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Business News/ Money / Calculators/  NPS may raise equity exposure to 75%
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NPS may raise equity exposure to 75%

PFRDA has proposed to up equity exposure of NPS and harmonise government and private investments in it

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Last year, the National Pension System (NPS) shifted its equity fund management from passive to active for the private sector based on the recommendations of the G.N. Bajpai committee report. Passive management entails no fund managers’ risk as the money is invested in equities that track an index and the fund manager has little role to play. Active management depends on a fund manager’s choice of stocks to beat the benchmark’s returns. So, not only do they carry the fund managers’ risk, they also come with a higher expense ratio.

On 22 April this year, the Pension Fund Regulatory and Development Authority (PFRDA) took further steps to incorporate the panel’s recommendations. It issued two concept notes, or draft proposals. The first proposes to increase the cap on equity investments from 50% to 75% through the life cycle fund, and the other is for harmonising investment patterns of government and private sector NPS.

The draft proposal should bring cheer to you and the pension fund managers (PFMs). You get to invest more in equities, and a complete parity means that a government employee can also choose from among private sector PFMs, who, in turn, will have more money to manage. But before we get into the details, here is a quick recap of how NPS works.

How does NPS work?

NPS is a pure defined contribution product, wherein you invest till 60 years. At 60, you need to buy an annuity—a pension product that gives you periodical payouts—with at least 40% of the proceeds. The remaining can be taken as lump sum. Complete withdrawal before maturity is discouraged by mandating you to annuitise at least 80% of that money, but it allows for partial withdrawals after 10 years.

You can begin with a minimum annual contribution of 6,000 in the pension account or the Tier-1 account. You can choose from three funds: Scheme G invests in government securities, scheme C in fixed income instruments other than g-secs and scheme E is the equity fund (equity investment limit is 50%). You can invest in any of these funds by picking any of the seven PFMs listed at present. Three are public sector PFMs—LIC Pension Fund Ltd, SBI Pension Funds Pvt. Ltd and UTI Retirement Solutions Ltd—and they are also entrusted with fund management of the government sector NPS. Four are private sector PFMs: HDFC Pension Management Co. Ltd, ICICI Prudential Pension Fund Management Co. Ltd, Kotak Mahindra Pension Fund Ltd and Reliance Capital Pension Fund Ltd. These four PFMs only manage private sector funds. Birla Sun Life Pension Management Ltd (which is yet to commence operations) is the fifth, which will take the tally up to eight.

Other than choosing the fund and the PFM, you also need to choose the asset allocation. The option of active choice is for those who know their asset allocation. You can invest in any of the three funds in the proportion you want (equity investment remains at 50%).

The auto choice adopts a life cycle-based approach and is meant for those who need help in deciding their asset allocation. It starts with a maximum exposure to equity in the younger days, which tapers off as you reach the retirement age. So, till 35 years of age, 50% of your money remains invested in equity, 30% in scheme C and the balance 20% in scheme G. The equity allocation tapers off every year until 55 years of age. It then remains fixed at 10% in scheme E, 10% in scheme C and 80% in scheme G till retirement.

New proposals

Instead of a 50% cap on equities, the Bajpai committee wants investors to be able to put all their money in equities if they want to. The report recommended a roadmap spanning six years and three phases towards this end. It recommends allowing an increase in equity exposure to 75% through the life cycle fund in the first phase, then allowing 75% allocation in the active choice and finally lifting the cap altogether. The report also recommends expanding the universe of investment instruments under the NPS.

To increase the equity investment, PFRDA has proposed two new life cycle funds: aggressive life cycle fund with equity allocation of 75% at the age of 35 years and conservative life cycle fund with equity allocation of 25% at the age of 35 years. The aggressive fund would taper to 15% in equities at 55 years of age, whereas the conservative fund would taper to 5%.

“The option to offer more equity allocation is welcome and is especially needed for long-term investments. But the rationale of the life cycle approach is to preserve investments as one approaches retirement, so there shouldn’t be any difference in equity allocation among all the three funds at 55 years of age," said Manoj Nagpal, chief executive officer, Outlook Asia Capital. “Also, the proposed aggressive funds starts by putting 15% in the g-sec scheme but only 10% in the corporate bond fund. Shouldn’t it be the other way around? The concept note should also explain the rationale behind such asset allocation," he added.

The proposal only increases the equity allocation through the life cycle fund. So, if you decide your own allocation through the active choice, your equity will continue to be capped at 50%. The note also recommends making the existing life cycle fund more dynamic and adding another life cycle fund with a 5% exposure to alternative asset classes. “We have proposed that asset allocation will be reviewed from time to time depending on macroeconomic factors, and changes in asset allocation will be made if required," said Hemant Contractor, chairman, PFRDA. The pension regulator wants to create a separate asset class of alternative assets as well. Hence, it has also suggested an additional life cycle fund with a cap of 5%.

NPS for government employees

The second set of proposals deals with harmonising the government sector and private sector NPS. Currently, NPS money of the government sector is allocated to the state-run PFMs in a predefined proportion and they invest the funds according to pre-determined limits: up to 50% in government securities, up to 45% in debt securities, up to 5% in short-term debt, up to 15% in equity and up to 5% in asset-backed, trust-structured and miscellaneous investments.

PFRDA has proposed to do away with the different investment patterns and restrictions in choosing PFMs. In other words, a government employee can also choose from the PFMs that manage private sector NPS and from the same investment funds. “So, it is proposed that the public sector should have the same choices as those of the voluntary sector," said Contractor. This would mean that the employee will also be able to increase the equity allocation to 75% through the proposed aggressive life cycle fund.

What does this mean?

These changes mean more choice and a higher allocation to equities. For PFMs, it means a chance to increase assets under management (AUM). As on 31 March, the total AUM for the state and central government employees stood at 1,05,633 crore, whereas for the private sector, it was about 10,500 crore.

As PFMs gear up for the ‘request for proposal’ (RFP) from PFRDA to apply for fund management licences again, they will only have to deal with only one RFP as the funds are harmonised. But what continues to worry is the fund management charge, which is currently at 0.01%. “Fund managers are debiting costs to shareholders as the current charge is insufficient to meet the unitary cost of fund management. Also, since there will be high equity exposure and the funds are managed actively now, PFM charges should go up," said Sumit Shukla, chief executive officer, HDFC Pension Management Co. Ltd.

For you, the investor, an increase in equity allocation is a welcome step, since an equity booster is needed for a long-term goal such as retirement. PFRDA has invited public comments within three weeks and is hoping to come out with the RFP on fund managers in about two months.

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Published: 01 May 2016, 10:20 PM IST
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