Real Returns. How the EPFO manages your money

Every month, 12 per cent of your basic pay is deducted from your pay cheque and parked with the Employees’ Provident Fund Organisation which is tasked with building your retirement kitty.

But with the recent furore about EPFO investing in the stock market, questions are pouring in about how the provident fund manages its contributions.

Well, India’s largest retirement fund manager doesn’t disclose its portfolio or investment strategies regularly. But we sifted through its archives and responses to Parliament questions to answer these FAQs.

How does the EPFO manage the money contributed by subscribers?

The money contributed by active EPFO subscribers goes into a common pool and is invested based on guidelines formulated by the Central Government. The Central Board of Trustees of the EPFO selects the fund managers and monitors their adherence to these rules.

According to the recent disclosure to Parliament, the EPF’s ₹3.6 lakh crore corpus (the provident fund alone and does not include the pension fund) was invested to the extent of ₹1.74 lakh crore in Central and State Government securities and Government-guaranteed securities; ₹52,845 crore in the special deposit scheme of the government; and ₹1,31,691 crore in corporate bonds (both public sector and private sector) as on December 31 2014.

The government’s approved investment pattern for the EPFO requires that up to 55 per cent of the corpus be parked in government securities or State/Central Government-guaranteed bonds. Five per cent within this limit may be invested in gilt mutual funds.

Another 40 per cent of its corpus is to be earmarked for term deposits in banks or corporate bonds, of which 75 per cent has to be rated investment grade. The remaining 5 per cent of the corpus may be parked in money market mutual funds.

A recent amendment requires the EPFO to park a minimum of 5 per cent and a maximum of 15 per cent in stocks or equity-linked mutual funds. All these investments are managed on a buy and hold basis, without any active trading on market movements.

How does the EPF select stocks?

No stock selection is involved. Though the mandated investment rules allow the scheme to invest in any listed stock on which derivatives are available, the EPFO’s current equity investments are being made only through exchange-traded funds.

This year, the scheme plans to invest 25 per cent of the allocated ₹5,000 crore in SBI Mutual Fund’s Sensex Exchange Traded Fund and 75 per cent in SBI Mutual Fund’s Nifty Exchange Traded Fund. SBI Mutual Fund will charge 7 basis points (7 paise for every ₹100 managed) as fees for managing the EPF money, of which 5 basis points will go to the fund and 2 basis points towards investor education initiatives.

Do I face higher risk to my capital, now that it has begun to invest in equities?

No. The EPFO is taking real baby steps with its stock market investments.

The equity ceiling of 15 per cent exists only in theory. For the current year 2015-16, the sum invested in equities will be capped at ₹5,000 crore.

This is 5 per cent of the incremental inflows of ₹1 lakh crore that the EPFO expects to receive from subscribers this year. At last count, the EPFO managed a total portfolio of ₹6.5 lakh crore (under the PF and pension schemes). The equity investments, even if they hit the limit of ₹5,000 crore, will amount to just 0.7 per cent of this portfolio.

So, for every ₹100 of subscriber money that is already in the EPF, only 70 paise is being deployed in equities.

Even if this becomes zero (which is highly unlikely) ₹99.3 of every ₹100 you invested will still remain safe in gilt and bond investments.

But on the flip side, if the money doubles, don’t expect it to generate a big kicker to your returns this year.

Who manages the other 99.3 per cent?

The EPFO’s debt investments are managed by SBI and four other private sector fund managers. The trustees allocate the EPF kitty between these fund managers and monitor that the money is managed according to the investment pattern.

While SBI has been a portfolio manager for the EPFO from 1995, the four other private sector fund managers were inducted eight years ago to improve fund management. At present, ICICI Securities Primary Dealership, Reliance AMC, HSBC AMC and UTI AMC are the private sector managers.

How are they selected?

They are selected through a bidding process, once every three years. The current managers have just been appointed for the period from 2015 to 2018. The EPFO selects the managers based on their ability to bid the lowest fee for managing the EPF kitty entrusted to them.

How are EPFO returns earned? Why don’t they move with inflation or interest rates?

The EPFO ‘declares’ the annual interest paid out to subscribers each year. This interest is decided based on the surplus of its income over expenses.

The fund earns income from the interest on government deposits, gilts, corporate bonds and the other securities it holds in its portfolio.

It incurs costs on subscriber payouts and expenses. In the last four years, the fund has been unable to declare more than 8.75 per cent a year.

While EPF returns depend on the fund’s annual income, the Employees Pension Scheme has been running a deficit for several years. According to a recent valuation report, by end of 2013-14, the pension scheme faced a deficit of ₹7,800 crore.

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