On Thursday, the Employees’ Provident Fund Organisation or the EPFO’s highest deciding body, the Central Board of Trustees (CBT), took a decision that could enable its 4.5 crore subscribers to track and redeem at market price the portion of their Provident Fund (PF) money invested in equity shares. The EPFO, which manages a retirement corpus of around Rs 10 trillion, has been investing in the stock market since August 2015, using Exchange Traded Funds (ETFs), marketable securities that track an index like the BSE Sensex or the NSE Nifty, a commodity, bonds or a basket of assets. ETFs, unlike mutual funds, are traded like a common stock on a stock exchange. While the EPFO’s exposure to ETFs has been growing, it was unclear as to how it would credit gains to subscribers. But Thursday’s decision is effectively a new accounting and disbursing mechanism for the EPFO’s equity-linked
How much of the EPF’s money is invested in equities?
In 2015-16, the EPFO invested a total of Rs 6,577 crore in ETFs including Rs 4,922 crore in SBI Nifty 50 ETF and Rs 1,655 crore in SBI Sensex ETF. In 2016-17, the total investment of the retirement fund body in ETFs was Rs 14,984 crore, of which Rs 7,912 crore was invested in SBI Nifty 50 ETF, Rs 2,691 crore in SBI Sensex ETF, Rs 1,911 crore in UTI Nifty 50 ETF, Rs 662 crore in UTI Sensex ETF and Rs 1,808 crore in CPSE ETF.
While the Fund invested five per cent of the annual incremental corpus in equities in 2015-16, it raised this to 10% last fiscal. The investment limit has now been raised to 15% by the Central Board of Trustees (CBT) in its 218th meeting held on May 27, 2017. Accordingly, the estimated investment in ETF for the current financial year is approximately Rs. 22,500 crore.
What is the rationale for offering differential returns to subscribers for the EPFO’s equity and debt investments?
The EPFO has an annual incremental corpus of over Rs 1.2 lakh crore — 15% of that works out to nearly Rs 19,000 crore. The EPFO has said that the new policy will help it monetise equity investments. Cumulatively, on its investments of over Rs 32,300 crore in ETFs so far (till October 31, 2017), the Fund has earned an annual return of nearly 22% (the gains are notional as the investments in ETFs are yet to be liquidated and the numbers would change with market movement). These gains are sharply higher than the 8.5% on its debt investments, which accounts for about 85% of its annual accruals.
As per a report submitted by IIM Bangalore to the EPFO, detailing the accounting policy for investment in equity and related investment, the total units purchased by the EPFO in ETFs as on August 31, 2017 (comprising subscription for 2015-16 and 2016-17) are 703.29 at a weighted average cost of Rs 9,743.64 crore. The market value of this investment is close to Rs 12,144.81 crore, implying a cost per unit of Rs 13.85 and a net asset value of Rs 17.27 per unit.
At present, the return on the equity part is neither taken into consideration when the interest rate is decided every year, nor is it reflected in the subscriber’s PF balance sheet. With the implementation of the new policy from possibly the financial year starting April 1, 2018, subscribers to the EPFO will have two accounts — one that reflects the 85% money put in debt on which the EPFO will pay a pre-determined interest, and a second one that accounts for the corpus invested in equity, where returns will depend on the market price of the ETF at the time the investment is redeemed.
So, essentially, the EPFO will maintain both the cash and equity component for a subscriber, with the 15% invested every month in equity being allotted to subscribers in the form of units. So, EPFO subscribers will see ETF units as well as the non-equity component of their retirement corpus in their account. Plus, they also gain from the dividend earned by the EPFO on its equity investments, which would be distributed among the subscribers.
How does the new policy work?
Under the proposed mechanism, when a subscriber decides to withdraw her PF accumulations, while the investment in debt instruments would be paid back with the accumulated interest, on the remaining 15% invested in equities, the payment will be calculated by multiplying the number of accumulated units with the prevailing market price of the ETFs. As an example, of, say, an accumulated corpus of Rs 1,000, if Rs 150 is the equity component and the price of a single unit at the time of exit is Rs 10, the subscriber will get 15 units in her account. At the time of exit, the subscriber would have an option to defer the withdrawal of the equity investment for up to three years if she thinks that can fetch her better returns in the coming years.
So, when a subscriber wants to withdraw her savings from PF, she can opt for cash or equity. Subscribers would also have the option to withdraw the non-equity component and keep the ETF units in their account even after retirement or in the case of early withdrawal.
If a subscriber wishes to withdraw both equity and cash components, she would have to mention this in the withdrawal application. Whenever the subscribers take an advance or settle their PF accounts, the ETF units would be liquidated by the EPFO.
Is there a flip side to the Fund’s ETF investments?
Even though the CBT, which is headed by the Union Labour Minister and has on board representatives of major trade unions, did not discuss whether the EPFO should ramp up its equity investments beyond the permissible upper limit of 15% of its annual accruals, Labour Ministry officials reportedly said that given the 22% return on equity investments, higher equity exposure “could not be ruled out”. Like all equity investments however, the EPFO’s investments in ETFs is subject to market risk. In case of a downward movement in the indices the ETFs are benchmarked to, the investments too will reflect the slide.