Is it time to allow a little freedom to fund managers of EPFO?

KS Badri Narayanan Chennai | Updated on March 28, 2020

Hedging via call and put options, widening the portfolio ambit may fetch better returns

The stock markets have been tamed by the coronovirus. In the four months since Covid-19 hit the world in December, benchmarks across the globe have slumped by around 35 per cent.

In line with the global markets, the BSE Sensex and the NSE Nifty too crashed by 28 per cent each since January 1.

So, if you are an indirect investor through EPFO, what could be your loss?

The EPFO has been investing in ETFs since August 2015. Initially, it was mandated to invest only 5 per cent of its investible funds into the stock markets. Later, the proportion was increased to 10 per cent in 2016-17, and 15 per cent in 2017-18.

The BSE Sensex and Nifty were around 25,000 and 7,800 levels, respectively, when the retirement fund organisation started investing in the equity market through Sensex and Nifty exchange-traded funds (ETFs).

Initially, the EPFO was mandated to invest only in four ETFs — two by SBI and two by UTI tracking the Nifty and the Sensex. However, later the rules were tweaked (mainly to participate in the Government’s disinvestment process) to invest in two other ETFs — CPSE ETF and Bharat 22 ETF, both having large exposures to public sector companies.

According to the latest disclosure in Parliament, EPFO has invested ₹86,966 crore in ETFs till September 2019. As of March 2018, the Employees’ Provident Fund Organisation (EPFO) had a corpus of about ₹13.26-lakh crore.

Look beyond ETFs

As the investments are long-term in nature, it is not wise to analyse the equity investment returns generated by EPFO now.

However, it is time to rework this strategy, with a review of how the funds can be deployed to enhance returns and protect capital. The investment rules can be tweaked so that at least 1 or 2 per cent of the mandated corpus is allowed to be invested outside these passive instruments. There should be a criteria such as ESG-compliance or a minimum market-cap as filters.

More importantly, EPFO should be allowed to hedge its equity portfolio through covered calls and put options.

With the organisation sitting on huge underlying shares, selling deep-out-of-the money call options may generate returns on them.

If the volatility index rises to a certain level, the EPFO should be allowed to buy put options based on the risk profile of the portfolio.

Published on March 28, 2020

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