No harm parking PF money in equities

In India, any suggestion that the retirement corpus of the salaried be invested in equities is usually met with alarm and trepidation. However, completely avoiding stocks while building a retirement nest-egg too is risky for savers. Only, no one realises it.

A case in point is the Employees’ Provident Fund Organisation (EPFO). Though the Finance Ministry has been pitching for the EPFO to invest up to 15 per cent of its assets in stocks, the latter has studiously avoided doing so with its Rs 5 lakh crore corpus, instead choosing to invest passively in government bonds. This shows up in its annual returns, which declined from 9.5 per cent in 2010-11 to 8.75 per cent in the latest fiscal, despite rising inflation and interest rates.

Now, the EPFO seems to have forgotten that the very purpose of a provident fund is to preserve one’s lifestyle post-retirement.

If your provident fund consistently fails to keep pace with inflation for 20 or 30 years, your retirement nest-egg will fall substantially short of your needs in your sunset years. Given that India is a high-inflation economy and that most of today’s generation has no access to social security in any form, there is a real risk of under-funded retirement leaving many in a state of penury.

As corporate profits benefit directly from price rise, equities represent a good vehicle to earn inflation-beating returns over the long term.

There are many who argue against parking pension funds in equities, pointing to the disastrous experience of US retirees with their market-linked pension plans (401k) plans. When the US markets went into a meltdown in 2007-08, retirees who had parked 50-100 per cent of their savings in these equity-linked plans took a hard knock.

But no one is suggesting that the EPFO make an all-or-nothing bet on equities like the 401k plans. The statute, in any case, limits the fund’s equity investments to 15 per cent of its total corpus. Therefore, for every Rs 100 that the EPFO collects, it can put only Rs 15 at risk. If the markets were to enter a prolonged bear phase and the Sensex halve in value over the next five years, the Rs 15 invested in equities would become Rs 7.5. But the Rs 85 still parked in debt would earn sufficient interest to ensure that the investor’s capital is intact. Thus, fears about equity investments reducing the provident fund to rubble are overdone.

It is unlikely that blue-chip stocks held over five years or more will lose money for the investor. An analysis of Sensex returns over the last 20 years suggests that the best five-year return it has made is 46 per cent, while the worst is a 7 per cent loss in value. Thus, the EPFO can take equity exposures while adhering to prudential limits. To further contain risks, the managers can invest only in the index, avoiding small- or mid-cap stocks that can suffer larger losses.

In any case, it is a misconception that only equities carry risk. With interest rates changing course often and corporate default rates rising, the bond markets, in recent times, have offered investors quite a wild ride too.

Yet, the EPFO has recently sought flexibility to trade more actively on its debt portfolio by transacting in public sector and corporate bonds.

Channelling retirement money into the equity markets is good from a macro perspective too. It adds a stable, long-term component to equity market fund flows, which is sorely missing in the markets today.

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