EPF equity moves: Positive or negative? - Views on News from Equitymaster

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EPF equity moves: Positive or negative?

Sep 9, 2004

There has been talk that the Labour Ministry is looking to allow 5% of the vast Employee Provident Fund (EPF) corpus for investment is equity-linked instruments. Let us look at what could happen if this proposal comes through. As per the official EPF website, the total contributions received in FY03 towards EPF were to the tune of Rs 163 bn. The fund has a total of 39 m members, of which 27.5 m are pension fund members.

(Rs m) FY03
contributions
Corpus
till FY03
Investments
till FY03
EPF 113,881 1,085,101 1,027,476
Employees' Pension Fund 47,878 332,132 450,452
Employees' deposit linked insurance plan 1,586 14,784 34,852
Total 163,346 1,432,017 1,512,780
Source: www.epfindia.com

The total corpus of the fund stood at a huge Rs 1,432 bn at the end of FY03. Supposing 5% of this does come into equity related instruments, it works out to be a significant Rs 72 bn. As per our calculations, approximately Rs 1.1 bn investment will move the Sensex by 1 point. From that calculation, the EPF investment should move the markets upwards by only around 65 points.

But the move to allow pension related funds to invest in the equity markets would have a far bigger positive impact than the 65 points upward movement. Just to put things in perspective, Foreign Institutional Investors (FIIs), which were by far the biggest investors in the Indian equity markets in 2003, put in a record US$ 7 bn (approximately Rs 319 bn) during that year. The BSE-Sensex moved up by 96% during this period to 5,839 levels as on December 31, 2003. In essence, its the direction which matters over the long term.

Moreover, the 5% investment proposal is just a start. Going forward, it is likely that the fund members may be allowed to choose how they want the pension monies to be invested. For example, in the US, a similar fund (plan 401K) for pension allows members to choose how they want to invest their money, whether in debt or equity mutual funds. Infact, the largest US public pension fund, California Public Employees' Retirement System (CalPERS), has recently decided to invest in Indian equity. The US$ 166 bn CalPERs provides retirement and health benefits to more than 1.4 m public employees, retirees, and their families in the US.

It has been seen over the last few decades, that equities as an asset class outperform most other assets in the long term. Since members put in money in the EPF as a retirement investment, it makes sense to put some part of the corpus in equities. As the regulatory framework to manage this class of assets gets clearer, the management of this corpus is likely to become more efficient.

On the other side, the move will also enable the labour ministry to move to a market determined return over the long term, as compared to a self defeating fixed return in a soft interest rate scenario. This will in a way ensure, that the gap between the contributions and the future liabilities (in form of future pensions) is done away with over the long term. Of course, equity returns are not always positive.

For Indian equities, another positive from this move would be that the markets would get access to loyal base of investors, who are not speculative in nature. This would be a good stabilising hedge against the speculative investor breed, which is largely dominant in Indian equity markets.

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