Armchair investing in EPF may soon be over

If the changes being considered by the EPFO become a reality, investors may have to be more active in deciding equity preference and when to withdraw money, reports Sanjay Kumar Singh.

Illustration: Uttam Ghosh/Rediff.com

In recent years, the Employees' Provident Fund Organisation (EPFO) has been enhancing its exposure to equities. This year it will invest 15 per cent of its incremental corpus in this asset class and the rest in fixed income.

Now, EPFO is thinking of allotting units to investors for the portion of their corpus invested in equities. There are also plans to allow individual investors to allocate a higher proportion (above 15 per cent) of their EPF corpus in equities.

These will have to be accepted by its Central Board of Trustees (CBT).

EPF investors need to understand the implications of these changes, on what was hitherto a staid, fixed-return product.

Unitising equity holdings

EPFO has been investing in equities for over two years but there was no consensus on how the gains from this would be passed on to investors, say experts. It has now decided this will be done by allocating units to each subscriber.

Depending on your balance (the equity portion) vis-a-vis the total value of exchange-traded funds (ETFs) that EPFO holds, it will allocate units at the end of every year to each investor, and this will get reflected in his account statement.

In all probability, this will be an accounting entry.

When a subscriber wants to withdraw his money, EPFO will in all likelihood redeem the units based on their value on that day.

Investors might not be handed over ETF units, as that will require them to have a demat account.

Experts say a shift to unitisation is inevitable.

"You can't keep giving a fixed return in a product where you have an allocation of 15 per cent to equities in the underlying portfolio, whose return could be volatile. At some point, this could pose a serious problem," says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor (RIA).

With this change, he says, EPFO can continue to give a fixed return on the fixed-income side (85 per cent), while allowing you to bear the volatility on the equity side.

Weigh pros and cons

This development will have both positive and negative implications.

"The key positive is that subscribers will now become part beneficial owners of the corpus that EPFO has invested in ETFs," says Manoj Nagpal, chief executive officer, Outlook Asia Capital.

On the flip side, the return that EPFO announces every year (henceforth for the 85 per cent fixed-income investment side) is likely to drop, since the (notional) gains from equities will no longer be added to that rate.

The shift may help investors earn a higher rate of return from their EPF corpus.

"With clear allocation of part of the corpus to equities, investors can earn higher return," says Mumbai-based financial planner Arnav Pandya.

At the same time, a higher degree of volatility might creep into the investor's EPF portfolio.

While equity returns tend to be higher than bond returns over the long term, they can vary widely from year-to-year.

"In effect, a guaranteed return product (with an implicit government guarantee) is being converted into a market-linked product," says Nagpal.

Highly conservative investors, who want fixed returns, will have to acclimatise to the new regime.

Investors approaching retirement could face an issue.

Normally, as one gets close to retirement, financial advisors recommend a shift from equities, a volatile asset class, to debt. This ensures a last-minute downturn in the equities market does not affect the corpus.

If EPFO follows a fixed 85:15 allocation to debt and equities, this could pose a problem.

"There seems no way to take care of this risk at the moment. When the details are announced, maybe things could change," says Pandya.

EPFO has proposed allowing investors to delay encashment of units on retirement to deal with this risk.

Higher allocation to equities

EPFO is also thinking of allowing individual investors the option to invest a higher proportion of their corpus (more than 15 per cent) in equities.

Savvy investors with the requisite risk appetite will welcome this. Given the long-term nature of EPF investments, they should be able to ride out the interim volatility of equities and perhaps earn higher returns.

Conservative investors should avoid raising their equity allocation above the minimum level.

Finally, these changes mean the days of passive investment in EPF are over.

"Investors will have to take decisions regarding how much to allocate to equities, whether to withdraw the units at the time of retirement or wait for market conditions to improve, and so on. All this will call for some financial knowledge. Subscribers will have to take the responsibility of educating themselves," says Pandya.