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Business News/ Mutual Funds / News/  Govt ETFs in EPF fare poorly, but you can’t switch

Govt ETFs in EPF fare poorly, but you can’t switch

Although ETFs that have done badly are only a small part of the EPFO corpus at present, their poor performance can harm overall returns over time


The Employees’ Provident Fund Organisation (EPFO) brought some good and bad news last week. First for the good news: it raised the interest rate on deposits for its 60 million subscribers to 8.65% for 2018-19, giving a boost to retirement savings. The bad news was that EPFO’s investments in select exchange-traded funds (ETFs) yielded subpar returns. Although still a small part of the EPF corpus, over time this can harm returns from EPFO, especially once the authority decides to unitize the corpus.

EPFO first started investing in equities in 2015, allocating 5% of its incremental corpus (inflows) to equities and raised this limit of 15% in 2018. For its initial equity foray, the EPFO chose four ETFs—two by SBI and two by UTI tracking the Nifty and the Sensex. In January and then in November 2018, EPFO also decided to invest some of its corpus in two ETFs, CPSE ETF and Bharat 22 ETF, both having large exposures to public sector companies. But the decision seems to have backfired. Calculations by the EPFO show that its investments in CPSE ETF and Bharat 22 ETF have yielded just 1.89% and 0.48%, respectively, as of 31 December, according to official documents reviewed by Mint (read more here).

Lower EPF rates are, of course, unwelcome, but what is unitization and how can it affect subscribers?


A long-term goal like retirement is best served by equity investment. Unitization is a sound concept in theory because by allocating equity units to subscribers, it reduces the burden on the EPFO to generate returns for subscribers and instead allows the latter to invest for their own retirement. However, for unitization to work, it is important for the EPFO to have well-diversified ETFs. Right now that’s the biggest shortcoming when it comes to the ETFs that EPFO invests in.

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What happens now? Right now, the EPFO invests in equities but subscribers are not allotted separate units for the equity holding. Here is how it works: the money deposited by EPFO subscribers is pooled together and invested in debt and equity instruments. Unlike mutual funds, no units are allocated to individual subscribers against their money and, hence, there is no NAV or net asset value that is typically assigned to MF units. However, up to 15% of the incremental or fresh money that subscribers contribute to the EPFO is invested in equities. Based on the overall performance of the EPFO’s investments, an interest rate is declared every year. The rate for FY19 has been increased to 8.65% from 8.55% in FY18, back to its FY17 level.

What’s the plan? In November 2017, EPFO had announced plans to unitize its equity investments. This meant the crediting of ETF units bought by EPFO to the accounts of individual subscribers. A fixed rate of interest would be declared on the “non unitised" component. For example, for a PF contribution of 10,000, subscribers would get ETF units worth 1,500 and the balance 8,500 would earn a fixed rate of interest based on the returns earned by EPFO’s debt investments. Subscribers would be allowed to sell these ETF units at the time of withdrawing their EPF balance.

Unitization will require amendments to the Employees’ Provident Fund and Miscellaneous Provisions (EPF) Act, 1952. So for now, in the absence of unitization, even as 15% of your money is getting invested in equities, your money continues to earn interest as declared by the authority.

Unitization will affect a large cross-section of people for whom EPF is a major retirement saving tool. EPFO membership is mandatory for employees who earn up to 15,000 per month and work in a company that has more than 20 workers. In practice, many companies make it mandatory for those earning higher salaries too. A huge 24% of the cost-to-company of such employees consists of PF contributions. This amount is managed by EPFO. As of 31 December 2018, the EPFO managed a corpus of 13.33 trillion and had 45.10 million members who made their contributions in FY18.

What is the problem?

Poor returns: Separate equity units in the overall EPFO corpus have the potential to boost returns. However, poor returns from the two PSU-heavy ETFs puts a question mark on that possibility currently.

CPSE ETF was launched on 28 March 2014 and has delivered just 3.07% CAGR since its inception. Bharat 22, which was launched on 17 November 2017, has delivered -9.49% since its launch.

Companies in which CPSE ETF and Bharat 22 ETF invest have under-performed on various standard financial parameters vis-a-vis their private sector counterparts over different time periods, said Raunkar Omkar, fund manager, PPFAS Mutual Fund. He attributed the under-performance of such companies to the inability to pay market-related salaries to the management, social obligations of the government, lack of operating freedom and the absence of minority shareholder friendly practices.

As of now, PSU stocks do not inspire much confidence among experts. Aashish Somaiyya, CEO, Motilal Oswal Mutual Fund questioned the decision to invest in PSU-heavy ETFs. “PSU is not really an investing theme. One has to go bottom up as per the merits of individual businesses," he said. The S&P BSE PSU Index is down 19.65% compared to a 6.07% positive return on the S&P BSE Sensex over the past year. As on 31 January 2019, the 5-year return on the S&P BSE PSU index was 7.42% compared to 13.61% for the S&P BSE Sensex.

Mahesh Mirpuri, a Chennai-based distributor and wealth manager, said there is a constant supply of PSU stocks in the market due to the government’s investment drive. “I have held PSU stocks for well over a decade and they have not given good returns. When it comes to mutual funds and ETFs, I do not recommend funds with a PSU theme," he added.

Lack of choice: The other problem is lack of choice. EPFO has not proposed giving its about 45 million subscribers any choice vis-a-vis the funds or stocks in which their contribution will be invested. This, when the other government retirement vehicle, the National Pension System (NPS), provides some choice. NPS subscribers can choose between eight pension fund managers and four asset classes. Mutual fund investors, of course, get wider choice in terms of fund managers and fund types.

Shyam Sekhar, chief ideator and founder, iThought, stressed the importance of giving a wide set of options to subscribers. “I see this as the beginning and the choice of ETFs will definitely widen over time and investors deserve wider options. Introduction of debt ETF options is imminent and this will expand choices," he said.

The lack of choice risks saddling EPF subscribers with poorly performing investments, as has happened with the current set of investments chosen by the EPF. Rajat Sharma, founder, Sana Securities, said the government-run EPFO’s decision to invest in ETFs that primarily invest in PSU companies was a conflict of interest. “EPFO is a body run by the government. They should be conflicted about investing in ETFs that invest in government companies. Can this happen in a private set up?" he asked.

Element of risk: EPF rules allow complete withdrawal of the EPF balance after two months of unemployment. Such unemployment can occur even within a short period of time of joining EPF. Financial planners, typically, advise putting your money in equity for longer terms to average out marker risk and for better returns. Withdrawing units after short periods can lead to poor returns or even capital erosion as equity can be highly volatile in the short run.

Mint take

Currently, the entire EPF corpus earns the interest rate declared by EPFO and the poor performance of the ETFs is not accounted for as they are too small within the overall EPFO corpus, and EPFO is yet to unitize the corpus. Unitizing can be some time away given that it needs an amendment to the EPF Act. While for now sub-par returns in the equity portfolio may not show up in the interest rate declaration as it’s a tiny part of the overall portfolio but eventually it will hurt subscribers.

Moreover, once unitization happens, as much as 15% of subscriber contributions will give market-linked returns, and the choice of instrument will become even more important then. Since EPFO subscribers have no real voice when it comes to how their money is invested, they can’t do much as of now.

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Neil Borate
I head the personal finance team at Mint. I have been writing about personal finance for the past 8 years after finishing two degrees in law and economics respectively. I do what I do, to help the ordinary Indian saver and investor.
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Published: 27 Feb 2019, 07:00 AM IST
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