Defined pain or undefined gain?

Even as one writes this, Finance Minister P. Chidambaram, of late, has been busy trying to stump up more investments into India, including its equity markets. After meeting representatives of major Canadian pension funds, as well as CEOs of Canadian corporations in Toronto and Ottawa, he has moved on to Boston (despite the terror blast and the security alert) and New York, where he is slated to meet as many as 100 top executives of US pension funds, sovereign wealth fund managers and other large fund endowments.

He is not only being brave, but is also doing a job which sorely needs doing, and one which he does well — selling India to overseas investors. To all of them, he is making the same pitch: Invest in the India growth story, in order to maximise the returns for — and, presumably, secure the future interests of — your investors.

Which is not just good, but great news? India is no stranger to foreign investors, or, indeed, foreign funds. The billions which have flown into our markets over the years bear testimony to this. However, it has not been as much of a magnet for very large, long-term investors like national or state pension funds and sovereign wealth funds.

Missing the point

Which is a pity, because such investments tend to be long term, stable and strategic. In other words, exactly the kind of foreign portfolio investment that our markets need to dampen volatility and reduce the ‘flight risk’ from the kind of hot money which usually lands in emerging markets in search of the next big pay-out, and often leaves just as quickly, at the first signs of a stumble in the bull run.

One just wishes that what is sauce for the goose is also sauce for the gander. The government clearly has no hesitation in asking workers of other nations to bet their future income security on India — after all, that is what asking a foreign pension fund to invest in India amounts to. But when it comes to its own workers — whether employed by itself in the government sector, or by others in the private sector, from doing exactly the same!

India’s long stalled reforms of the pensions sector, and the acrimonious debate which has surrounded the issue, has failed to address one fundamental question — is the pension fund being run in a way that best secures future purchasing power?

Objections to changing the way the pension funds are managed in this country has centred on two issues. The first, and by far the strongest objection has been to switching from a defined benefit system — where the contribution by the employee, as well as the return are defined, to one where the returns are linked to the market’s performance. The second has been allowing private managers to run the investments.

Both, of course, ignore the larger problem with the pension system in the country, which is the extremely low coverage. Estimates put the percentage of the workforce covered at around 10-12 per cent, which leaves a bulk of the workers, all of them in the unorganised sector — which in turn accounts for a majority of the employment – completely uncovered.

The second issue is the differential treatment of private sector and government employees, with the latter getting a far more generous cover and benefit than their private sector employees. In other words, there is discrimination against contributors on the basis of the nature of employment.

The third problem is that the existing pension schemes are under-funded in terms of the returns which have been assured. This means that contributions of newer workers entering the scheme are being used, at least in part, to meet pay-outs, which is simply unsustainable.

The government’s answer, according to worker unions, has been to abdicate its responsibility, by switching the worker – and that includes all of us who have worked in any sort of position in the organised sector, and at least some of us in the unorganised sector – from a defined benefits to a defined contribution system, and leaving the market to deliver what return it can. This, given the very restricted investment ambit given to the fund managers, means that it would be extremely difficult to get returns which even beat inflation. This brings us back to the original question about the objective which a national pension fund should strive for – if a pension fund is not obligated to give a guaranteed return, then should it not be obligated at least to ensure the future purchasing power of the workers’ current savings?

International experience

Perhaps, Chidambaram should spend some time listening to his pension fund audience, rather then just talking to them. Because what they are doing to manage the money – and how well they are doing it – may well answer many of the questions in people’s minds about what is, or is not, happening to their pension money and future security.

Take the world’s second largest pension fund, The Norwegian Government Fund. Its assets, at an excess of $720 billion, are roughly 140 per cent of the country’s GDP. They are also managed by a division of the country’s central bank, which serves to provide an extra measure of reassurance to the people that the money is in safe hands. Last year, the fund returned 13 per cent, the second best performance in its history – while actually reducing the cost of managing the fund from 2.5 billion kroner to 2.2 billion!

Yngve Slyngstad, the CEO of the fund, who was in India last week, told this writer that many of the issues which have dominated the debate over the pensions issue were debated in Norway as well. “People are not different,” he says. The fund, for instance, updates its current asset value as many as 13 times a day on its website, so that “nobody gets anxious”.

The difference is that once the overall objective was made clear, it was left to the professionals to decide how to get there.

“The objective is to protect the future purchasing power of the people,” said Slyngstad. And over the years, the fund, though managed by a conservative central bank, took several far-reaching decisions. In 2009, the fund decided to invest as much 60 per cent of its corpus in equities. Last year, amidst the turmoil of the European crisis, it altered its global investment strategy.

The geographical allocation of the fund’s equity investments is now based on total market value. Investments in government bonds are allocated by country according to the size of its overall output. At the same time, nine emerging market currencies were approved for fixed-income investments. “Our aim is to command a larger share of the global output,” says Slyngstad.

The fund also uses a wide range of professional fund managers with specialist knowledge. It pays a standard 0.005 per cent as management fees (we pay 0.006 per cent, which many have argued is too low). What’s more, it is an active investor, using its investments to focus on issues which the Norwegians consider important. It was, for example, one of the first to raise a red flag on Vedanta’s mining operations in India. Just last week, it yanked more than $130 million in investments from palm oil producers, because unregulated palm oil cultivation was depleting rainforests. And so on.

Even the world’s largest pension fund, the notoriously conservative Japan Government Pension Investment Fund, which has traditionally invested more than 60 per cent of its assets in bonds, has been actively diversifying its portfolio for the past few years, after a rapidly ageing population and a generation of slow growth had pushed the pay-in-pay-out mismatch to record levels.

STUBBORN APPROACH

Back home, however, we continue to live in a time warp. Even the suggestion to invest a bit more in higher yielding equities, or allowing professional fund managers to run investments, is met with cries of government “abdication” and “sacrifice” of workers’ rights.

Isn’t the worker’s core right the assurance of better financial security in his old age?

The core right for a worker should be the assurance of better financial security in his old age.

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