Befuddling choices

The National Pension System (NPS) has only gained traction with private citizens in the last one year, with its assets from non-government employees at a modest ₹17,000 crore. Apart from income tax breaks, what makes this retirement vehicle attractive to laymen is its low cost, simple structure and the ability to put investments on autopilot. Given this backdrop, the move to add a new asset class —‘Alternate Investments’ to the NPS menu appears rather premature. The Pension Fund Regulatory and Development Authority of India (PFRDA) has recently allowed subscribers to allocate upto 5 per cent to ‘alternative investments’ to be made up of mortgage-backed securities, Alternative Investment Funds (AIFs), Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (Invits). While the intent may be good — redirecting long-term money into the needy sectors of the economy and providing diversification — these new choices add both risks and complexity to investor choices on the NPS.

Take AIFs for instance. The new rule allows investments in category I and II AIFs, mainly consisting of VC funds, SME funds, social venture funds and real estate private equity funds. Now AIFs are close ended, take stakes in unlisted companies for 5-7 year periods, participate in their management and target exit through an eventual public offer. But as neither business success nor exit is a given, many of them do struggle to get to a double-digit return. These risks are indeed why SEBI keeps retail investors out of AIFs by specifying a minimum investment limit of ₹1 crore. REITs, globally, offer a low-risk option for investors to earn regular rental income on commercial property. But in India, this vehicle is nascent with the first REIT yet to get listed. The large grey component in real estate, low rental yields (compared to local debt instruments) and illiquidity have been stumbling blocks to the take-off of Indian REITs. To allow retail participation in them at this stage, especially when the sector is in flux, seems imprudent. Invits — close-end funds designed to invest in income-generating and long-gestation infrastructure projects — are in a similar stage. With steep management fees, liquidity risks, opaque structures and no public disclosures to evaluate their performance, the NPS managers will have a difficult time managing these alternative investments, compared to familiar ones such as equities, government securities and corporate bonds.

Yes, PFRDA has checks in place to contain the risks from alternative investments. Total allocations to such assets are capped at 5 per cent, credit rating filters apply and the investment is wholly optional. But already, any new investor signing up for NPS has to choose between two types of accounts, two types of strategies, 3 asset classes and 8 pension fund managers (soon to be 10). More choices could have waited until alternative investments such as REITs acquire a credible record. In any case, affluent investors keen to add them to their retirement portfolios can do so directly on their own.

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