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Higher equity share can boost EPF's returns

By Priya Nair
August 09, 2016 17:21 IST
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Rather than one-year returns, look at benefits of long-term investment in equity.

It is mandatory for all salaried employees to invest in the Employees’ Provident Fund (EPF).

The interest rate for 2015-16 has been fixed at 8.8 per cent and the Employees’ Provident Fund Organisation (EPFO) has to pay subscribers no matter how much return the corpus generates.

Since August 2015, the EPFO has been permitted to invest up to 15 per cent of its corpus in equity and equity-related investments.

But, it currently invests only five per cent in equities.

This five per cent, which is Rs 7,500 crore, generated a return of about 12 per cent, as on July, while the 95 per cent of the corpus which is invested in government securities, generated returns of 7.5-8 per cent.

This was recently disclosed by the labour secretary. By this logic, if the equity share is increased from five per cent, will it not help generate higher returns? 

According to Deepali Sen, founder partner of Srujan Financial Advisers, the debate is really meaningless because even if the share is increased to 10 per cent, the increase in returns would only be by 24 basis points.

“EPF is a long-term investment and it matches with the equity philosophy of long-term investment. Also, the surest way to beat inflation is to invest in equities and the higher the better. But getting investors to invest in equities requires a behavioural change,’’ she says.

The average inflation in the 12 months was 5.05 per cent. But, as EPF is a long-term investment, there will be cycles of low and high inflation.

Let us assume 95 per cent of the portfolio is invested in debt and it generates 8.8 per cent return (the interest as fixed by the EPFO).

Let us also assume the five per cent invested in equity generates return of 12 per cent (as disclosed by the labour secretary).

The total returns would be 8.96 per cent. If the debt to equity ratio is changed to 90:10, the return would increase to 9.12 per cent.

If it increased to 85:15 (the maximum the EPFO is permitted to invest in equities), the return would be 9.28 per cent.

“We have assumed a conservative return of 12 per cent from equities. If we assume 15 per cent, the returns go up even more,” says Sen.

Assuming 15 per cent returns from equity, the returns would be 7.83 per cent for 95:5, 8.22 per cent for 90:10 and 8.61 per cent for 85:15.

There is a case for higher investment in equities, but it should be gradual and over the long term, says Suresh Sadagopan, founder, Ladder7 Financial Advisories.

“Increasing the equity portion based on one-year returns is not the right way to go about it. EPFO has to be convinced about the benefits of equity investment over the long term. Over a 20–year period, equity returns can easily give one to two times higher returns than bank deposits. So, ideally, the equity portion of EPF investments should be increased from five per cent to 20 per cent over a 20-year period,” he says.

Equities should definitely be a part of any investment that is being done over a 10-year period, and that includes EPF, says Manikaran Singal, founder and chief financial planner at Good Moneying Financial Solutions.

“Investors are wary of equities because they are volatile. But, from the retirement angle, there should be some exposure to equity, depending on the investor’s risk appetite,” he says.

With NPS allowing up to 50 per cent investment in equity and EPF investing five per cent in equities, investors must take this into consideration while investing for their retirement.

“If you utilise the maximum limit in NPS and also have the exposure to equity through EPF, your other equity investments could reduce by that much,’’ he says.

“Equity and debt can work complimentary to each in the long run. When interest rates fall, equities will perform well and compensate the fall in interest rate in the debt portion. Globally, too, pension funds invest in a combination of equity and debt funds,” says Anil Rego, chief executive officer, Right Horizons.

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