EPFO's asset data shows what an advantage equity exposure is for its members
18-Aug-2022 •Dhirendra Kumar
The debate over whether the Employees Provident Fund (EPF) should invest in equity is effectively over. A few days back, investment data about EPFO investments was tabled in parliament. The headlines said that total investments in equity of Rs 1.59 lakh crore had grown to Rs 2.27 lakh crore, yielding a gain of Rs 67,619 crore. That sounds great, but it doesn't tell you much about the actual rate of return these investments generated, which is what we need.
Remember, the debate is about whether the additional returns from equity are worth the additional risk. To conclude, one needs the annualised rate of return for both parts. Knowing the rate of return for the fixed income part is easy - it's likely to be between 6.5 and 7.5 per cent. Equity is tougher because detailed inputs are not in publicly released data.
To figure this out, I made some reasonable assumptions and calculated the ballpark returns for the equity part. Here's what I did. From the released information, we know the total investments for five periods. Rs 39,662 crore for 2015-2019, Rs 31,501 crore for 2019-20, Rs 32,070 crore for 2020-21, Rs 43,568 crore for 2021-22 and Rs 12,199 crore for the first three months of 2022-23. For each of these periods, let's assume that the investments were divided into equal monthly instalments, SIP style. For the latter four periods, this is probably quite accurate. However, for 2015-19, the monthly investments were likely not equal but increasing. This means that my assumptions will likely depress the guessed returns but let's go with that for the moment.
Given these assumptions, I created a spreadsheet where the XIRR function tells me that the annualised rate of return was 13.6 per cent. Not bad, especially as a counterweight to the fixed income part's anaemic returns. As I pointed out above, the actual returns are likely to be somewhat higher. A slightly different methodology that allows for increasing monthly investments in 2015-19 (which certainly happened) results in returns of about a per cent higher, which only strengthens the argument that I'm making.
The EPFO should make this calculation and release it regularly because it is a very effective counter to anyone worried about the equity part's risk. Releasing the total gains doesn't do that job. If the markets fall sharply, the total rupee gain could drop. However, from now on, the annualised rate of return will certainly stay positive and remain much higher than the fixed income component of the EPFO's earnings. Receiving this information regularly would be a great comfort for EPFO members who might wonder what equity is doing to their returns. The logical conclusion that one can draw from this is that the equity exposure in EPF should be higher. Not just that, the EPFO should restructure its inflow so that the total equity exposure (not just the fresh inflow) reaches a higher level quicker.
The data shows us that the real risk lies not in the equity but the fixed income. The fixed income component is barely - if at all - keeping up with inflation. Under fixed income, your retirement savings' real (inflation-adjusted) growth is basically zero. That opens retirees to the real risk, the frightening spectre of old age poverty. EPF investments have been made for decades. Over such long periods, the risk-reward trade-off for equities is hugely positive, and that for fixed income is hugely negative.
A few days ago, the EPFO board did not discuss a proposal to raise the equity limit from 15 per cent to 20 per cent because the employees' representatives opposed it. If one goes by the hard data, increasing the equity portion would be the most pro-employee move possible. The sooner Indian savers - and those managing their retirement savings - understand and appreciate this, the better it is for everyone. We've been talking about equity in EPF since at least 2002. That's almost two-thirds of the working life of most salaried people. Someone who started working in 2002 at 22 is now 42 years old. A huge opportunity for generating real wealth has been frittered away for such a person. Let's not extend this error into the future.
Suggested read: The impact of EPF taxation