Home / Money / Personal Finance /  Before you invest in NPS, understand its risks, liquidity and cost

The National Pension System (NPS) is a voluntary retirement savings scheme that was opened for the general public in 2009. Prior to that, only government employees could invest in NPS. What differentiates NPS from other retirement savings schemes is the low cost, and higher lock-in, which enforces the discipline investors need for retirement savings. Apart from this, it also offers tax benefits, which further enhances its attractiveness as a retirement savings product.

So, if you are looking to invest in NPS, there are various choices that you will need to make. Two of them are choosing the fund to invest in and making the choice between the active and auto choice option that investors get to make.

Let’s understand how you can go about choosing the right fund manager and choosing between the active and auto choice options under NPS.

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Choosing the fund manager: Currently, there are seven portfolio managers under NPS (see chart). At the time of investing in NPS (tier-I and tier-II accounts), the investor is given an option to choose the fund manager. In the case of a tier-I account, it is difficult to exit before retirement, while a tier-II account is just like an open-end mutual fund, where one can invest and exit anytime. Tier-II accounts can be opened only if you have a tier-I account.

Under NPS, investors are also given the option to change the fund manager once in a financial year. So, if you are investing in NPS for the first time or reviewing the performance of the pension fund manager, you need to look at the track record of the funds.

There are multiple ways of looking at the past performance. One can look at the point-to-point return, trailing returns and rolling returns. Experts feel the best way to look at the performance of the pension fund manager is the rolling return.

“To eliminate the bias towards returns obse-rved at a particular point of time, it is best to look at rolling returns. Rolling returns give a fair idea of the highest, the lowest and the average return of a fund for a specified period. Thus, rolling returns allow investors to set the right expectations from the fund," said Prableen Bajpai, founder, FinFix, a financial research and wealth management company.

However, under NPS, you get to invest in different asset classes, including equites, corporate bonds, government securities and alternative investments. But you will have to choose a single fund manager. You can’t invest in a debt scheme of, say, HDFC and equity scheme of SBI Pension fund. Therefore, it will be better to give more weightage to the performance of the fund manager of the asset class that has the highest allocation in your portfolio. So, suppose you choose an equity allocation of 70% while corporate debt and government securities have an allocation of 20% and 10% respectively, you should choose the portfolio manager whose equity fund has done relatively better than the others.

Investors are generally influenced by the size of the fund while making the decision. Size may have some bearing in the case of an open-ended fund but may not have any much relevance in NPS where exit is conditional before retirement.

“With NPS, since there is no unexpected redemption like it is with regular mutual funds, the risk of NAV (net asset value) impact due to outflows is lower. Hence, that need not be a major criterion," said Vidya Bala, co-founder, head of research and product, PrimeInvestor, an investment advisory firm.

In terms of portfolio, in case of equity funds, one can look at the allocation to large-, mid- and small-cap stocks to understand the risk in the portfolio. Most NPS equity funds are invested in large-cap stocks.

“With debt, there is not much risk of credit since the funds invest in high-quality papers but the downside risk or volatility—that is, how much the fund swings or falls—will be an important factor to look at," said Bala.

The PFRDA recently announced that it will expand the universe of companies that NPS funds can invest in to the NSE and BSE 200. Previously, only companies with a market cap above 5,000 crore and were part of the futures and options segment of the stock exchanges were eligible.

Active versus auto choice: Under NPS, the investor can choose between active and auto choice options. Under active choice, the investors can decide the allocation to the respective asset class. While in auto choice the subscriber gets to choose between three lifecycle funds: aggressive, moderate and conservative. The allocation to various asset classes is predefined and rejigged as per the age of the investor.

So, if you are an investor who wants better control over the asset allocation and slightly higher risk appetite, you should go for active choice.

“If you have other equity options such as MFs that you are using towards retirement, you can consider a 50% equity allocation in the NPS, and peg your corporate bond allocation at 30% and government bond allocation at 20%," advises Bala.

NPS is a good low-cost retirement savings product but you should understand all aspects such as cost, liquidity and risks before investing.

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