EPFO may soon invest in equity; high time, but members must be allowed to flee to NPS

The Employees’ Provident Fund Organisation (EPFO), the institution invested with safeguarding and growing your retirement savings, usually does a poor job of its mandate.

Apart from shoddy accounting , which saw the organisation claim a surplus in 2010-11 when it was actually in deficit, it also provides poor service to the millions of workers who are forced to rely on it to safeguard their lifetime’s savings. The organisation is now managing a corpus in excess of Rs 7,00,000 crore - and rather poorly. Between 2005 and now, it earned its subscribers a negative real rate of return - Rs 100 invested in 2005 became Rs 193, but after adjusting for inflation, the Rs 100 became Rs 97, according to this Mint story.

And now, with interest rates set to fall in the coming years, the EPFO will have trouble trying to generate even the 8.5-9.5 percent average returns that it has been managing so far. Yields on the safest of safe securities (the 10-year government bond) are down to 8 percent or less after the RBI’s recent monetary policy guidance, which talked of rate cuts “early next year.”

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Against this backdrop, the labour ministry is said to be considering allowing the EPFO to invest a small portion of its corpus in equities in order to improve returns, says Mint.

It is the right move, but even if union objections to this proposal are overcome, there are good reasons to proceed with caution. But proceed it must.

First, while equity does yield higher returns over the long term, a lot depends on competent fund management. The EPFO should thus use competent fund managers for this purpose - at the very least. Its own record is not great.

Second, subscribers should be given the option of deciding the level of risk that the EPFO can take on their behalf. For example, those with balances below Rs 1 lakh should be totally protected from capital depreciation in a bear market, while those at higher levels can opt for, say, 5-10 or even 20 percent allocations to equity. There is a simple way to protect small subscribers: this is by decreeing that only half their interest earnings in any year should go into equity. This way the core capital stays protected and keeps growing no matter how the stock market fares. But the small portions going into equity can enhance their overall returns.

Third, all EPFO subscribers, especially those who have the ability to judge the risks they want to take, should be allowed to migrate their corpuses to the National Pension Scheme (NPS), which has both lower costs and a better track record with investment returns. The NPS is a defined contribution scheme where returns are not guaranteed. But subscribers have the option to earn more by earmarking a larger portion of their contributions to equity. The NPS was started for new entrants to government services (barring the armed forces) in 2004, but is now on offer to all individuals on a voluntary basis. What is now needed is to allow all private and exempted organisations (those who manage their own PF funds) to the NPS.

Fourth, another option, which will reduce fund management costs but not the risks, is to invest 5-10 percent of the EPFO’s corpus in index funds. Index funds mirror the broad market trend and take the discretion out of investing.

Subscribers to the EPFO deserve better. It’s time to end the EPFO’s near monopoly.