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'Managing' Pension Funds

The government has chosen SBI, LIC and UTI to manage pension funds. The word 'manage' means a lot less as these entities will have only a marginal say in how they money is invested

Before I go on to this time's topic, I have a mistake to own up to. Last week, while writing about the impact of making PAN mandatory for all mutual fund investments, I wrote under the assumption that if anyone who has a PAN card must file returns. This is not true. However, the point about the PAN requirement making things a lot tougher for marginal investors is still very much valid.

The long-running saga of the new pension system has finally reached conclusion, some fourteen years after it began. That's right, it was as long ago in 1993 that serious talk first started of reforming the pension system. During these years, the proposals went through many forms but the most important change from the old system has been clear for a long time-this was to be a 'defined contribution' plan instead of a 'defined benefit' plan. Under the old system, the government guaranteed what employees' funds earned. Now, the government only defines what is added to the fund, what it earns is up to market forces.

The government has chosen three public sector outfits-State Bank of India, Life Insurance Corporation and UTI-to manage pension funds. However, the word 'manage' here means a lot less than it does for a mutual fund. The reason is that the way investments will be made is already mandated and these three entities will have only a marginal say in how they money is actually invested.

There are two investment patterns that will be on offer to investors--one of them being a conservative plan and the other an extremely conservative plan. As originally presented, the new pension system was to have five plans, ranging from a high-returns one suitable at the beginning of one's career to the ultra-conservative one that would have been suitable for those nearing retirement. Now, somewhat like the presidential elections, the final choice came down to the ones that were originally bottom of the list.

The extremely conservative plan will put all the money in Government of India securities and that is that. The other one has 85 per cent government securities, five per cent in stocks in the pattern of an index and ten per cent in equity funds. At least that's what appears to be case based on what the government has already allowed for provident fund. This isn't much, but it's better than nothing. It is beyond doubt that over the very long periods of time that pension investments are made, equity offers high returns with moderate risks. As such, even though 15 per cent isn't much, I believe that this is enough to make a reasonable difference to the size of an individual's nest egg.

Interestingly, investing in Government of India securities is not as straightforward as is apparently believed by those who promote it out of political beliefs. Over long periods of time, there are bound to be significant changes in the interest rates offered on these securities. How an investment manager responds to these changes (and whether the manager is allowed to do so at all) opens up avenues for higher returns as well as foregoing high returns.

There are yet other issues. For example, is the 15 per cent limit on equity to be applied to fresh investments or to assets held? The difference between the two (in terms of returns as well as risk) can be considerable. If you had kept putting in 15 per cent into equity over the last five years, your held assets today would be more than 25 per cent equity because equity assets would have grown faster than the rest.

Interestingly, the pension money earmarked for all new hires since 2004 is being held in limbo, awaiting the actual implementation of the new scheme. Now, it will be shifted to the new pension managers. It would have been interesting had the equity option been available over these last three years. Anyhow, all things said, there's no doubt that the new system is a huge step forward.