How in­vest­ments in Na­tional Pen­sion Sys­tem Tier 2 stack up against those in mu­tual funds

India Today - - SMART MONEY -

When look­ing for an in­vest­ment, cost is usu­ally an im­por­tant fac­tor. On that count, Na­tional Pen­sion Sys­tem (NPS) in­vest­ments score well above fi­nan­cial prod­ucts like mu­tual funds, since NPS man­age­ment fees are as low as 0.01 per cent.

While investing in the NPS is manda­tory for cen­tral gov­ern­ment em­ploy­ees (ex­cept mem­bers of the armed forces), it is a vol­un­tary re­tire­ment savings prod­uct for non-gov­ern­ment em­ploy­ees. There are two kinds of accounts in­vestors can open—Tier 1 (NPS1) and Tier 2 (NPS2); but those seeking to in­vest in NPS2 must al­ready have an NPS1 account. The main dif­fer­ence be­tween them has to do with liq­uid­ity. Under NPS1, in­vestors are al­lowed to with­draw only 60 per cent of the cor­pus on re­tire­ment; the bal­ance must be in­vested in an an­nu­ity. NPS2 accounts have no limit—in­vestors can with­draw as much as they want, when­ever they want. This makes NPS2 accounts com­pa­ra­ble to mu­tual funds in terms of liq­uid­ity. These accounts also score well on returns, out­per­form­ing mu­tual funds under gov­ern­ment and corporate bond cat­e­gories (see ac­com­pa­ny­ing ta­ble).

How­ever, not many peo­ple with NPS1 accounts seem to have

opted for NPS2 in­vest­ments. The to­tal NPS2 assets under man­age­ment to­tal to just Rs 857 crore as on June 1, 2019.


One rea­son NPS2 accounts haven’t caught on may have to do with how many de­ci­sions are re­quired. First, in­vestors must de­cide be­tween ‘ac­tive’ and ‘auto’ al­lo­ca­tions—choos­ing be­tween mi­cro­manag­ing their in­vest­ments (‘ac­tive’) or opt­ing for a pre­set port­fo­lio type (‘auto’). Se­condly, there are four as­set classes that funds may be in­vested in—eq­uity, gov­ern­ment bonds, corporate bonds and al­ter­na­tive assets (Real Es­tate In­vest­ment Trusts, In­fra­struc­ture In­vest­ment Trusts, etc). Under ‘auto’, in­vestors must choose one of three port­fo­lio types— ag­gres­sive, mod­er­ate or con­ser­va­tive, based on their risk ap­petite. (An ag­gres­sive port­fo­lio will have a greater exposure to eq­uity than oth­ers.) ‘Ac­tive’ in­vestors must de­cide how to al­lo­cate their funds among these four classes them­selves, sub­ject to reg­u­la­tions—for example, in­vestors may al­lo­cate a max­i­mum of 75 per cent of their funds to eq­uity, and a max­i­mum of 5 per cent to al­ter­na­tive assets. In the ab­sence of pro­fes­sional ad­vice, choices like these can prove too com­pli­cated for ev­ery­day in­vestors. As Rahul Jain, head, Per­sonal Wealth Ad­vi­sory, at Edel­weiss says, “There is too much com­part­men­tal­i­sa­tion in the over­all struc­ture, which re­quires in­vestors to make choices at every stage. This makes the process of investing cum­ber­some and in­tim­i­dat­ing at times.”


An­other rea­son for the lack­lus­tre in­vest­ment num­bers in NPS2 accounts may have to do with am­bi­gu­i­ties over tax­a­tion. As Saraswathi Kas­turi­ran­gan, part­ner, Deloitte In­dia, says, “There are no spe­cific tax ben­e­fits avail­able for con­tri­bu­tions to NPS2 accounts, and no clar­ity on how with­drawals from NPS2 accounts will be taxed, in the ab­sence of spe­cific pro­vi­sions in the Act or clar­i­fi­ca­tions from the gov­ern­ment.” This is one area that mu­tual funds score over NPS accounts— in­vestors know ex­actly how much they will have to pay at the time of with­drawal, and what sort of tax de­duc­tions are per­mis­si­ble.


