Home / Money / Personal Finance /  EPF interest rate split highlights a basic problem

Reeling under pressure from huge withdrawals, declining interest rate and underperformance of its equity portfolio, the Employees’ Provident Fund Organization (EPFO) has split the interest rate payment of 8.5% for FY20. It has decided to credit only 8.15% interest (returns from its debt portfolio) into subscribers’ accounts and the remainder 0.35% (from its equity portfolio) by December, subject to redemption of units.

EPFO attributed this exceptional move to the economic duress due to covid-19, but in doing so, it has glazed over its own shortcomings on two important counts: it has failed to effectively unitize the corpus that went into the stock market and it continues to be opaque and inflexible about where this money is invested.

EPFO in 2015 put the cart before the horse when it decided to put 5%, and subsequently 15%, of the incremental corpus in equities through exchange-traded funds (ETFs), but it didn’t devise a methodology to unitize the equity corpus. To this day, any plans to this effect have not been implemented. The first attempt at the methodology was a failure (read bit.ly/3hksVKV) but at the time EPFO wasn’t too worried given the tiny equity exposure. When EPFO declared an interest rate of 8.8% for FY16, it didn’t factor in the equity portion in the absence of a methodology and the tiny proportion, even though the equity portfolio had given negative returns. While the methodology was still being worked upon, EPFO increased equity exposure to the maximum limit.

After much deliberation and almost two years after the decision to invest in equity, EPFO did come out with a final methodology. It decided to unitize the corpus by splitting the EPF accounts of subscribers into two. The first being a cash account, which gets credited with the interest declared by EPFO every year as is the case now. The second being an equity account, which shows the units held by the subscribers and the net asset values (NAVs), just like in the case of mutual funds or National Pension System (NPS) funds. For EPFO, this was a mammoth task as it needed a software change, but five years and three PF commissioners later, the equity corpus of EPFO is yet to be unitized.

This has resulted in the mess that EPFO finds itself in now: of declaring interest rate on the entire corpusand then having to redeem the equity portfolio to make good on the promise, subject to realization of equity gains. In doing this, it would also be drawing from the current financial year’s returns to pay for FY20, but EPFO has recommended accounting such capital gains in the income of FY20 as an exceptional case.

This move also raises some questions. What happens to a subscriber who withdraws her corpus from EPF before December? Will she have to contend with a rate of 8.15%? What happens to the rate for FY21 since returns have already been drawn for FY20? Hashing the details out must be causing a lot of grief at the EPF office not to mention the exempt PF trusts that take cues from EPFO. A pension expert told me that many PF trusts are contemplating biting the bullet and crediting 8.5% directly as splitting it could be an administrative nightmare.

While there is little doubt that EPFO got the sequence of market-linking the corpus wrong, unitizing the equity corpus is a task it can’t afford to put off for later. And now that the equity allocation comprises over 5% of its corpus, it needs to right one more wrong: the opacity and arbitrariness of managing the equity corpus.

Of course, a mass product does well with passive investing and EPFO’s choice to go with ETFs was sensible as they have low expense ratio and obviate fund manager risk. But unlike NPS, which auctioned NPS fund management and got wafer-thin fund management costs, EPFO decided to side with comfort. It decided to invest in ETFs of state-run mutual fund companies first—SBI Mutual fund and later UTI Mutual Fund—and subsequently in PSU ETFs through CPSE ETFs and Bharat 22 ETFs. Both these funds don’t find favour with financial planners.

What’s worse is that for the investor this means inflexibility, poor returns and an opaque structure as EPFO doesn’t disclose periodically where the money is invested and the performance. Selecting fund managers on merit and maximizing returns was something EPFO could get right, but it didn’t (read bit.ly/32mhiyV). EPFO’s shortcoming could be due to many things, but its decision to invest in the market meant signing up for transparency and market-linked returns. It can’t preside over mark-to-market investments with an opaque mindset that it’s been used to so far. In the interim, customers will bear the brunt.

Deepti Bhaskaran is a researcher and writer of all things related to personal finance

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