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Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

EPFO must let you choose your investment mix

Individuals should decide their own risk level and expect returns in accordance

The Employees’ Provident Fund (EPF) is one of the key pillars of retirement planning for almost 50 million people in the private sector. In the first week of March, the EPF Organisation had announced an interest rate of 8.5% for the year 2019-20. This may not be possible now, given the decline in the stock market.

Many subscribers may not be aware, but EPFO has been investing in stocks for nearly five years now. At the beginning of March, it had roughly 1 trillion invested in Nifty and Sensex exchange-traded funds (ETFs), along with other ETFs. The benchmark Nifty index has fallen nearly 20% (or more than 2,000 points) since then. Falling stock prices have brought down returns for all equity-linked instruments, including mutual funds, unit-linked insurance plans (Ulips) and even the equity funds of the National Pension System (NPS). So there is no reason why PF subscribers should feel insulated against any downturn in the equity markets.

However, the present downturn would be used as a weapon by those who had opposed EPFO’s decision to invest in equities. The decision was taken after several years of debate. The move was bitterly opposed by trade unions, but was eventually given green signal in 2015. Even then, it was decided not to touch the existing corpus, and only 5% of fresh contributions were channelized into the stocks markets. Mathematically speaking, investing 5% of fresh inflows into stocks has very little impact on the returns. So, the following year, the inflows into equity ETFs were increased to 10% of fresh contributions and eventually raised to 15% in 2017.

While critics will say "we told you so", the decision to invest in equities can’t be faulted. Historical data shows that equities have the greatest potential to deliver the highest returns among all asset classes. For a long-term investment like retirement planning, equity exposure is not just desirable but necessary. A corpus that invests purely in fixed-income instruments will never be able to beat inflation.

Still there is a case for changing the way PF functions. When the equity foray started, subscribers were not given a choice. But asset allocation is a very personal decision and takes into account several factors, including the age of the individual, risk appetite and the overall asset mix. Two people working in the same organization and drawing roughly the same income can have vastly different asset allocations. Older subscribers who are close to retirement may not want to put their money in volatile instruments, while younger investors may want to allocate a higher proportion to equities than what EPFO allows. Also, while younger investors can wait for the stock markets to recover, older investors won’t have that luxury. And even if older investors are unwilling to invest in volatile assets, they will have to make do with lower returns.

How can these problems be fixed? Fixed-income returns will continue to shrink in the coming years as the Indian economy matures. So, equity exposure is necessary for retirement savings. But EPFO needs to give subscribers a choice. Taking a leaf out of the NPS book, it should let investors decide the asset mix.

Unitization of the corpus is not immediately possible, so maybe EPFO can follow NPS and offer three-four broad options. A risk-free option can have no equity exposure, a conservative option can have up to 25% into equities, a hybrid option can have up to 50% into equities, while an aggressive option can put up to 75%.

Giving the investor a choice will be more fair than herding everybody into the same asset allocation, often against their will. Individuals can then decide their own risk level and expect returns that are commensurate with that.

Raj Khosla is managing director,

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