10% Equity Investment By EPFO – What It Means For The Aam Aadmi

By BankBazaar | November 8, 2016

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The Employees Provident Fund is one of the best small savings schemes available to salaried individuals. It currently earns annual returns of 8.75%, comfortably beating inflation figures as well as returns on all other small saving schemes, and is proving to be a great, secure, long-term investing option.

Traditionally, the EPF was not allowed exposure in the equity market. But last year, the government lifted this restriction. Now, the government has decided to increase the equity exposure of its Investments from 5% to 10%. This raises plenty of questions in the minds of investors.

Additional Reading: Decoding The New EPFO Guidelines

Why is EPF investing in the equity market?

The rates of return from debt instruments have been trending downwards in the last couple of years. This has led to lower returns for EPF as well. To boost EPF returns, in August 2015, the government decided to allow EPF investment in the equity market in a calibrated manner. The EPFO started out with 5%, but now the limit has been raised to 10%, with the option of going as far as 15%.

How are equity investments managed?

The EPFO will be investing in equity through Exchange Traded Funds (ETFs) that invest in index stocks. The performance of these ETFs will therefore be linked to their underlying indices.

At present the investment in the ETFs is managed by the SBI Mutual Fund. They have been preferred by the EPFO due to their lower expense ratio. Other asset management companies (AMCs) are expected to relax their expense ratios. It is therefore possible that more AMCs will be part of the EPFO’s equity investment program.

Additional Reading: Gold Bonds Or ETFs? Take Your Pick!

What does it mean for the investors?

We will need more time to understand the impact of the EPFO’s participation in the equity market. The present exposure – not just in volume but also in duration – is too small to have caused an impact. While 90% of the EPF is allocated to government securities, public and private sector bonds, only 10% is now apportioned to the equity market. Even if good returns are achieved from equity investing, its impact on the overall returns from EPF would be minimal.

Interest rates are expected to keep trending downwards in the coming months with inflation continuing to remain under control. While low rates are great for the industry and the equity market, a debt investor’s returns will be lower. However, the returns from equity are expected to offset the falling debt investment returns to a degree.

In the long term, equity investments are expected to significantly boost overall returns from the EPF. However, such an impact is to be tracked and analysed for a long period for better understanding.

Let’s try to understand the impact of equity returns with the help of the following illustration:

Rs.100 Invested   Rs.100 Invested Increase In Rate of Returns (1-2)
100% Debt   90% Debt 10% Equity Total Returns (A+B)
Rate of Return (1) One Year Investment Value Debt Returns Rate One Year Investment Value (A) Equity Returns Rate One Year Investment Value (B) Total Investment Value (A+B) Total Returns Rate (2)
8.8 Rs. 108.8 8.80 97.92 5% 10.5 108.42 8.42 -0.38
10% 11 108.92 8.92 0.12
15% 11.5 109.42 9.42 0.62
20% 12 109.92 9.92 1.12

Are there any risks to the investors?

There is always an inherent risk of negative returns from the amount apportioned for equity investments. But, with assets managed by one of the best fund houses in India, the performance is expected to be good in the long term.

According to information available through various media, many countries in the world are allocating up to 30% of retirement funds for the equity market. India’s 10% equity allocation is small in comparison. But, even this small investment is expected to boost overall EPF returns in the long run.

The 10% equity allocation will be considered only out of fresh contributions received during the year. The existing corpus will remain as it is. Therefore, existing long-term EPF investors will not find any difference in their returns. However, new investors should see a difference in their returns over the next few years. If they find the returns to be unsatisfactory, they have the option of reducing their PF contributions and looking for alternate investment avenues.

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