New Delhi: India’s National Pension System (NPS) has been celebrated as the cheapest retail investment product in the world with an annual fund management charge of 0.0009% on the assets under management. That will go up to 0.25% in November, still lower than the comparative figures for mutual funds in India and market-linked pension plans by insurers.
But the number is deceptive. NPS fund managers say the problem is that the scheme, introduced in May 2009, hasn’t gained enough traction to generate the kind of cash flows they need to make direct investments in equity index funds. Pension fund managers (PFMs) investing in existing index funds offered by mutual funds, which have an expense ratio or an annual cost limit of as much as 1.5%, are adding their fund management cost of 0.0009% on top of it.
According to the investment guidelines of the Pension Fund Regulatory and Development Authority (PFRDA), equity investments should be made in index funds that replicate either BSE’s Sensex or the National Stock Exchange’s Nifty 50 index. Index funds invest in securities in the same weightage as the index. PFMs have to choose which index to track at the beginning of a year. An individual is allowed to invest up to 50% in equity funds through NPS.
“Our cash flows are not even a lakh a day. And to invest in the indices we need much more than that,” said a chief executive officer (CEO) of a pension fund management firm who did not want to be named. “To buy a basket of Nifty, we need about Rs.1.5 lakh. So, we either hold cash and have a lot of tracking error or invest through mutual funds.”
According to their websites, three out of six PFMs that manage funds for individuals and companies—Reliance Capital Pension Fund Ltd, IDFC Pension Fund Management Co. Ltd and Kotak Mahindra Pension Fund Ltd—invest in index funds through mutual fund firms. UTI Retirement Solutions Ltd also invests through mutual funds, according to its CEO Balram P. Bhagat. ICICI Prudential Pension Funds Management Co. Ltd and SBI Pension Funds Pvt. Ltd, however, invest directly.
PFMs that invest though mutual fund companies do so with the regulator’s blessing.
“The guidelines don’t prohibit PFMs to invest through AMCs (asset management companies). However, this is just an interim arrangement. Once the PFMs are able to mobilize sufficient money, they will have to invest directly,” said Yogesh Agarwal, chairman of PFRDA. However, these PFMs can’t invest in index funds of their sponsor companies.
“PFRDA had some time back asked all the PFMs to exit from the index funds of their parent company,” said Gautam Bhardwaj, director of Invest India Economic Foundation Pvt. Ltd, known as one of the key architects of the original NPS.
However, it’s not clear why PFMs are investing through mutual fund firms in index funds and not exchange-traded funds (ETFs) that also track the index.
“PFMs could have invested in ETFs that are less expensive than index funds and have a lower tracking error. Also, if shortage of funds is the reason, they could invest in each other’s schemes, which is allowed by the regulator,” said Manoj Nagpal, a wealth and asset management professional in a Fortune 500 financial services company that is in the process of setting up shop in India.
Nagpal had drawn Mint’s attention to PFMs investing through mutual fund firms. According to a finance ministry report on pension reforms, the private sector has about Rs.444 crore of assets under management as of 4 August. “There are mutual fund companies with a corpus of around Rs.1 crore that have index funds, that too with a very low tracking error,” he said.
UTI Retirement Solutions’ Bhagat said, “Now we have enough marketable lots, but we don’t want to exit the index fund before a year since there is an exit load. Moving on, we will definitely invest directly.”
For a product that’s just three years old, is regulated, and was envisioned for a workforce of around 284 million that don’t have any retirement products to invest in, the flaws in the product are already visible. NPS in its current form suffers from issues of transparency and full disclosure. For instance, the offer document or the brochure on NPS on the PFRDA website does not clearly mention that PFMs are allowed to invest in index funds through mutual fund companies that will have an impact on the net asset value.
Additionally, SBI Pension Funds and others have not disclosed their portfolio on the website. “We have disclosed our portfolio to the regulator and are awaiting further directions on the periodicity of disclosure,” said Biswajit Mohanty, managing director of SBI Pension Funds. UTI Retirement Solutions doesn’t provide a full portfolio disclosure.
Other PFMs said once NPS gains traction, investments will flow directly through index funds managed by them.
“It is unfair for the customers to pay additional cost. But the new guidelines state that the investment management fee will cover all expenses and will be capped at 0.25%. In other words, the PFMs will have to manage the funds on their own or within the cap,” Mohanty said. Until then, NPS’s claims of being the cheapest product holds good only in theory.