PENSION FUNDS: READY FOR A BIGGER BITE

At last the government has decided to ease the foreign direct investment (FDI) limit in the pension sector to 49 per cent from 26 per cent in line with the FDI cap in the insurance sector. This signals the NDA government’s intent to draw capital and investment into an economy that is struggling to claw out of a crippling slowdown. All investments in the pension sector, however, will have to abide by the pension sector regulator, Pension Fund Regulatory and Development Authority (PFRDA). Including the private parties, there are seven players in the domestic pension sector licensed by PFRDA as pension fund managers for the corpus under the aegis of the National Pension System (NPS). More than 90 per cent of the business is from the government. Similarly, allowing the employees to choose between Employees Provident Fund (EPF) and the NPS is expected to bring in more business for the pension players.

According to an industry official, the Indian pension sector was pegged at around Rs 80,000 crore in FY15 and a bulk of it is managed by just three players - LIC, SBI Pension Funds and UTI. In 2004, the central government introduced the New Pension System (NPS) which covers new entrants to central government services (excluding the armed forces) and some state government services. From May 1, 2009 PFRDA has extended NPS to all citizens of India, including workers of the unorganised sector. In the Union Budget 2015-16, the government has not only made it optional to choose between the EPF scheme run by the EPFO and the NPS but also between health insurance products and the Employees State Insurance Corporation’s (ESIC) health cover.

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Pension Funds into Infrastructure

Considering that Indian commercial banks face difficulties in financing infrastructure projects owing to asset-liability mismatch because funds are required for over a period of 15 years or so while deposits are of shorter maturity, there is a need to channelise greater amounts of pension funds into infrastructure development. The government alone cannot invest huge amounts of money required to shore up physical infrastructure like expansion of road and rail networks, building more power plants, developing the ports, etc. and thus a substantial portion of the corpus for this should come from the long-term source of pension funds. The government’s target to fill up a gap of about 30 per cent in infrastructure funding requires around Rs 41 lakh crore as per the 12th Plan (2012-17).

Therefore, FDI in the pension fund industry will provide a booster dose to the sluggish economy. Witnessing a fall in corporate performance, the private sector too is currently experiencing monetary constraints and therefore unable to fund huge infrastructure projects. Long-term income streams, stability, predictable cash flows, low default rates, diversification and the overall benefits to society at large are the certain characteristics of infrastructure projects that assist in attracting investments from pension funds.

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EPFO Corpus in Stock Markets

For the past several years there has been a debate about whether the Employees Provident Fund (EPF) should be invested in the stock market or not. Finally the government has allowed the retirement fund body, Employees Provident Fund Organisation (EPFO), to invest 5 per cent of its corpus in exchange traded funds (ETF) which will result in an inflow of around Rs 5,000 crore into the stock markets during this fiscal. ETF is a basket of stocks that reflects the composition of an index like the BSE Sensex or NSE Nifty. The value of ETFs is based on the net asset value of the underlying stocks that it represents. The investment will begin with 1per cent and gradually go up to 5 per cent by the end of the financial year as per the new investment pattern notified by the Ministry of Labour.

As per certain estimates, the EPFO’s incremental deposits for FY15 would be around Rs 80,000 crore. During the current fiscal, incremental deposits could be around Rs 1 lakh crore as the body has increased the monthly wage ceiling for coverage under its social security schemes to Rs 15,000 from Rs 6,500, beginning September last year. The overall corpus of EPFO at present stands at Rs 6.5 lakh crore, but the outstanding investible funds are worth about Rs 1 lakh crore. The quantum of investment in equities may increase in the coming years. This does not take into account gratuity funds and superannuation funds, also allowed to invest up to 15 per cent in equities. Recently, the EPFO retained its existing four fund managers - SBI, ICICI Securities Primary Dealership, Reliance Capital and HSBC AMC - for a three-year term, starting April 1, 2015.

