Managing expectations

The Employees’ Provident Fund Organisation (EPFO) for the first time has decided to credit interest — at the rate of 8.5 per cent — in a staggered manner, because the pandemic has affected its income. It would credit 8.15 per cent interest in the accounts of subscribers for the financial year 2019-20 now and the balance 0.35 per cent will be released by December if the retirement fund manager is able to sell its equity investment. Its income would fall short by about ~2,500 crore if it credits the entire 8.5 per cent interest in one go. In case the EPFO is unable to credit the full 8.5 per cent, returns for 2019-20 would be the lowest since 1977-78. However, they will still be higher than those on fixed deposits in banks and small savings instruments of the government. Thus, the EPFO could have avoided the idea of staggered payments. Also, the way it has decided to defer a part of the interest payment deserves attention, and its approach to fund management needs to be reviewed.

For instance, dependence on selling equity investment to pay interest to subscribers is a flawed strategy. Equity investment is inherently more risky than debt, and a fund manager cannot depend on equity returns to generate near-fixed returns for investors. It is likely that equity investment would not yield the expected return on a yearly basis. Depending on economic and market conditions, it can generate higher returns in some years and disappoint investors in others. The EPFO’S equity investment worth over ~1 trillion is reported to have lost about 8 per cent at the end of the last fiscal year. Expectedly, negative returns have triggered demands for a review of the EPFO’S exposure to equity. Both the government and the EPFO would do well not to take a hasty decision.

However, the way the EPFO manages its equity exposure must be reviewed. Should the EPFO diversify its investment more broadly instead of investing in frontline benchmark indices? Why did it invest principally in government-backed exchange-traded funds? Public-sector companies are not seen as value creators. This begs the question: Was the investment made to support the government’s disinvestment programme? If this is the case, it is possible that the EPFO would continue to invest in such offers in future as well, which will affect returns. The objective should be to maximise long-term returns for subscribers.

More broadly, the EPFO would need to manage expectations as returns on financial investments in the near to medium term are likely to remain muted. The cut in policy rates by the Reserve Bank of India to support economic activity after the Covid-19 outbreak has reduced market rates and this would affect the EPFO’S returns as well. Further, although the stock market has recovered much of the lost ground after the pandemic-induced fall, returns could remain subdued in the coming months. The Indian economy’s growth potential is projected to have declined significantly, which will be reflected in corporate earnings and stock market returns in the medium term. This is not to suggest that the EPFO should not invest in the equity market, but it needs to be prepared for lower overall returns in the medium term. This should be conveyed to subscribers as well. Returns cannot remain removed from the reality for long.