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Why NPS debt fund returns are more than MF peers

Satya Sontanam BL Research Bureau | Updated on October 27, 2021

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Schemes C and G of National Pension System (NPS), which invest mainly in corporate bonds and government securities, respectively, have been in the spotlight on the back of outperformance over mutual funds.

There is an added advantage as NPS is lower cost (expense ratio) compared to mutual funds. This is especially relevant since debt funds have been grappling with low returns lately.

Before you think of investing in the debt schemes of NPS, it is worth taking a look at where these funds invest and how they are different from comparable mutual funds.

Investment mandate

As per NPS guidelines, corporate bond funds are eligible to invest in rupee bonds, listed debt issued by corporates, including banks and public financial institutions; Tier 1 bonds issued by commercial banks, term deposits, units of debt mutual funds, infrastructure-related debt instruments, credit-rated municipal bonds and units of REITs and InvITs— subject to certain limitations.

In case of bonds, the funds can invest in anything with rating ‘AA’ and above.

In 2018, the NPS guidelines were amended to include instruments with ‘A’ rating as well, subject to not more than 10 per cent of the overall corporate bond portfolio exposure under instruments with rating between A and AA-.

On the other hand, the only condition for the corporate bond funds under mutual funds is that at least 80 per cent of total assets should be in highest rated instruments — typically AA+ and above.

Meanwhile, the other debt option — Scheme G of NPS — is mandated to invest in Government Securities (Central/State). Besides, they are allowed to invest in units of debt funds (not more than 5 per cent of the holding).

The comparable gilt funds in the mutual funds space are required to invest a minimum of 80 per cent of the total assets in G-Secs (across various maturities).

Reasons for outperformance

The investment mandates for the debt products (corporate bonds and gilt) under NPS and mutual funds schemes are similarbut the NPS schemes score well in terms of returns so far.

In the last one-, three- and five-year time period, the scheme C of NPS (Tier I) delivered average returns of 6 per cent, 10.8 per cent and 8.3 per cent, respectively, while the corporate bond funds from mutual funds generated 4.3 per cent, 8.3 per cent and 7.1 per cent in the same sequence of the said time period.

Similar is the case with performance in the gilt segment which, as a whole, was impacted by the rise in G-Sec yield in the last one year. The NPS scheme G (Tier I) returns (average)are higher by 50 basis points, 238 basis points and 132 basis points respectively in the one-, three- and five-year time periods.

In case of corporate bond funds, the credit exposure of NPS schemes (ie exposure outside sovereign instruments) is higher than that of mutual funds. For example, as on September 30, 2021, one of the top performing NPS schemes - HDFC Pension - took a credit exposure of 92.15 per cent, while the top-rated corporate bond fund, ABSL Corporate Bond Fund, has a credit exposure of 71.51 per cent of the total portfolio, with almost quarter of the portfolio invested in sovereign bonds (G-Sec).

The other factor that can explain the superior returns of the NPS schemes is the average maturity of debt instruments held. Generally, debt instruments with higher maturity tends to give higher returns. The average maturity of some of the top NPS corporate bond schemes is 6-7 years, while it’s just 3-4 years in case of mutual funds.

Scheme G of NPS is not an exception either. The average maturity of some top NPS schemes is 14-15 years, while that of gilt funds is 7-9 years. However, longer maturity has its cons. Returns from these schemes could be more volatile because of longer duration.

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Published on October 23, 2021

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