authority (PFRDA) in 2003 that lays down the architecture for a contributory pensions scheme for all individuals. These pension schemes allow investment in equity but this is capped at a maximum of 50 per cent. However, large pools of capital such as the government-run Employee Provident Fund Organisation (EPFO) still does not invest in equity despite several proposals to that effect. The EPFO is of the view is that equity is risky and that return of capital is more important that return on capital.
There is no doubt that equity as an asset class is more risky than bonds. This is one of the established principles of finance. But that is only half of the story because the theory and experience indicates that this risk is compensated for by a higher return. Further, it is equally true that equities are the best hedge against inflation that insidiously eats into the true value of our savings. Return of capital is of no value when the value of that capital is itself eroded.
Indian equities have returned over 18 per cent over the last 10 years and 14 per cent over the last 20 years. As anybody who has seen a mutual fund advertisement is well aware in the equity markets the standard disclaimer — past return are not indicative of future returns. So, while this past performance alone cannot be a sufficient basis for the EPFO or for private trusts to make the allocation to equity, it is a good reason to explore the issue in further detail and conceive of systems and processes to manage this risk rather than to avoid it altogether.
Today, the EPFO by its own admission is unable to earn the returns required to meet its obligations. It is worrying that it cannot see the obvious solution — raise the overall return of the portfolio by making a small allocation to equities. A small step in this direction could be made by making allocations only out of the fresh inflows rather than an attempt to change the allocation of the existing corpus. Further, in the early stages the allocation could be made using a passive approach. Once comfort with the system builds, active management styles can be added to the platform.
Using information technology it would be possible to also allow each member to choose the right allocation pattern for his or herself. This would be subject to prudent limits to prevent a member from doing harm to oneself. Experience from the pension industry in the developed world suggests that individualisation and customisation of such a system is a must. A person’s asset allocation choice and needs are driven by their age and must take into account their risk tolerance.
The EPFO has over 40 million subscribers and it is time we allowed Indians to invest a part of their retirement savings in the stock market and own a portion of it.
