NPS fund managers have more choices as investment universe expands

The Pension Fund Regulatory and Development Authority (PFRDA) has made changes to the investment norms that pension fund managers (PFMs) of the National Pension System (NPS) must follow. According to experts, while these changes will allow PFMs to invest in a wider array of products, they could also make their portfolios more volatile.

Investment universe expanded

PFMs could earlier invest in stocks that were part of the futures and options (F&O) segment and had a market capitalisation of more than Rs 5,000 crore. This effectively meant they were able to invest in the top 100 stocks by market cap. Now, their investment universe has been expanded to include the top 200 stocks by market cap.

“Pension fund managers will now have the flexibility to diversify into a wider basket of companies. Among companies ranked 101st to 200th by market cap, there are many quality names, which PFMs will now have access to,” says Sumit Shukla, chief executive officer, HDFC Pension Fund Management.

According to the Securities and Exchange Board of India’s (Sebi’s) definition, the top 100 companies by market cap are large-cap. With this change, PFMs will now be able to foray into mid-cap stocks as well.

As the experience in mutual funds shows, it has become hard to beat the benchmark in the large-cap segment, which has turned highly efficient. The mid-cap segment offers greater scope for outperformance. “With the size of assets managed by PFMs growing, there is a need to widen the scope of investments. Now that they can foray into mid-caps, they will have greater scope to generate alpha,” says Arnav Pandya, founder, Moneyeduschool.

While mid-caps have the potential to grow at a faster pace, they can also be more volatile than large-caps.

PFMs can invest in IPOs

PFMs have also been allowed to invest in initial public offerings (IPOs) whose market cap is above a certain threshold. The full float market cap, calculated using the lower band of the IPO’s issue price, must be higher than the market cap of the 200th company (currently Rs 21,241 crore).

Investment advisors are not comfortable with the idea of a retirement product like NPS investing in IPOs. “The amount of information available about an IPO is always less than what is known about a company that has been listed for several years. And IPOs, especially in buoyant market conditions, are usually priced on the higher side,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi-registered investment advisor.

Adds Pandya: “The IPO boom we are seeing currently in a high-liquidity environment may not sustain. Many of these new-age companies are not even making profits, so this could well turn out to be another bubble.” According to them, allowing PFMs to invest in new issues will increase the risk in NPS portfolios.

The limits on how much PFMs can invest in their group companies have been raised. If the group companies are of a high quality, pension funds could gain from this measure. However, experts say they should not become a source of funding for groups companies, via investments in debt instruments.

What do these changes mean?

When NPS was launched, its fund managers invested passively. Later, active fund management was allowed. And now, the scope of instruments has been expanded. The expense ratio has also been revised upward, though it is still among the cheapest investment products. “If more such changes are introduced, the original simplicity of the product could get lost,” says Raghaw.

In future, it will not suffice to select a PFM based on past returns. “Investors will have to take a closer look at the portfolio and try to assess its risks as well,” says Pandya.