The Hindu Business Line : It's the rate of return that matters

There has been a great deal of controversy over the issue of investing Employees' Provident Fund (EPF) money in the equity market. The Central Board of Trustees (CBT), the custodian and caretaker of funds of close to 40 million subscribers, seems unable to take a decision on the interest payable for fiscal 2006-07.

The CBT had rejected the Finance Ministry's proposal to invest only 5 per cent of the EPF money in the equity market at one go. The Trustees, who seem convinced that investing in the stock market is fraught with danger, are unfortunately unable to decide on the fixed rate of return. They also seem unable to figure out that, perhaps for the first time in India (where interest rates are no longer regulated), banks are offering more than the 8 per cent given by the EPF.

The people at large must understand somefacts so that the subscribers to the EPF can choose their own course of action.

Robust growth

First, even as India posted robust economic growth averaging above 8 per cent three years running, , the EPF rate went down from 9.5 per cent to 8 per cent in this period. World Bank data show that, adjusting for the US inflation rate of 3 per cent, India has been growing at the rate of 13.4 per cent in dollar terms.

In the last three years, the profits of India Inc have also grown at a CAGR (compounded annual growth rate) of above 30 per cent. While some sections of the people are doing well, others, especially the subscribers to the EPF, are losing out. Second, the Cost Inflation Index, which stands at 519 for 2006-07, has grown at a CAGR of 6.8 per cent the last 25 years; the actual increase in the cost of living is probably above 9 per cent.

Third, the BSE Sensex has grown at a CAGR of around 19 per cent since 1979, whereas the EPF has earned close to 11 per cent per annum during this period.

Fourth, assets under mutual fund managements have grown at a CAGR of more than 40 per cent the last four years. In India, active portfolio management started with the setting up of the Unit Trust of India, which launched its first equity diversified scheme (UTI Mastershare) in October 1986 and has given a return of 22 per cent per year (double the EPF rate) the last 20 years.

Private players entered in 1993. The top performing scheme, has given compounded returns of 34 per cent per annum since its launch in October 1995. This fund has also been rated as a top performing open-ended equity fund in the world by global agency Lippers, based on its five-year performance (71.39 per cent per annum in dollar terms).

Stock market boom

This performance reflects the stock market boom, post-reforms. The BSE Sensex has grown at 17 per cent per year till February 2007 and the Indian equity premium has been quite high, averaging 10 per cent above the corresponding risk-free rate of return.

The average return by all the 74 equity-diversified growth funds, including tax-saving schemes, has been above 40 per cent per annum during the last five years. Both the India-designated country funds, IIF and IFN, have grown rate of 51.91 per cent per annum (ranked third, out of 73 country-designated funds ) and 47.38 per cent per annum (ranked fifth ) respectively during the last five years ended on December 31, 2006 (Source: Bloomberg.com).

Missing the bus

While international investors have enjoyed a good ride on the India growth wagon, the EPF subscribers seem to have missed the bus. According to an internal study by the US Embassy, American firms earn a return of around 40 per cent in India compared to 5-6 per cent in China.

Had the EPF funds been invested on a monthly basis in equities through the mutual fund route, it becomes relatively safer as this, to some extent, takes into account the concept of averaging the cost of investment. A study by the valueresearchonline.com, that assesses and rates mutual funds in India, endorses this view. Of course, high returns and high risks go together. But Indian portfolio managers' ability to ensure good returns under varying market conditions is well known. During the last five years life insurance funds (initiated by private insurance companies, led by ICICI Prulife Insurance Co) have started investing in equities. For too long the Trustees of the EPF have refused to accept the evidence that investing in equities makes sense.

Perhaps it is time the subscribers raised their voices for taking a more informed decision. The market regulator has an important role to play, ensuring prudence and transparency. It should also take the initiatives to provide training and education in risk management. This would go a long way in creating an environment of sound sentiment building and assist people at large in taking better and well informed decisions, as at the end of the day, it is the ultimate rate of return that matters.

(The author is Associate Professor, Department of Business Management, Guru Jambheshwar University of Science & Technology, Hissar.)

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