Nest egg under threat: changes in pension fund could put our futures at greater risk
How much return would you want from your pension fund when you retire?
The question is tricky as there is no limit to a man's desire for returns, especially at the time of retirement.But there is certainly a need for prudence on the part of the government while it formulates schemes meant to invest money, for people whose old age would depend on the money that is generated through pension funds.
In their search for a higher rate of return in the pension funds, the Pension Fund Regulatory and Development Authority (PFRDA) is considering allowing an increase in the cap on equity investments from 50% to 75% through the life cycle fund, and harmonising the investment patterns of government and private sector National Pension System (NPS).
What is NPS?
NPS is a defined pension scheme, in which an individual invests a pre-defined amount every month till the age of 60. At 60, she needs to buy an annuity-a pension product that gives her periodical (monthly/ quarterly) payouts-with at least 40% of the proceeds. The remaining can be taken as lump sum. The amount of pension that the buyer receives depends on the performance of the fund she chose.
As per the recommendation of the expert committee headed by G N Bajpai, the PFRDA will establish two new funds. The first would be an 'Aggressive Life Cycle Fund', which will have maximum exposure of 75% to equities at the age of 35. The equity exposure will keep on reducing progressively and will decline to 15% by the age of 55. The second fund under would be "Conservative Life Cycle Fund". In this, the maximum exposure to equities will be 25% at the age of 35 and it will fall to 5% by the age of 55.
At present, NPS offers a default life cycle fund, where the equity exposure is 50% at the age of 35 and comes down to 10% by the age of 55.
What would these changes mean?
Because the amount of returns that one receives depends on the performance of the fund, it becomes very important for the government to ensure that the fund managers invest the money of pensioners in a way that doesn't incur loss of value in the fund. All regulations by PFRDA revolve around creating an ecosystem that benefits the future pensioners.
The proposal to allow 75% investment by pension funds into equity (share markets), means that money invested in pension funds would face more risks and if the risk gives positive results than the value of the funds may go up significantly. But in case the share market is on the downhill at the time of one's retirement, for example just like it went down in 2008, people may see a significant erosion in the value of their funds.
Why is the PFRD considering this high-risk route?
Till 2015, pension funds delivered very good returns on the back of well-performing equity markets. Remember in March 2015, the Sensex had touched an all-time high of 30,000 points.
Over a three-year period, between 2012 and 2015 the returns from fund managers dealing in equity was above 18%.
The worldwide trend
World over, pension funds are moving towards riskier assets to generate higher returns. While pension funds are becoming aggressive, they are facing criticism from analysts for risking the investment of pensioners.
An article by Financial Times quoted the Organisation for Economic Cooperation and Development (OECD) as saying that the "move into riskier investments could result in the solvency position of pension funds being "seriously compromised" in the event of a market shock where there is a "freeze on liquidity."
Clearly, by moving towards riskier assets for pension funds, India too is following international trends. But the question is, to what extent should pension funds increase their risk portfolio.
While there are various studies which show that the stock markets give positive return which are higher than debt market returns after 10 years, there is no trustworthy data available on the impact of sudden stock market crash on the fund value of pension funds.
Therefore it would make sense on the part of PFRDA to issue some data base analysis that could project rate of return for pension funds based on worst case scenario on the stock market performance over a period of over 10 years. This becomes important in the backdrop of big market crashes, as seen in 2008 and early 2016 that eroded the value of pension funds across the world.