BackEPFO yet to account for equity gains
The Employees' Provident Fund Organisation does not have a calculation methodology in place to account for returns from its equity portfolio
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It may have been over a year that the Employees’ Provident Fund Organisation (EPFO) started investing in equities, but did you know that you are yet to reap the benefit of EPFO’s equity investments? This is so because the authority is yet to devise a methodology by which to account for the returns from these investments. Therefore the gains, if any, do not reflect in the EPF interest rate yet.
Calculating the returns
This is EPFO’s second attempt at devising this methodology. The first was in December 2015, when it had specified the accounting manner in a circular, which stated that the EPFO would give a guidance on government security (g-sec) rate, against which the equity return would be benchmarked. If the equity portfolio beats the benchmark, then a part of that profit would be credited to the employees and the remaining would go to the equity income stabilisation reserve, to be used for a rainy day. “The problem is that this reserve is notional and unrealised as there is no profit booking," said Amit Gopal, senior vice-president, India Life Capital Pvt. Ltd. “The basic problem is that EPFO will have to declare a rate of interest out of earnings from an asset (equity) that is marked to market. To do this, EPFO will either have to sell equities and realise the gains every year—which is inefficient pension fund management—or it will have to unitise the employee accounts, which means an overhaul of the EPF as we know it," he added.
The circular also could not come into effect as it didn’t meet the accounting standards as per the Comptroller and Auditor General of India (CAG). “The December circular was a proposal, which was then sent to the CAG for approval. But according to the CAG, it didn’t meet the accounting standards as returns were on notional basis," said V.P. Joy, Central Provident Fund Commissioner, EPFO.
“We were advised by the CAG to consult ICAI (Institute of Chartered Accountants of India) to devise a methodology to factor in returns from the equity portfolio. We have received the report from them, so now we will work on it internally and we hope to come out with a methodology in a couple of months," he added.
After investing in equities in August last year, EPFO declared an interest rate of 8.8% for the financial year (FY) 2015-16 for the EPF subscribers early this year. This rate didn’t account for equity returns due to two reasons: first, a lack of policy on how to factor in the equity returns; and second, the minuscule proportion of equity investments and their poor performance.
“To account for equity returns we first need to devise a methodology and book gains to realise our revenue. Last year, the portion of equity was tiny and the returns from the portfolio were negative when we declared the interest rate early this year for FY16. Hence, equity returns were not factored in," said Joy.
Even as the authorities work on a plan to account for equity returns, the labour ministry in September decided to double the equity exposure from 5% to 10%. For FY17, EPFO will invest 10% of the incremental corpus, or about Rs13,000 crore, through exchange traded funds (ETFs). An ETF is a basket of securities that tracks the stock prices of the companies of an underlying index, and is traded on the exchanges.
For FY17, EPFO is yet to declare an interest rate and it is not clear whether this time the returns from equity portfolio will be included.
Selection of fund managers
EPFO primarily invests in debt products through government securities and some portions in corporate bonds. But it decided to enter the stock market in order to improve returns over the long term. To invest in equities, EPFO chose two ETF schemes of SBI Mutual Fund—SBI ETF Nifty and SBI Sensex ETF. The reason behind choosing this fund house was that State Bank of India (SBI) was the sole banker, and also that the authority didn’t have time to come out with a tender and spend another year finalising the asset management company. However, in June this year, it called for a request for proposal to select fund managers for EPFO’s investments in ETFs. But instead of going ahead with the process, it decided to appoint UTI Asset Management Co. Ltd as the second fund manager. Currently, UTI Mutual Fund manages 25% of the corpus whereas SBI Mutual Fund manages 75% of the corpus. The split between the Nifty and Sensex ETFs is 75% and 25%, respectively. Both come with an expense ratio of 0.07%.
The choice of fund manager for the ETF corpus is in sharp contrast with the way EPF chose fund managers for its debt portfolio.
Last year, it called for a request for proposal in which the fund managers had to bid and the contract was for 3 years. Accordingly, SBI, ICICI Securities Primary Dealership, Reliance Capital and HSBC Asset Management Co., Reliance Capital Asset Management Co. along with UTI Asset Management Co. were selected to manage EPF funds for the 2015-18 period. Even the private sector National Pension System, despite its relatively small corpus, has a system for selecting fund managers. Opening EPF money to equity is good for the long term, but EPFO still has to tie the loose ends.
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