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EPFO Funds: The Chance to Get Higher Returns in not an agenda

Relying on debt alone opens up the risk of effectively becoming poorer and poorer as the years pass

India’s labour ministry wants the finance ministry to provide a guarantee for equity investing. It wants a guarantee of capital safety, as well as guaranteed returns. Apparently, it had sought these guarantees in response to the latter’s demand that a small part (up to fifteen per cent) part of the EPFO funds be invested in equities. According to a news story that reported this exchange, the labour ministry continues to be worried by the finance ministry’s refusal to underwrite equity investing.

Of course, the labour ministry is not alone in wanting such guarantees. I have myself wished many times that my personal equity investments should have such guarantees and I’m sure that the same is true of many equity investors. And just like the ministry, I too have never managed to convince anyone to give me such guarantees. I can fully sympathise with the ministry because I have personally always felt that it would be so much better if I too could get such a guarantee. I completely understand and appreciate their point of view here, as will other equity investors who are looking for a guarantee.

However, most equity investors—including me—are willing to get by without a guarantee for two reasons. The most important is that we can see that even if we want just to preserve the value of our money, then it’s positively dangerous to just rely on fixed income investments. Debt returns almost never match up to the real inflation rate that we have to contend with in our lives. Relying on debt alone opens up the risk of effectively becoming poorer and poorer as the years pass.

Balanced against this is the fact that while equity is volatile over the short-term, it gives hefty returns over the long-term. Effectively, even for conservative investors who can’t stomach losses, it is hugely beneficial to have ten or fifteen per cent of one’s assets in equity. That much is enough to create real returns that can more than match the inflation rate.

Real investors, who have to balance the fear of short-term volatility with the attraction of having a bigger nest egg, easily see the sense in investing at least a little bit in equity. However, this is never going to happen with the EPFO funds. Clearly, this is the case because the decision-making logic of the EPFO Board of Trustee and the labour ministry sees only one side of the above picture. They have no skin in the game, and therefore the chance to get somewhat higher returns holds no attraction for them. They can only see the risk side of the picture and have no problem with ruinously low returns as long as there is never any volatility.

This column first appeared in the Hindustan Times on 28 December, 2010