The Employees' Provident Fund Organisation's plans to invest Rs 30,000 crore every year through the ETF route are questionable, given the ETF scenario in India
11-Aug-2015 •Research Desk
It has been around 14 years since the first exchange-traded fund (ETF), Nifty BeEs, was introduced in India. Still, ETFs have not been able to take off. The total assets under management of the ETFs in India stand at slightly above 14,000 crore at the end of May 2015. On the other hand, the total AUM of mutual funds in India has crossed ₹12 lakh crore mark. Clearly, ETFs have remained underdogs in the fund industry. Of the total money managed by ETFs, gold ETFs (AUM ₹6,600 crore) and Hang Seng BeES (₹850 crore) have more money than all equity ETFs (₹6,400 crore) combined, pointing at the lacklustre equity ETF market.
While ETFs are very popular in western countries, they have been given a cold shoulder by Indian investors. There are a number of reasons which are responsible for this. First, unlike the American case, where index funds have beaten most actively managed funds, the actively managed funds in India give better returns than index funds. Second, since Indian ETFs manage low AUMs, they tend to have higher expense ratios. Third, low AUMs also lead to low liquidity.
However, it seems like the dull world of ETFs has found a suitor in the Employees' Provident Fund Organisation (EPFO). The government has allowed Indian employees to choose between the EPFO and the National Pension System (NPS) to manage their retirement money. The NPS scores over the EPFO in that it provides the option of equity investing, which the EPFO doesn't. Given that equities are the best asset class over the long term, the NPS has already started to attract investors. The EPFO, in order to retain its turf, has drafted plans to invest ₹30,000 crore per year in the stock market in five years. As reported in an interview with Mr K K Jalan, the central provident fund commissioner, in Business Standard (July 6, 2015), EPFO plans to start investing in equities in as early as July. It plans to invest ₹5,000-6,000 crore in equity this year, which is 5 per cent of the total incoming EPFO contributions of ₹1 lakh crore. In five years, the equity corpus is to rise to 15 per cent and could become ₹30,000 crore a year.
The path to equities for the EPFO will go through ETFs. The EPFO commissioner justifies the decision by pointing at the lack of in-house capacity to invest in individual stocks. Since ETFs, such as those based on the Sensex or the Nifty, have a clearly defined universe, the EPFO finds passive investing suited to it.
While the EPFO's decision to invest in the equity market is a welcome move, the size of the contribution is too little to make any noticeable difference to the resulting corpus. Value Research has been a supporter of investing retirement money in equities so that it not only grows faster than the rate of inflation but also becomes a sizable amount at the time of retirement.
The idea of putting retirement money into equity has been a sensitive issue. Hence, the EPFO stuck to 'safe' avenues, which yielded inadequate returns for one to retire, taking inflation into perspective. With trade unions clamouring against the move and the government still developing pluck to consider the stock market as an investment avenue for retirement money, perhaps the EPFO wants an avenue which shifts responsibility off its shoulders in the case of a bad surprise, for which stock markets are infamous. That may be the motivation for selecting ETFs in spite of the problems associated with them.
The demand of the situation is to assess how retirement money can be managed best so that returns generated serve the purpose for what they are meant.