Apart from these four portfolio managers, EPFO has also appointed UTI AMC for managing its corpus for the next three years. Market experts have welcomed the move of EPFO to start investing in the equity market. Even though 5 per cent equity exposure is too low, yet it will make a meaningful difference. For someone who puts Rs 3,600 into his EPF every month, only Rs 180 will flow into equities. The impact of 5 per cent in equities is hardly anything. However, 0.5 per cent additional returns will be significant in the long-term period due to the power of compounding. Commenting on this move, an official of the labour ministry said, “Across the world, equity is a preferred class of investment for pension funds. These funds invest 30-40 per cent in equity as it gives them inflation-indexed returns.”

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Asset Allocation of Pension Funds Around the World

Source: Mercer (2014)

It has been observed that the proportion of the pension fund’s equity allocations by several countries has changed from time to time as per the market situation. For example, equity allocation by Japanese pension funds have decreased from 48 per cent in 2004 to 30 per cent in 2014 while equity allocations by UK pension funds have fallen from 67 per cent to 40 per cent in the same period. In the Netherlands equity allocations fell from 39 per cent to 20 per cent and Canada’s allocation to equities fell from 51 per cent to 35 per cent. Australian pension funds have maintained the highest allocation to equities over time, reaching 50 per cent in 2014.

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Pension Fund Assets to GDP

The market value of assets accumulated relative to the size of the economy as measured by the GDP is a key indicator of the scale of pension funds’ activity. From the below table we can see that only five countries reached asset-to-GDP ratios higher than 100 per cent and out these the Netherlands reached the highest ratio at 165.5 per cent. The weighted average asset-to-GDP ratio for pension funds increased from 77.1 per cent of GDP in 2012 to 84.4 per cent of GDP in 2014. Based on the study, the three largest pension fund markets are the United States which accounts for 61.2 per cent of the total pension assets and United Kingdom and Japan which ranked second and third, accounting for 9.2 per cent and 7.9 per cent of the total pension assets respectively. The top three markets account for 78.3 per cent of the total global pension fund assets.

However, India’s asset-to-GDP ratio is around 5 per cent which is too low compared with other developed and developing countries. By 2050, the country’s population of 60-plus will be 300 million, thrice the current number. Clearly, India is staring at a huge pension problem and would be able to raise the share of pension fund assets to GDP from the current level of 5 per cent to close to 17 per cent going forward.

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Key Findings

 * Brazil pension assets only include those from closed entities.

** Only collect pension assets for company pension schemes.

*** Do not contain the unfunded benefit obligation of corporate pensions (account receivables).

# Only includes total of autonomous pension funds. Do not consider insurance companies assets of USD 139.5 billion.

## Includes IRAs.

### Assets/GDP ratio for the world is calculated in USD and assets were estimated as of December 31, 2014.

Source: Towers Watson and secondary sources

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EPFO Gets More Flexibility

* This investment pattern of Ministry of Finance is notified with effect from April 1, 2015.

** Including ETF.

Source: Ministry of Labour

The investment pattern was last revised on August 14, 2008 and was to be made effective from April 1, 2009. Under the 2008 pattern, there was no provision of investment in exchange traded funds, index funds, asset-backed securities, real estate units and infrastructure investment trusts. With infrastructure creation as the key focus area of the Narendra Modi-led government, there is a huge requirement of resources to fund the development of infrastructure in the country. Therefore the government has also allowed investment of 5 per cent in asset-backed securities and units of infrastructure investment trusts.

The other key changes under the new investment pattern include providing minimum and maximum limit, ranging from 45-50 per cent for central government securities against 55 per cent allowed earlier; raising the investment ceiling in debt securities from up to 40 per cent to up to 45 per cent; providing new category instruments such as index funds, exchange traded funds, and debt mutual funds besides strengthening credit rating requirements for some financial instruments.

With the aim to boost infrastructure development and low-cost housing in the country, the finance ministry is suggesting changes in the investment rules in debt securities from April 2015 and investment in listed, or proposed to be listed, debt securities issued by companies engaged mainly in ‘the business of development or operation of infrastructure or construction/finance of low-cost housing’. Similarly, infrastructure debt funds will also be eligible investments. The only rider is a minimum credit rating of AA.

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Source: NSE

There are voluntary contributions that may get impacted by the arrival of private pension funds. The EPFO needs to give better service. If EPFO improve their services, as they started doing, there is no reason why they will not be able to compete with private pension funds even in returns.