Why NOT to invest in New Pension Scheme (NPS)?

Pension | admin | February 19, 2011 at 9:29 am

Skalzang Youdon has been trying to open an account in the New Pension Scheme (NPS) for the past three months but to no avail. The Faridabad-based mother of two works for a UK-based charity and needs a pension account into which her employer will deposit her retiral benefits. “I spent one month trying to find a way to open an account. But every time I approached a bank, the agents would start pushing other products,” she says. She finally managed to get an application form from one of the six mutual funds managing the NPS corpus.

However, there are other hurdles in her way. “I don’t know which is the best fund to invest in. There’s no one to advise me on that,” she says. Unlike in mutual funds, the returns from the NPS funds are not widely known, nor well-researched. There is also ambiguity on the asset allocation of different fund options. The NPS offers three fund options to investors. The E funds invest primarily in equities, C funds invest in corporate bonds and G funds in gilts.

While officials of the Pension Fund Regulatory and Development Authority and fund managers contend that E class funds invest the entire corpus in equities, the performance of the Tier I funds of the six fund managers since their inception on 1 May 2009 belies this.

All the equity funds have grossly underperformed the benchmark indices (see table ). The E fund managed by SBI Mutual Fund has given annualised returns of 5.5%, while the index returns are 30%. Clearly, the E class schemes are not putting their entire corpus in equities. “If they were, the difference would not have been so much,” says Dhirendra Kumar, CEO of Value Research .

new pension scheme (NPS)

This means the NPS is not suited for someone with a high risk appetite. An investor can choose his investment mix in E, C and G funds, but there is a 50% ceiling on E funds. If the investor has not provided this information, his allocation will be automatically governed by his age. For instance, till the age of 35, 50% of his corpus will be in the E fund. As he grows older, the exposure to stocks will reduce progressively. By 40, this would have come down to 40%, and by 55, he would have only 10% in this class.

But if E class funds are only putting 50% of their corpus in equities, his actual allocation to stocks is 25% till the age of 35. This reduces to 20% when he turns 40 and goes down further to 5% at 55.

Surprisingly, fund managers and PFRDA officials insist that E schemes invest the entire amount in stocks. A fund manager with one of the pension schemes has confirmed this but is unable to explain the wide chasm between his fund’s performance and the returns from the index. Another fund manager blames market timing for the variation in the returns.

An index fund should closely mirror the returns of its benchmark. A tracking error (or the difference in the returns of the index fund and its benchmark) of more than 3-4 percentage points is enough to put the fund in the doghouse. In case of the equity funds in the NPS, the error is too huge.

What this also means is that the NPS Tier II accounts should not be seen as an alternative to mutual funds. Sure, with a fund management charge of 0.0009%, they are low on costs compared with the 2.25% charged every year by mutual funds. But the opportunity cost of not investing in an equity mutual fund is far higher.

To be fair, NPS fund managers have handled the debt investments quite deftly. The C schemes of all funds, which are mandated to invest in bonds, have outperformed the Crisil Composite Bond Fund Index, some by a handsome margin. The G schemes, which invest in gilts, have also beaten the I-Sec Short-term Bond Index.

We also looked at how investments by three different types of investors new pension scheme (aggressive, balanced and conservative) have fared till now. It’s here that the NPS begins to look attractive, not as a replacement for equity funds but as an alternative to fixed income options. A balanced investment, with only 20% in equities, has yielded good returns in the past 21 months. Five of the six funds have beaten the Crisil MIP Blended index.

The NPS is also a great tax-saving tool, maybe not right now but after the Direct Taxes Code (DTC) comes into effect from April 2012 and all other options close. The DTC proposes to keep ELSS funds out of the tax saving umbrella and places a `50,000 limit on Ulips. That leaves the field open to the NPS as the only market-linked tax saving option. However, the mutual fund lobby is working hard to bring ELSS back into the fold just as the insurance industry is fighting for a bigger limit for insurance plans.

Source: Economic Times