Private sector investors of National Pension System (NPS) who opt for active choice may be able to invest up to 75% in equity against the existing cap of 50%. Pension Fund Regulatory and Development Authority of India (PFRDA) has come out with a concept paper which proposes to increase the equity cap.
At present, investors who opt for auto choice, or the life cycle fund, already have the option to invest up to 75% in equity. The PFRDA’s proposal is up for public comments and if implemented, experts say, it will help young investors who would like to decide on their asset allocation between equity, government and corporate debt, and alternative assets. It will also bring parity to both active and auto choice options as far as equity cap is concerned.
Those who invest under the active choice, decide on their asset allocation mix subject to a 50% cap in equity investment, 5% in alternative assets. A subscriber can invest up to 100% in corporate bonds and government securities.
Higher equity option in active choice
Taking a leaf out of the GN Bajpai committee report on review of investment guidelines for NPS submitted in 2015, PFRDA has come out with the concept paper. The proposal says the increase in equity exposure to 75% from 50% will be for private sector investors up to the age of 50 years. It will taper off to 50% by the age of 60 years. The tapered portion is to be reinvested by the subscriber in other asset classes. In NPS, which is a defined contribution scheme, the market risk in borne by the subscriber. “One of the methods of ensuring adequate income security is through stipulation of investment guidelines which enable the subscriber to generate optimum returns as per his risk profile and build his pension pot,” says the PFRDA concept paper.
Investors prefer higher equity exposure
In November 2016, PFRDA had introduced two more life cycle funds apart from the existing moderate life cycle fund (with 50% equity cap) for private sector investors in auto choice. The two were: aggressive life cycle fund (LC 75) with 75% equity cap and the other, conservative life cycle fund )LC 25) with cap on equity at 25%. The concept paper notes that subscribers have preferred LC 75 over LC 25 as the former has 52,454 subscribers with assets under management (AUM) of `330.63 crore as compared with the latter’s 10,574 subscribers and `45.55 crore AUM as on December 27, 2017.
In the first life cycle fund, or the moderate one, subscribers till the age 35 years can invest up to 50% in equity. The equity component falls with the increase in age of the subscriber and it becomes 10% when the subscriber is 55 years old. In the aggressive life cycle fund, the equity allocation is up to 75% till the age of 35 years, 51% in age 41, comes down to 26% when the subscriber turns 48 and 15% when he is 55 years old. In conservative life cycle fund, equity allocation is up to 25% till the age of 35 years and comes down to 5% by the time the subscriber is 55 years old.
In fact, the Bajpai panel had suggested that equity portion should be 100% after a six-year window. It also pointed out that government employees need to be given the same flexibility as their private sector counterparts who are subscribers to the New Pension Scheme—as they are allowed only a 15% equity component.
Higher returns from equity
The panel’s simulation model shows a rejigging of portfolio from 10% equity plus 50% government debt plus 40% corporate debt to 50% equity plus 25% each for corporate and government debt will increase the pension wealth by 46% after three decades. “The provision of old age income security also entails working towards adequacy of income post-working life, which can be done by optimising returns through appropriate investment guidelines,” says the Bajpai panel report.
The concept note, citing a CRISIL study on returns of life cycle fund having equity cap at 25%, 50% and 75% and under various market scenarios, says the returns given by life cycle fund having equity cap at 75% is maximum as compared with the other two life cycle funds. Also, as NPS is a long-term product, it will enable investors to reap the reward of risk premium and volatility will be evened out.
