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Illustration: Shyamal Banerjee/Mint
Illustration: Shyamal Banerjee/Mint

Fixing the pension system

One of the major hurdles the pension system is facing is building awareness and increasing the reach of the product

India’s pension fund regulator appears keen to correct the flaws in the national pension system and make it an attractive retirement savings product. But it should tread carefully and avoid unnecessary changes to the existing system. A case in point is its reported plan to allow pension fund managers flexibility in valuing their portfolios to help them show better returns to investors.

According to a report in Mint, the Pension Fund Regulatory and Development Authority (PFRDA) may soon give fund managers the option of valuing their government bond holdings on a held-till-maturity basis rather than on a mark-to-market basis. PFRDA appears to be sympathetic to the view that since a pension fund makes long-term investments, the valuation of its portfolio shouldn’t suffer from the vagaries of short-term interest rate movements. And, especially when interest rates are rising, a marked-to-market portfolio will show poor returns. Prima facie, this looks like a good plan, as long-term investors in the pension fund will get a better understanding of the true value of the underlying portfolio.

But this is fraught with complications. Most importantly, the new method of valuation will result in discrimination between existing investors and new investors. Existing investors, for instance, will feel short-changed if, after a drop in interest rates, new investors are allowed to make purchases at nearly the same valuation as them. And, vice-versa, when interest rates are rising.

One suggestion to tackle this problem is to publish two net asset values (NAV)—one where government bonds are valued on a held-till-maturity basis, which existing investors can use to measure the performance of their fund, and another where the entire portfolio is marked-to-market, which will be used as the sale price for new investments by both existing and new investors.

While this is undoubtedly a workable solution, it will only end up making the product more complex to understand. One of the major hurdles the national pension system is facing is building awareness and increasing the reach of the product. Since this is the main goal, the product design should be as simple as possible. The main selling point should be the fact that the national pension system is the lowest cost retirement savings product in the country, with a transparent unit-based investment plan. Artificial props such as an inaccurate NAV must be avoided.

What should be done to make the national pension system more attractive to investors?

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