Pension fund equity play to outshine FII debut

FY16 set to mark their debut in equity markets, a much-needed step, hopefully to be widened, say observers

Domestic pension funds required to make equity allocations for the first time this year are likely to contribute more to inflows than foreign institutions did in the first three years after they were allowed into the stock market in the 1990s.

The Union labour ministry announced on Tuesday that the Employees’ Provident Fund Organisation (EPFO) would be required to allocate five per cent of incremental inflow to equity, pegging inflows for this year at Rs 7,500-8,000 crore. Details are expected in a notification.

An earlier notification regarding private pension providers is likely to add another Rs 3,400 crore. So, total pension inflows this year could reach Rs 11,000 crore, more than foreign institutional investors’ Rs 9,936 crore brought in over the first three years of their stock market debut in 1992.

The Rs 7,500-8,000 crore figure is based on a reported estimate of Rs 1.5 lakh crore of inflows during the year. However, private trusts accounted for Rs 33,966 crore  of the total Rs 1.06 crore in FY14 inflow, the latest available figures provided by KPMG, based on EPFO data.

Even assuming this does not change, these private trusts can invest up to 15 per cent in the share market. This would mean their equity allocation could be as high as Rs 5,095 crore, assuming no growth in inflow since FY14. Add the five per cent allocation on flows from non-private sources and this works to Rs 10,897 crore.

This does not take into account gratuity funds and superannuation funds, also allowed to invest up to 15 per cent in equities. How much of this can actually make its way into the stock market would depend. Experts believe it would make sense for them to do so.

“This move by the government is to encourage long-term retirement money into the equity market, which tends to provide higher returns over the long term. For instance, the average 20-year daily rolling return of the S&P BSE Sensex is 15 per cent since 1979,” said Jiju Vidyadharan, Director, funds & fixed income research, CRISIL.

“...A robust regulatory mechanism for investment in equity by non-government PF, superannuation funds and gratuity funds will ensure the safety of funds by trusts, as well as facilitate the deepening of capital markets in India and fuel economic development,” said Vikas Vasal, partner, tax, at KPMG.

The potential equity investment this year is higher than the total equity allocation of the National Pension System (NPS), the only other major Indian pension provider which invests in equities. NPS had assets of Rs 4,160 crore invested in equity or 8.6 per cent of its Rs 48,136 crore, shows its report of FY14. The move by EPFO and private pension providers could arguably mark the largest Indian pension commitment to equities.

The March 2 notification allows for equity investments in companies with a market capitalisation of not less than Rs 5,000 crore. Derivatives can also be invested in, so long as the contract value does not exceed five per cent of the total equity portfolio.  Other equity investments can be through actively managed mutual fund equity schemes and exchange-traded funds.  

“One of the ways could also be investment in other assets like REITs (real estate investment trusts). This is one way to increase the overall returns,” said Rajesh Srinivasan, partner, Deloitte Haskins and Sells.

The notification allows for investment in REITs, infrastructure investment trusts, commercial mortgage-backed securities, residential mortgage-backed securities and asset-backed securities.

“Today, only eight per cent of private sector employees have a pension cover in India. By 2050, the country’s population of the 60-plus will be 300 million, thrice the current number. Clearly, India is staring at a huge pension problem,” according to a note from CRISIL.

“Allowing for equity is positive…pension funds are long-term (and the money) should come in equity,” said a senior fund official.

EPFO CUSHION FOR MARKETS

• The labour ministry says will invest 5% of incremental flows in equities
   
• This would reportedly work out to Rs 7,500-8,000 crore in inflows
   
• However, an earlier notification mandates non-government funds’ investment in equities
   
• The minimum has been set at 5% but the maximum is up to 15%
   
• This could take the total EPFO-led pension investment to Rs 11,000 crore this year
   
• This dwarfs the total equity corpus allocation of NPS
   
• It is also higher than first 3 years of FII investments combined