NPS accumulates savings into a subscriber’s personal retirement accounts (PRA) while he is working. On retirement, 60% of the accumulated corpus is paid out as lump sum to the subscriber.
Having a secular cash flow at all times is what every individual investors looks for, especially after retirement. With this in mind, National Pension Scheme (NPS) which is a defined contribution scheme, was started for government employees in 2004 and was extended to all in 2009.
NPS accumulates savings into a subscriber’s personal retirement accounts (PRA) while he is working. On retirement, 60% of the accumulated corpus is paid out as lump sum to the subscriber. The rest is used to pay pension for the rest of his life. In Tier I structure, the asset allocation is determined on the basis of age of the subscriber and is divided into equity, corporate bonds and government securities. As the subscriber ages, allocation in equity gradually comes down to 10%. This strategy helps in managing volatility in the portfolio as the age progresses and investor approaches retirement.
Let’s take the case of a 40-year-old investor in 2009 (current age 49), who invests `25,000 every July and January (starting July 2009), in NPS Tier 1 option, managed by one of the biggest pension fund managers in India, with moderate (auto) asset allocation mode. The period considered in this exercise is July 1, 2009 to June 25, 2018. It was observed, in the period 2009 –18, total investment of `4.5 lakh in NPS had grown to `7.14 lakh (touching a high of `7.23 lakh) and registering an internal rate of return (IRR) of 9.6%. We also observed that the investor did go through a drawdown of 10.23% in the portfolio as on August 28, 2013. The overall volatility, however, has remained quite benign; a total of four drawdowns greater than 5% and only one instance of drawdown greater than 10%.
Asset allocation in mutual fund
Another dimension of this analysis was to replicate the asset allocation of NPS in mutual fund portfolio. The same strategy of rebalancing the asset allocation, being dependent on the age of the investor, was then replicated using one large-cap, one credit opportunity fund and one gilt fund (instead of equity, corporate and government allocation of NPS).
We observed the following trends after the exercise: The invested amount of `4.5 lakh has grown to `7.75 lakh in the span of 9 years (2009–18) with an IRR of 10.88% (as compared to 9.6% in the case of NPS). One interesting observation is that, even though this MF allocation is more volatile (in terms of number of drawdowns), the extent of drawdown is more limited than that of NPS. For example, the maximum drawdown in MF allocation is 7.51% as on August 28, 2013 (as compared to a drawdown of 10.23% in NPS). But the instances of drawdown greater than 5% has climbed up to 12, as compared to just four in case of NPS.
We continued this exercise with a half-yearly SIP of `25,000 into large-cap, mid-cap and ELSS category and the results are:
Each of the investments in large, mid and ELSS category funds have registered progressively higher returns than NPS or MF asset allocation, but these returns have come with added volatility as well. We observed that ELSS, large-cap and mid-cap have an IRR of 11.97%, 13.6% and 18.73%, respectively. Also, the maximum drawdowns in the same are 21.2%, 15.58% and 19.79%, respectively. In all three investments, there are 25 instances of drawdowns that are greater than 5%, while only ELSS has recorded instances of drawdowns of 20% and greater (two instances of drawdowns >20%). From above, we can conclude the following: NPS is the least volatile among all options. MF asset allocation has higher volatility, compared with that of NPS. Pure equity MF investment generates higher return and supports wealth creation, but is accompanied by much higher volatility.
The writer is managing partner, BellWether Advisors LLP. Inputs from Siddharth Prasai