A bigger share

It is good to know that the Employees’ Provident Fund Organisation’s baby steps into equity investing are going well so far. The labour minister recently disclosed that the fund’s ₹7,468-crore equity investment, initiated last August, had gained 12.1 per cent as of July 2016. One certainly must not read too much into these returns, as a year is too short a time-frame. But hopefully, the positive experience will help the fund convince trade unions of the return potential of market-linked investments, as opposed to guaranteed returns. Despite the finance ministry clearing a 5 to 15 per cent allocation to stocks in the EPFO corpus, it has invested just 1 per cent in the past year. At these minuscule allocations, even a healthy 15-20 per cent return on equities will fail to make any material impact on returns to subscribers.

The recent double-digit returns, however, should not lead to any complacency on the part of the EPFO or its fund managers. After all, the EPFO’s equity strategy so far has been designed more to minimise controversy than to maximise returns. The entire equity allocation so far has been routed through passive Exchange Traded Funds (ETFs) tracking the CNX Nifty and the S&P BSE Sensex, managed by two public sector money managers (SBI and UTI), ostensibly chosen for their low fees (6 to 7 basis points). However, a few tweaks need to be considered for the EPFO’s equity bets to generate better returns. For one, while index ETFs are the accepted vehicle for pension funds the world over, in India, a buy-and-hold strategy with the Nifty/Sensex has generated poor long-term investment results. While the Nifty has managed a ten-year CAGR of just 10 per cent, active equity funds averaged 13 per cent. As a compromise, the EPFO can explore the global trend of investing in custom-made indices that filter stocks on superior fundamentals, rather than mere size and liquidity. Two, given that ETFs passively mirror market movements, it is essential the EPFO puts greater thought into timing its investments and mitigating risks. Using rupee cost averaging to invest, tactical cash calls to avoid over-valued markets and hedging against losses, are all options to explore. This is the kind of value addition that EPFO must demand from its external fund managers.

In its desire for equities, the EPFO cannot afford to neglect its bond portfolio, which, at 85-90 per cent of its corpus, will continue to generate the bulk of its returns. Though the investment mandate has been relaxed over the years to allow a wide range of debt instruments — corporate bonds, mutual funds and bank bonds — the EPFO has so far stuck mainly to government securities. Active management of this bond portfolio, with risk controls in place, offers a good via media between risky equities and low-return gilts. Finally, for subscribers and unions to gain confidence, the EPFO must abandon its black-box operations and disclose portfolio performance on a regular basis.

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