By Invitation. Equities in pension pool — a good start

Consider the hypothetical aam aadmi :

Ram, an average Indian, joined government service in 1979 at a salary of ₹3,800 per month. He was a hard working individual who contributed 12 per cent of his salary towards provident fund (PF) every month. His employer also used to contribute an equivalent amount. As he received increments in line with inflation, his contribution towards PF also increased. When he retired in 2016, he received a corpus of ₹66 lakh which compounded at 8.3 per cent per annum.

Assume a scenario where the PF Trust has invested 15 per cent of his corpus in equities and that too in Sensex Index. He would have received a corpus of ₹1.03 crore at the time of retirement – an additional payout of ₹37 lakh.

Now, instead of Sensex Index, if the PF Trust had invested in equity funds that have generated an alpha of 3 per cent, he would have received a bounty of ₹1.66 crore as provident fund – an additional bounty of ₹1 crore.

At this juncture, by putting money in a safe asset, the incremental monthly inflow can fund a better lifestyle — better house, better car and hiring better help.

The reality is that very few to almost none in India would have realised what, hypothetically, Ram has realised as mentioned above. The good news, however, is that things are changing.

The social and economic dynamics which require how the retirement corpus has to be managed and invested are changing. One, there are more people either joining the private sector or becoming entrepreneurs. The erstwhile trend of longevity of tenure in government service may no longer be taken for granted as the current job is dependent on various factors like company’s competitiveness, one’s capability, cost factor, automation, regulations, etc.

Two, life expectancy is rising. According to statistics from the Union Ministry of Health and Family, men would live 67 years and women 69 years on an average. Life expectancy is increasing by 4-5 years every decade which implies that the need for a higher corpus is also increasing. Third, the mindset of independence within families is also on the rise. This leads to less dependence on one’s kith and kin for old-age financial support.

It is welcome that the Labour Ministry, last year, allowed the Employees Provident Fund (EPF) to invest 5 per cent of incremental flows into equity ETFs. This year it has increased the limit to 10 per cent. The private PF trusts are allowed to invest up to 15 per cent of incremental flows into equities. At this rate, it will take many years before equity becomes a sizeable part of the corpus. So, the pace of allocation has to be increased. More importantly, the Labour Ministry should allow EPF investments into actively managed funds so as to get an opportunity to earn alpha for its investors which goes a long way, as highlighted above.

Globally, the US and Australia have been at the forefront in implementing retirement benefits for their citizens. Anecdotally, while both systems may be far from perfect, they lend direction. The US has a pension AUM of 125 per cent, Australia has 101 per cent while India has 4.5 per cent of its GDP. In both countries, majority of the corpus is managed by the private sector. Equity is over 50 per cent of the corpus in the US and Australia and it is over 40 per cent in the UK and Canada. The other ‘developed’ aspects of the markets are that some part of it is invested in international equities and some in alternative assets like real estate, infrastructure and private equity funds.

Structurally, the rates are coming down in India. With the intent of the government to keep inflation within a range of 2-6 per cent, interest rates would also be lower (PF included). So, debt alone would not be able to meet the commitments. Fortunately, India has the tail wind of demographics for many years to come. We have half the population below the age of 25 years and about 65 per cent below the age of 35 years. Our population will be young and working for many years to come (implying a lower dependency ratio).

The initial steps of letting PF Trusts invest in equities and building the National Pension Scheme (NPS) is commendable. Still the road is long for every Indian to be covered under pension and annuity for the constantly increasing post-retirement life without burden to the exchequer.

The writer is Co-Chief Investment Officer, Birla Sun Life Asset Management Company

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