Personal Finance

Are NPS equity funds finally bringing cheer to investors?

Kumar Shankar Roy BL Research Bureau | Updated on May 08, 2021

An assessment of schemes returns on the 12th anniversary of the All Citizens Model

The National Pension System (NPS) marks another anniversary since opening up for all citizens in May 2009. At this juncture, an assessment of the performance of different investment options under NPS shows that growth investing and high risk appetite seem to have paid off for investors over the long term. The market rally in the last year has played its part too, in pushing up returns in the equity (Scheme E) option under NPS in the short term. The performance of NPS funds over various time periods can be seen in the accompanying table.

Equity wins....

The average returns of Tier I Scheme E funds has outperformed government securities (Scheme G) and other fixed income instruments (Scheme C) over one-, five- and ten-year time frames. But Scheme E under-performed in the three-year period, where government securities (G-Secs) and other fixed income instruments still hold an edge. But NPS being a long-term investment with restricted withdrawal options, investors can depend on equity to deliver the goods, show the numbers.

Scheme E of NPS has also beaten the relevant mutual fund category (large-cap) funds by 90-430 basis points in 1-, 3- and 5-year periods. Even on a ten-year basis, they are almost at par with mutual funds, lagging the average large-cap MF returns by just 35 basis points. One basis point is one-hundredth of a percentage.

Under the ‘Active’ choice, investors can allocate up to 75 per cent in Scheme E up to the age of 50. Under the ‘Auto’ choice, Scheme E allocation ranges from 5 to 75 per cent based on your age and option chosen (conservative, moderate or aggressive).

....But not enough alpha

There are 7 pension funds (HDFC, ICICI, Kotak, LIC, SBI, UTI & Aditya Birla Sun Life) for the All Citizens Model.

After eating humble pie for some years, investors with a majority of their NPS exposure to equities now can smile. Scheme E invests predominantly in large-cap stocks and its average returns are now better than those of large-cap funds and the BSE 100 TRI. While the polarised market conditions until early 2020 and the sharp fall in February-March 2020 previously dented the performance of Scheme E funds, the rebound last year has taken everybody by surprise.

NPS equity funds may have done well in comparison to relevant mutual funds . But there is room for improvement in terms of alpha (i.e. excess return over benchmark BSE 100 TRI). Over the one-year period, only one among the seven Scheme E funds has beaten their equity benchmark. Over 3-, 5- and 10-year periods, alpha remains weak. One can, of course, argue that large-cap funds, even in MFs, have lagged benchmarks.

The poor alpha generation track-record of NPS equity funds is in contrast to Scheme G and Scheme C funds. Despite G-Secs and other fixed income instruments at this moment losing sheen to equity, they boast of better alpha. All the Scheme G funds have outshined their relevant benchmark across all periods. Scheme C funds have lagged their relevant benchmark in 1- and 3-year periods, but returns are at par in 5- and 10-year periods. Like NPS equity funds, Scheme G and Scheme C funds show comprehensive out-performance over average returns of equivalent mutual fund categories (gilt, medium to long and long duration mutual funds). Scheme G funds took advantage of the fall in long-term bond yields in 2014, 2016 and 2019 to clock good returns. Investing in G-Secs today may lead to lower returns in the short- to medium-term, but with NPS being a long-term investment, returns smoothen out. Also, Scheme G carries near zero default risk.

Scheme C carries slightly higher risk than Scheme G, though funds invest over 80 per cent in AAA-rated bonds. Scheme C funds have not been immune to the turmoil in the corporate bond market. However, over the long term, small losses from such events could be compensated to a good extent by capital appreciation.

Published on May 08, 2021

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