Playing it safe has paid off for NPS investors

It has been 11 years since the National Pension System (NPS) was opened up for all citizens in May 2009 and, in this period, conservatism seems to have paid off for those investors. The average returns of Tier I schemes that invest in government securities (Scheme G) and other fixed income instruments (Scheme C) have outperformed equity (Scheme E) and alternate assets (Scheme A) categories over three-, five- and ten-year time-frames. Funds of Schemes G and C have also outshone the average returns of the relevant mutual fund category(ies) by up to 2.2 percentage points over longer periods of five- and ten years.

The long-term outperformance of these two options makes them a suitable choice for investors trying to build their retirement kitty. Under the ‘active’ choice, NPS subscribers have the option to invest entirely in Schemes C or G or distribute between the two.

The lower cost vis-à-vis mutual funds and tax breaks available for NPS make this product hard to resist.

Winners

Currently, there are seven pension funds (HDFC, ICICI, Kotak, LIC, SBI, UTI and Aditya Birla Sun Life) for the all citizens model.

Over longer time frames of five and ten years, all the seven Scheme G and Scheme C funds have managed returns on par with or better than their benchmarks (Crisil 10-year Gilt index and Crisil Composite Bond index) as well as the average returns of equivalent mutual fund categories (gilt, medium to long and long duration mutual funds). The performance of the NPS funds over various time periods can be seen in the accompanying table.

Scheme G funds have taken advantage of the fall in long-term bond yields in 2014, 2016 and 2019 to clock good returns. Investing in government securities now could lead to short-term volatility, given the uncertainties surrounding the economic impact of Covid-19. But being a long-term investment, NPS returns can smoothen out. Also, Scheme G carries near zero risk of default.

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 with many pension fund managers having invested in instruments from companies such as Dewan Housing, IL&FS and YES Bank. However, the exposure is not substantial. As per regulatory requirement, NPS funds have a cap of 10 per cent to securities in the A to AA minus band. Since NPS is a long-term product, small losses could be compensated to a good extent by capital appreciation over a period of time.

Thus for retirement goals, NPS Schemes G and C could suit the needs of investors who do not want exposure to gyrations in the equity market.

Equity loses sheen

In comparison, investors with a majority of their NPS exposure to equities have had to eat humble pie. Scheme E invests predominantly in large-cap stocks and average returns have failed to beat those of large-cap funds and the Nifty 100 TRI. The polarised market conditions until early 2020 and the sharp fall since February have dented the performance of Scheme E funds.

Besides, while NPS funds are allowed to take exposure to stocks with market cap of over ₹5,000 crore, they have stuck to large-caps and many of them have only up to 5 per cent exposure to the mid-cap category. The long-term returns of Scheme E could improve if exposure to lower market cap stocks is altered in tune with market conditions.

Scheme A funds, which invest in alternative assets, do not have a long track record but they seem to have contained the downside risk better than Scheme E funds.