RBI outlines steps to improve investment management of EPFO corpus

Suggests differentiated investment strategies, market-linked accounting

The Reserve Bank of India (RBI) has advised the Centre to consider a range of measures to improve the investment management and accounting practices of the country’s largest retirement fund, the Employees’ Provident Fund Organisation (EPFO), at a time when it is announcing significantly higher annual returns for its members than prevailing yields on  government bonds, where most of its funds are parked.

 

The RBI advisory follows a labour ministry request earlier this year seeking the central bank’s expertise to identify gaps in EPFO’s investment strategy and fund management practices, including accounting, risk management, and internal governance. The EPFO is the custodian of retirement savings worth more than ₹25 trillion, belonging to around 300 million 

formal-sector workers. 

“EPFO manages as well as regulates over ₹25 trillion of accumulated funds in provident fund, pension and insurance, but lacks an independent regulatory mechanism, leading to potential conflicts of interest. The investment division and investment committee of the Central Board of Trustees (CBT) could do better with enhanced expertise in areas such as accounting, treasury/portfolio management and actuarial assesments,” the ministry told the RBI in a meeting earlier this year, learnt Business Standard.  

A person familiar with the matter said: “Every year, there is pressure to maintain and even raise the returns for the large subscriber base, even as bond yields have fallen far below that level recently. The gap has been met through the realisation of capital gains on equity investments.” 

According to its current investment pattern, EPFO allocates 45-65 per cent of fresh accretions to government securities, 20-45 per cent to debt instruments, 5-15 per cent to equities via index funds, and zero to 5 per cent to short-term debt instruments.

 

For FY25, EPFO declared an interest rate of 8.25 per cent on members’ EPF balances, while the average yield on 10-year government securities was 6.86 per cent. The Nifty50 and BSE Sensex returned 5.3 per cent and 5.1 per cent respectively.

The Labour Ministry had also sought the RBI’s advice on whether it should adopt a differentiated investment strategy, reflecting the distinct asset-liability profiles of the three funds managed by the EPFO, rather than deploying pension, provident and insurance funds into the same instruments. It also sought guidance on reinvesting returns generated by exchange-traded funds (ETFs). 

Detailed queries to EPFO and the Labour Ministry on this matter had not elicited a response by the time of going to press.

In response to the government’s outreach, a team led by senior RBI officials reviewed EPFO’s functioning, met its fund managers to understand operational challenges, and submitted a detailed set of recommendations to address the Centre’s concerns. 

Flagging EPFO’s reliance on redeeming its equity holdings “programmatically without regard to market dynamics,” with the intention of distributing only realised earnings, the RBI has advised that “EPFO should switch to the best practice of applying asset allocation rules on the outstanding stock of all its investments instead of just incremental flows received every year,” a source said. 

It also recommended a shift to modern portfolio management practices so that any redemption strategy applies to all available investments in the corpus, not only ETFs. Currently, the EPFO has an exit policy that requires redemption of ETFs held for four years and disposed of if there is capital gain beyond a certain threshold. 

As of March 2024, EPFO had invested 40.7 per cent of its investible corpus in state development loans, 16.3 per cent in central government securities, 15.9 per cent in corporate bonds issued by public sector enterprises, 9.8 per cent in the public account with the central government, and 9.5 per cent in ETFs linked to the Sensex and Nifty50. 

Central bank officials also cautioned the EPFO on its accounting policy, which does not require recognition of losses or provisioning by charging realised income on bad investments. While EPFO follows a held-to-maturity approach to accounting for its assets, the RBI noted that its holdings are not marked to market. “At the same time, the policy permits holding of many legacy investments that have turned bad… While returns that accrued on these bad investments are reportedly not considered at the time of announcing returns to subscribers, it is not a prudent policy,” one of the source said. 

Noting that EPFO manages various funds for its members while also overseeing and regulating similar provident funds operated by other trusts, the RBI underscored that this dual responsibility can create potential conflicts of interest, as it functions both as a market participant and as a regulator. 

However, since EPFO primarily monitors investments made by portfolio managers through their consultants and does not function as a direct fund manager, the potential for conflict is mitigated, it is understood. “To further strengthen this separation, EPFO may consider implementing clear operational boundaries between its regulatory and fund management functions,” the RBI observed. 

Regarding the preparation of differential investment strategies for its funds, the central bank noted that applying a common pattern of investment across schemes with different actuarially assessable liabilities is “not appropriate,” and that “the deployment pattern of corpuses should ideally match the disparate liabilities of each scheme and benchmarks should also accordingly be redesigned.