NPS funds are doing well. Should you invest?

Debt category has given double-digit returns. But, go beyond returns before investing

The Pension Fund Regulatory and Development Authority (PFRDA) declared the annual weighted average returns for the National Pension System (NPS) investment funds on 15 May. In the private sector category, the corporate debt scheme (C), and government debt scheme (G) reported an impressive return of 14.19% and 13.52%, respectively, for FY13. The equity scheme (E), where an investor can put no more than 50% of her money, returned 8.38% for the same fiscal.

The returns look impressive but when you are looking at a long-term product, you can’t set much store with just one indicator of annual return. You need to go beyond returns and understand the product fully and your commitment towards it. Read on to get a sense of how impressive the returns are and what it means to invest in the NPS.

A look at the returns

To take the equity scheme first, the weighted average return for FY13 is 8.38%. Even individually, the returns of all the five fund managers have been in the range of 6.42% to 8.66%. For the private sector, NPS started with six fund managers—ICICI Prudential Pension Funds Management Co. Ltd, Kotak Mahindra Pension Fund Ltd, SBI Pension Funds Pvt. Ltd, Reliance Capital Pension Fund Ltd, UTI Retirement Solutions Ltd and IDFC Pension Fund Management Co. Ltd. IDFC Pension Fund dropped out last year due to the poor footfall in the scheme and a very low fund management fee; the investors of IDFC Pension Fund were then moved to SBI Pension Fund.

Since most pension fund managers track Nifty, we looked at the returns of the Nifty index for FY13. Nifty returned 6.05% in FY13. “Nifty return doesn’t take into account the dividend yield which index funds factor in their return calculation. Dividend yields can make a difference of about 1.5-2 percentage points. So if the returns are more than Nifty by that margin, it means the funds have returned close to the Nifty returns," says Manoj Nagpal, chief executive officer, Outlook Asia Capital, a wealth management firm.

For an investor, the maximum exposure to equity is capped at 50% but for the other two schemes—government and corporate debt—you can invest up to 100% of your money. However, there isn’t a benchmark that can be strictly comparable. Even PFRDA has not recommended any benchmark for these two schemes. Mukesh Jindal, partner, Alpha Capital, a financial planning firm based in Gurgaon attempts a comparison. “If you look at the Crisil 10-year Gilt Index, for FY13 it has returned 11.25%. Even other mutual funds that invest purely in government securities have returned in the range of 12.54-14.89%. Looking at these numbers, the NPS government scheme has outperformed most of the other comparable schemes," he says.

Even the corporate debt scheme looks like an outperformer. “If you compare the corporate debt scheme to Crisil Composite Bond Fund Index, NPS scheme has outperformed by a huge margin. Crisil Bond Index Fund returned 9.24% compared with 14.19% of the NPS scheme. Other comparable mutual funds have returned in the range of 11.12-12.62%," says Jindal.

Understand the product

The one-year return definitely looks impressive but it’s not enough to take a decision on whether you should park your retirement savings in NPS. “NPS returns have been good in the debt category and that category has generally done well. However, NPS is still in its infancy stage and need to be understood well by investors. An investor needs to look at diversification, risk appetite, liquidity and tax issues" says Nitin Vyakaranam , CEO and founder,, an online personal finance company.

These are the three things you need to understand about NPS:

Lock-in: Since it is aimed at targeted savings, it locks in your investments till 60 years of age. If you wish to withdraw it before you turn 60, you will have to annuitize at least 80% of your money. Annuity is a pension product that gives you a periodic income for life. At 60 you can withdraw 60% of the money as lump sum. The remaining 40% needs to be annuitized.

Returns are market linked: Even as the returns are impressive these are not the final return on your investment. That’s because this is a market-linked product and the returns are not guaranteed. In other words your returns go up when markets go up and come down when markets plunge. The final return on your investment will only depend on the market conditions at the time of redemption. But if you take Public Provident Fund (PPF) or Employees’ Provident Fund (EPF), if you are a salaried individual, the return on your investment is guaranteed once declared. For instance for FY14, the rate of interest on the PPF is declared at 8.7% which means this year your money will compound at the rate of 8.7%.

NPS is taxable: The amount you contribute qualifies for a tax deduction of 1 lakh subject to a maximum of 1 lakh under the overall section of 80C of the Income-tax Act. On maturity, the 60% of the corpus that you can have as lump sum is taxable. But under the proposed direct taxes code, NPS is likely to be at par with other long-term vehicles such as EPF and PPF. EPF and PPF are tax-free investment vehicles.

What should you do?

NPS is not meant for equity investors since the scheme caps equity investment at 50%. But even for an investor who is looking to balance her portfolio with a limited exposure to equity, there have been certain changes in the investment pattern of NPS that needs a mention. Unlike the original idea of investing in equities through index funds, PFRDA has allowed pension fund managers to invest directly in stocks, although with guidelines to ensure investments in large and liquid stocks and caps to mitigate concentration risks. This has made investments in equities riskier as it has introduced the risk of the fund manager’s choice. “The Indian securities market is yet to become efficient like in the developed markets which mean that active fund managers should outperform passive managers in the long term. NPS with low expense ratio may not be able to tap the best fund manager for active management and may not incentivize the NPS fund manager to outperform the broader market," says Jindal.

But if you want to invest in debt schemes, then you should first maximize your EPF and PPF. “The scheme offers no liquidity and makes it mandatory to annuitize a part of the corpus on maturity. Investors looking to save for retirement should first invest in guaranteed products such as EPF and PPF before looking at NPS. Right now we are not recommending NPS is a big way," says Suresh Sadagopan, founder, Ladder7, a financial planning firm.

Have a proper asset allocation and maximize your debt savings first with PPF and EPF before you look at NPS.