MOVE OVER NPS, ETFS WILL EAT YOUR LUNCH

Mint ST - - PERSONAL FINANCE - You can real all of Monika Halan’s ear­lier col­umns at www.livemint.com/ex­penseac­count mint

ICICI Pru­den­tial Mu­tual Fund’s new fund of­fer (NFO) of Bharat 22 ex­change traded fund (ETF) is in the mar­ket this week seek­ing in­vestor money for the gov­ern­ment’s dis­in­vest­ment pro­gramme. Look­ing through the doc­u­ment, I was struck with the ex­pense ra­tio of this fund. At 0.0095% per year, this is the cheap­est ETF in the mar­ket today. Un­der­stand what this cost means first. The ex­pense ra­tio de­scribes the price you pay for the fa­cil­ity of hand­ing your money over to a fund man­ager and it is charged on your funds un­der man­age­ment. For ex­am­ple, a Rs10 lakh cor­pus, with an ex­pense ra­tio of 1%, will cost you Rs10,000 a year. You don’t have to cut a cheque for this cost since it is taken by the fund house out of your cor­pus—that’s why it is called net as­set value, it is ‘net’ of costs. Ex­pense ra­tios have a big im­pact on in­vestor re­turns over a life­time of in­vest­ing. At 0.0095%, Bharat 22 will cost you Rs95 a year. Re­liance AMC’S CPSE ETF (the first gov­ern­ment dis­in­vest­ment fund) costs 0.07% or Rs700 a year. A 2% man­aged fund ex­pense ra­tio costs you Rs20,000 a year.

ETF costs have been fall­ing over time in In­dia. Three of the cheap­est broad mar­ket ETFS (these track in­dices like Sen­sex and Nifty) cost 0.05% cur­rently and there are more than 10 ETFS with costs of 0.10% or less. Other than an ex­pense ra­tio, ETFS have other costs— bro­ker­age and de­pos­i­tory fees and charges—with bro­ker­age cost­ing about 0.20% to 0.40% of the in­vest­ment and de­pos­i­tory par­tic­i­pant (DP) costs be­tween Rs300-700 a year. Some of these costs are ne­go­tiable with your ser­vice provider and some are shared with the other di­rect eq­uity trades you may do. But it is safe to say that ETF costs are now wafer-thin. Here’s a pre­dic­tion, as the ETF mar­ket gets big­ger, I ex­pect that it will eat the lunch of the erst­while low-cost and sim­ple prod­uct, the Na­tional Pen­sion Sys­tem (NPS). NPS was sup­posed to be In­dia’s very-low-cost, mass-mar­ket pen­sion prod­uct that had a sim­ple prod­uct struc­ture, few cost heads and was mis­selling-proof. All that is his­tory now. With con­stant tin­ker­ing to the ba­sic struc­ture, the NPS today is a mess with more than 10 cost heads (see this ex­cel­lent story by my col­league Deepti Bhaskaran for a ta­ble of costs bit.ly/2zf8ukp). Worse, it is open to ma­nip­u­la­tion by the dis­trib­u­tor for gath­er­ing a higher com­mis­sion.

A col­league got a What­sapp for­ward that com­pared the in­cen­tives of sell­ing NPS ver­sus mu­tual funds. Aimed at the dis­trib­u­tor of fi­nan­cial prod­ucts, the mes­sage was us­ing a strat­egy that would yield a higher com­mis­sion for the NPS seller over mu­tual funds. Pen­sion Fund Reg­u­la­tory and De­vel­op­ment Au­thor­ity (PFRDA) rules al­low an up­front com­mis­sion of 0.25% of the in­vest­ment, sub­ject to a min­i­mum com­mis­sion of Rs20 or a max­i­mum of Rs25,000 a year. Some pen­sion fund man­agers are en­cour­ag­ing NPS sell­ers to break a sin­gle in­vest­ment of Rs12,000 into Rs1,000 monthly con­tri­bu­tions to har­vest more com­mis­sions (see ta­ble). Till a monthly in­vest­ment of Rs8,000, it makes sense for the dis­trib­u­tor to switch from an­nual to monthly con­tri­bu­tions. Af­ter that the ar­bi­trage goes away.

NPS at its core was de­signed to keep such sit­u­a­tions of ar­bi­trage at bay. En­cour­ag­ing a sys­tem­atic in­vest­ment plan (SIP) to get ru­pee cost av­er­ag­ing is a dif­fer­ent story from en­cour­ag­ing it to har­vest com­mis­sions. Where did the NPS lose its way? It be­gan with the Ba­j­pai Com­mit­tee (bit.ly/2aazwxk) that was set up by the erst­while PFRDA chair­man Yo­gesh Agar­wal. The re­port prac­ti­cally over­hauled the NPS prod­uct to make it more com­pet­i­tive than other prod­ucts in the mar­ket—life in­sur­ance and mu­tual funds. The first tin­ker­ing be­gan then with the ba­sic struc­ture of the prod­uct and PFRDA has gone on chip­ping away at it so that today the NPS has a com­pli­cated cost struc­ture, is al­lowed to in­vest in ac­tively man­aged prod­ucts (ear­lier NPS could only in­vest in in­dex-linked eq­uity prod­ucts which are lower risk than man­aged funds) and has up­front com­mis­sions that the in­vestor pays. There are 10 heads un­der which charges are levied and it does look as if PFRDA has lost the plot. It wants to take the bat­tle to the in­sur­ance in­dus­try by en­cour­ag­ing com­mis­sions, but a 0.25% com­mis­sion won’t cut any ice when the com­pe­ti­tion is do­ing 40% plus. The hik­ing of up­front costs from Rs125 to Rs200 (read this story for more: bit.ly/2i8zxjr) and an ad­di­tional per­sis­tency charge of Rs50 a year is not en­thus­ing dis­trib­u­tors but is en­cour­ag­ing com­mis­sion ar­bi­trage strate­gies that don’t have in­vestor in­ter­est in mind. PFRDA should have fol­lowed the ex­am­ple of the mu­tual fund prod­uct struc­ture that puts all the costs un­der one head—ex­pense ra­tio—and leaves the ap­por­tion­ing of costs to dif­fer­ent func­tions un­der the bon­net. A bu­reau­cratic tin­ker­ing of costs and heads has de­stroyed the NPS.

NPS used to be a good prod­uct in a bad mar­ket (see this video where I make that case: bit.ly/2id7g1j). It has now shifted over to be­ing a part of the bad mar­ket. It can now nei­ther com­pete on costs with ETFS nor in sim­plic­ity. Risk-averse in­vestors who do not want fund man­ager risk (the risk of the de­ci­sions of a fund man­ager go­ing wrong) but want to take a generic, that is, they are fine with get­ting an in­dex-based re­turn, will do well to use the ETF route to long-term wealth cre­ation tar­get­ing their re­tire­ment. The ex­tra Rs50,000 tax break that the NPS en­joys may fi­nally not be worth the while.

Monika Halan works in the area of con­sumer pro­tec­tion in fi­nance. She is con­sult­ing edi­tor Mint and on the board of FPSB In­dia.

She can be reached at monika.h@livemint.com.

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