EPFO's returns shine brighter than bonds, but are they built to last?

All fund managers aim to deliver superior returns to investors, but few consistently achieve this over time. Several factors, including the fund manager’s skills, affect returns generated on the invested corpus. However, the Employees’ Provident Fund Organisation (EPFO), the country’s largest retirement fund, to which organised-sector employees contribute a part of their monthly salary, has been consistently giving superior returns to its contributors. For 2024-25, for example, it declared a return of 8.25 per cent while the average yield on 10-year government bonds was 6.86 per cent during the year. Given that the EPFO invests largely in government bonds, its returns on investment are unlikely to be vastly different from the interest offered on such bonds. The gap is reportedly being met with the realisation of gains on equity investment. This is clearly not a sustainable model. Returns in equity markets are significantly more volatile than those in debt markets. 

To its credit, as this newspaper recently reported, earlier this year the EPFO had asked the Reserve Bank of India (RBI) to review its investment strategy and fund management practices, among other things. The EPFO manages the retirement fund as well as regulates such investment by several other entities, which creates a potential conflict of interest. The RBI is reported to have made several recommendations, including adopting modern portfolio-management practices. The EPFO has now decided to constitute a committee to study the RBI’s recommendations. The committee, with representatives from the RBI, the Ministry of Finance, and the Ministry of Labour & Employment, is expected to submit its recommendations by the end of this financial year, and the suggestions are likely to be implemented next financial year. 

The EPFO manages or oversees a retirement corpus worth about ₹25 trillion, which is expected to grow sharply as India’s workforce becomes more formalised. It is thus crucial that funds are managed with greater professionalism and transparency. While the expert committee is expected to look into all aspects, the EPFO may choose to invest part of its corpus through professional asset- management companies, which can not only boost returns but also help diversify risks. Further, it is important that returns are driven by the performance of the invested corpus not by political considerations. It also needs to communicate to its subscribers that returns can vary, depending on market conditions. Given that the EPFO manages retirement money, it is expected to provide stable returns over a long period of time. It would thus keep investing overwhelmingly in debt instruments, particularly government securities. It can also go for relatively high-yielding, long-duration bonds because it manages long-term money.  To improve returns, it has been investing a small part of its corpus in equities through index funds. 

Equity investment should be with a long-term view. Gains cannot be booked to give fixed returns to investors simply because this cannot be sustained over a long period. Instead, the EPFO can give subscribers the option to opt for an equity component. Such options can be designed keeping in view the longer-term objective of improving returns with stability. Subscribers may also be given the choice of switching between options under a broader set of conditions. In sum, the fact that the EPFO sought inputs from the RBI suggests that there is both the need and willingness to reform the way funds are being managed. It should implement changes with the objective of enhancing transparency, promoting professional fund management, and potentially boosting long-term returns.