Babar Zaidi | May 16, 2016, 03.14 AM IST | Times of India
When Avinash Chandnani invested in the National Pension System (NPS) last year, he planned to put money in five different pension funds.However, when he was putting the second tranche of `10,000 in another fund, he realised that NPS investors can’t opt for two pension fund managers. He also couldn’t switch to another pension fund for a year.
Our story examines the performance of Tier I funds of the NPS and identifies the best pension funds. The performance of individual schemes does not give an accurate picture because investors put money in a combination of funds. So we looked at blended returns of four combinations of the equity, corporate debt and gilt funds.
Chandnani, for instance, is an aggressive investor, with 50% of his corpus in the equity fund, 30% in the corporate bond fund and 20% in the gilt fund. A balanced allocation would put 33.3% in each of the three funds. A conservative investor would put only 20% in stocks, 30% in corporate bonds and 50% in gilts. The ultra-safe investor would not invest in equities, put 40% in corporate bond fund and 60% in gilt.
The past 9-12 months have not been kind to aggressive investors. While bond prices have risen, the 50% allocated to equities has dragged down returns. But ultra-safe investors who stayed away from stocks or conservative investors who put only 20% in equity funds have earned good returns.
Playing safe has also helped NPS funds for government employees. These funds can invest up to 15% in equities but most have 8-10% allocated to stocks. They have given double-digit returns, thanks to interest rate cuts that have enhanced the value of long-term bonds.
Should you switch from EPF to NPS?
The healthy returns from the NPS come at a time when the interest rate of the EPF is being debated and the interest rate for PPF has been pruned to 8.1%. So, should you shift your retirement savings to the NPS?
A legislation to amend the Employees’ Provident Fund & Miscellaneous Provisions Act has been framed. The amendment allows EPF subscribers to make a switch to the NPS. Once he shifts to NPS, the employee will have a onetime chance to return to the EPF fold. The amendment also seeks to ensure that employers don’t force a scheme down the throats of employees.
However, the tax treatment of the NPS may prove a hurdle. While the EPF corpus is tax-free, this year’s Budget has proposed to make 40% of the NPS corpus tax-free. There is another problem. At least 40% of the NPS maturity corpus has to be put in an annuity to earn a monthly pension. Annuity rates in India are very low compared to what other options can offer. However, investors will face that issue much later. Right now, we identify the best performing funds for various types of investors.
ULTRA SAFE INVESTORS
Whether they invested through SIPs or a lump sum, risk-averse individuals have earned the highest returns. They stayed away from stocks and divided their NPS corpus between gilt funds and corporate debt funds. On average, gilt funds have given 9.75% annualised returns while corporate debt funds have churned out more than 11% in the past five years. Even in the short term, safe investors have been the biggest gainers.
Will the good times continue? The gilt funds of NPS are holding long-term bonds with an average maturity of over 19 years and a modified duration of about nine years. These funds have done well because interest rate cuts have pushed down bond yields. But experts say this trend will not stay forever. “Over a longer period, the portfolios will deliver returns similar to the yieldto-maturity of bonds in the portfolios,” says Manoj Nagpal of Outlook Asia Capital. The average yield-to-maturity of the bonds is 8%, which is higher than the PPF rate but lower than EPF. The average yield-to-maturity of corporate debt funds is higher at 8.25%, and their average tenure is also shorter at seven years. Ultra-safe investors should consider higher allocation to these funds.
Investors who allocated a small portion of their corpus to equity funds have also earned good returns. The best performing ICICI Prudential Pension Fund has given double-digit returns over 5 years.
Including 15-20% equity in your retirement portfolio is a sound strategy as an ultra-safe portfolio won’t be able to beat inflation in the very long-term. NPS funds for government employees also follow a conservative allocation, with a 15% cap on equity exposure.
These funds have also done fairly well. However, younger investors should not play too safe. They can afford to have a larger portion of their NPS corpus in equity funds. Also, it shouldn’t be assumed that bond funds won’t lose money. If interest rates rise, the NAVs of gilt funds holding long term bonds will slip.
Investors who spread their money across all three types of funds have not done too badly. Here again, the shortterm picture is rather bleak. But the medium- and long-term returns are reasonably attractive. ICICI Prudential Pension Fund is again the best performing fund for this allocation, with returns of 9.85% in the past five years.
The balanced approach, which puts 33.3% in each of the three classes of funds, suits most investors. It has the potential to give reasonably good returns in the long term without taking too much of a risk. The investor will need to change his allocation as retirement nears. There are several theories about how much the allocation to equities should be at different ages. Some planners say that it should be 100 minus your age. But the maximum equity allocation in the NPS is 50%. Besides, you might also have invested in other instruments for your retirement.
Investors who can’t take a decision should opt for the lifecycle fund of the NPS. Under this option, the investor’s age decides the equity exposure. The 50% allocation to the equity fund is reduced every year by 2% after the investor turns 35, till it comes down to 10%. The rebalancing happens every year. The PFRDA is considering more asset mix options for these lifecycle funds.
Equity funds of the NPS have not done too well. They have lost money in the past year and delivered lower returns than corporate debt and gilt funds in the past five years. This has dragged down the returns of aggressive investors who allocated 50% to equity funds. But this should not make investors ban this critical asset class from portfolios.
Till last year, equity funds were mirroring the returns of the index because pension funds were supposed to invest in proportion to their weight in the index. But from September 2015, fund managers have been allowed to invest in a larger universe of stocks and follow an active investment strategy that does not mirror the index.
Experts see this as a positive development because a predominantly largecap orientation would have prevented the NPS equity funds from beating the market. More importantly, poor quality index stocks can now be dropped.