An investment product that offers guaranteed return doesn’t evoke much curiosity among investors about how the seller manages to give that guaranteed return. Those with a conservative investment appetite bring home the promise and sleep in peace. So when an insurance plan guarantees return of capital, you don’t ask the insurer how it’s going to invest the money. Or when the Employees’ Provident Fund (EPF) promises to declare a guaranteed rate of interest every year, you don’t ask what the actual return is on the portfolio. That’s because the risk and responsibility lies with the manufacturer. Using that line of thinking, the entities too don’t disclose their investments. But what happens when the investment risk shifts to the customers? Disclosure and choice become paramount and are no longer an option that manufacturers of products can choose to ignore. If you are bearing the risk, it’s only fair that you are in charge.
It’s unfair to pass on investment risk to a customer, while retaining decision-making, without making portfolio disclosures or giving the customer a say. It is like blindfolding the driver of a vehicle, where the risk of crashing is real but you can’t see where you are going.
Portfolio disclosure in market-linked products, therefore, is mandatory and most of these products, including the National Pension System (NPS) and unit-linked insurance plans (Ulips), across the financial industry give customers the flexibility to choose and switch their investment funds. EPFO, however, offers neither choice nor disclosure. In 2015, when EPFO decided to put a portion of your money in the stock market, it essentially shifted the risk of investment to you, but has fared badly on the metrics of disclosure and choice.
The authority decided in 2015 to park 5% of the incremental corpus with two exchange-traded funds (ETFs) of SBI Mutual Fund: SBI ETF Nifty 50 and SBI ETF Sensex. An ETF is a basket of securities that tracks the stock prices of the companies on an underlying index, and is traded on the exchanges. Being a passive fund, it not only comes with a much lower expense ratio but also obviates the fund manager risk. While the decision of passive investment is sensible given that EPF is a mass product—the NPS also was originally designed to participate in the stock market through the passive route—the choice of the fund manager did raise some questions. For EPFO, the choice was not merit based but comfort based. In fact, then EPF commissioner K.K. Jalan had told Mint (bit.ly/2EtS9oJ) that since SBI was their sole banker and they didn’t have time to come out with a tender to finalise the asset management company, the authority decided to go ahead with SBI Mutual Fund.
Given the large assets under management (AUM) of the ETF portfolio of SBI Mutual fund and the fact that these ETFs have one of the lowest tracking errors, the choice probably makes sense, but for EPFO the investment strategy to stick to state-run mutual fund company is due to their comfort zone and that hasn’t changed—subsequently, EPFO also invested in ETFs of UTI Asset Management Co. Ltd.
Sticking to comfort doesn’t make sense when you have passed on the risk of investment to the customers as other metrics such as costs become relevant and there are other ETFs in the market that charge less. But EPFO doesn’t seem to be addressing these questions. If anything, it’s moving deeper into its fixation for PSUs. In 2017, it decided to also invest in PSU ETFs through CPSE ETF and Bharat 22 ETF. While it helps the government with its disinvestment programme (former EPF commissioner V.P. Joy told Mint earlier that EPFO invested in these ETFs at the behest of the finance ministry; read more at bit.ly/2GUpPyA), this move appears to be at the cost of subscribers’ interest.
Of course, many of the subscribers (EPFO has a subscriber base of more than 60 million who have contributed at least once in the last one year) don’t know that the money is being invested in PSU ETFs, but what’s worse is that this has been counterproductive for subscribers who despite being the biggest stakeholders have no say in the matter. Both CPSE ETF and Bharat 22 ETF have underperformed the Nifty ETF and Sensex ETF. In fact, most financial planners advise caution against investing in these funds. Read more at bit.ly/2GRl7Ct and bit.ly/2UfV22W. So it’s unclear why EPFO will choose to park your money in these ETFs and not give you any choice on funds or fund managers.
The only silver lining is the fact that EPFO has still not been able to unitize the investments it has made in the stock market even though it has increased the allocation from 5% to 15% of the incremental corpus that the authority gets every year. For you this means that the entire corpus under EPF will earn a guaranteed rate of return—for FY19 the rate has been hiked to 8.65%—even as 15% of it is parked in equities. But once the system is in place and 15% of the incremental corpus becomes market linked in the truest sense, EPFO must be ready to pass on choice to the customers and for that it needs to look out for options on the basis of merit. Much like the NPS that looks for fund managers who can operate on wafer thin costs, looking for AMCs that can offer ETFs at lower expense ratios is a good starting point.
Deepti Bhaskaran is editor, personal finance, Mint