The recent proposal of the of the Employees Provident Fund Organisation (EPFO) to increase the allocation of its assets to equity linked instruments from the current limit of 15 per cent to 25 per cent reflects the dire straits the government pension fund finds itself in. Though the interest rate declared for 2021-22 at 8.1 per cent is the lowest since 1977-78, the EPFO may find it difficult to meet its obligation given the sharp decline in interest rates and government security yields since the beginning of the pandemic and until recently. With 85 per cent of the corpus invested in fixed income, it is obvious that the pension fund will have to turn to the equity allocation in its portfolio to provide the additional returns to make the annual payouts. In response to a parliamentary query recently, the Minister of State for Labour and Employment had divulged that around ₹1.59 lakh crore had been invested in exchange traded funds as of March 2022 which had notional value of ₹2.27 lakh crore.  The 42 per cent return is certainly more attractive compared with the return from other assets, but it comes with the risk of equally sharp losses in bear phases for stocks. Of concern is the fact that the EPFO is also considering investing, albeit smaller portions, in other risky assets such as alternative investment funds, InvITs and REITs too.  

Instead of declaring outsized and untenable returns and then accumulating high-risk assets to attain them, a shift in the accounting and disclosure policy of the EPFO may be a better idea. This, combined with a better understanding of the funds’ portfolio mix and risk-return from the employee representatives, can obviate the need to take excessive risk in retirement portfolios. The lack of ongoing and transparent mark-to-market valuations on the EPFO’s portfolio is also an issue. The interest payments are being done from the profit booked during the year and interest earned on fixed income securities. The past practice of dipping into capital or dormant accounts to shore up the return is clearly untenable. The market value of EPFO’s equity holding, gain or loss made in the equity portfolio and the average yield on its debt portfolio needs to be computed and disclosed to investors periodically. This will help prepare investors for lower interest payouts in periods when stock market returns are adverse or when interest rate cycle is down and thus reduce the pressure on the trustees. The employee representatives in EPFO also need to be better informed regarding the debt and equity market dynamics instead of bargaining for stable payouts from volatile assets. The employee representatives need to communicate the same to the labour unions who in turn need to spread awareness among investors so that return expectations are tempered and are not out of sync with the interest rates in the economy. 

The EPFO can also consider setting up an in-house asset management department which actively manages the portfolio, booking profits when necessary so that returns are optimal. The current practice of employing fund houses to manage the funds for a pittance is far from ideal. The EPFO also needs a department for carrying out active risk management of the portfolio.