As mentioned, NPS in­vest­ments have the low­est fund man­age­ment charges among in­vest­ment prod­ucts. How­ever, the cost does in­crease when other fac­tors—such as ini­tial sub­scriber reg­is­tra­tion charges


(Rs 200) and con­tri­bu­tion up­load charges (0.25 per cent per trans­ac­tion, to a max­i­mum of 25,000) are fac­tored in. Even so, the over­all cost of investing in NPS schemes still works out lower than mu­tual funds. How­ever, while these low charges do ben­e­fit con­sumers, they also mean that in­vest­ment dis­trib­u­tors have a lower in­cen­tive to sell them, since they earn lower com­mis­sions. As Jain says, “Since NPS in­vest­ments are low-cost, there is no in­cen­tive for fi­nan­cial in­ter­me­di­aries to dis­trib­ute or pro­mote them, lead­ing to re­duced aware­ness among in­vestors, leav­ing them on their own to open, op­er­ate and man­age these accounts.”


An­other is­sue with NPS2 in­vest­ments is that there is very lit­tle choice in terms of in­vest­ment man­agers and op­tions in NPS schemes. First, NPS in­vestors only have eight fund man­agers to choose be­tween, while there are 47 fund houses for mu­tual fund in­vestors to choose from. Sec­ond, mu­tual fund in­vestors have a much wider group of assets to choose from, with 11 cat­e­gories of eq­uity and 16 cat­e­gories of debt. Third, NPS in­vestors may change their fund al­lo­ca­tion only twice in a sin­gle year; there is no such lim­i­ta­tion for mu­tual funds. (How­ever, there is a sil­ver lin­ing—NPS in­vestors may switch fund al­lo­ca­tions with­out in­cur­ring any tax li­a­bil­ity, while mu­tual fund in­vestors will be taxed if they do so.) And then there are the re­stric­tions on in­vest­ment—NPS in­vestors can only al­lo­cate a max­i­mum of 75 per cent of their assets to eq­uity in­vest­ments. “Under NPS, the choice of fund man­agers is lim­ited to eight. And one can choose only one fund man­ager to man­age all the schemes. Com­pare that with mu­tual funds—they of­fer a wide va­ri­ety of funds to choose from,” says Jain.


NPS2 funds in­vested in gov­ern­ment and corporate bonds have de­liv­ered bet­ter returns than mu­tual funds in those cat­e­gories (see ta­ble). How­ever, this pat­tern has not been repli­cated in eq­uity in­vest­ments. Ex­perts be­lieve that this may be a re­sult of con­ser­va­tive man­age­ment, as eq­uity fund man­agers must also pro­vide liq­uid­ity to their cus­tomers, which re­duces their risk-tak­ing ca­pa­bil­i­ties. How­ever, ex­perts also say that mu­tual funds are a bet­ter choice for those look­ing to in­vest in debt. “Debt mu­tual funds have in­dex­a­tion ben­e­fit af­ter three years, NPS2 does not. And both are man­aged by fund man­agers and take risks. I think mu­tual funds are more transparen­t and give you more op­tions com­pared to NPS,” says Sh­weta Jain, founder, In­vestog­ra­phy.


While NPS2 in­vest­ments do have a cost ad­van­tage over mu­tual funds, ex­perts say that the choice should not be over­sim­pli­fied. “Costs are not the only thing that should de­ter­mine your choice. It should be one of the fac­tors,” says Sh­weta. With a lack of clar­ity on tax­a­tion rates and no tax in­cen­tives for NPS2 in­vestors, ex­perts still be­lieve that mu­tual funds are the bet­ter op­tion. “If you look deeply, there aren’t any ap­par­ent ad­van­tages of NPS2 in­vest­ments over mu­tual funds, ex­cept for the fact that NPS funds are man­aged con­ser­va­tively and with a lower ex­pense ra­tio,” says Jain. How­ever, ex­perts also say that if NPS2 in­vest­ments are granted tax ben­e­fits, that could make them more at­trac­tive. “The NPS is an evolv­ing prod­uct. Tax ben­e­fits would def­i­nitely boost its ap­peal, be­cause in­vestors love any­thing that gives them tax ben­e­fits,” says Sh­weta. And it does seem likely that NPS2 in­vest­ments will gain some ben­e­fits in the up­com­ing bud­get. “There are no tax ben­e­fits for NPS2 in­vest­ments as there is no lock-in pe­riod and the funds are freely with­draw­able. How­ever, in De­cem­ber 2018, the Union Cab­i­net ap­proved a pro­posal pro­vid­ing tax ben­e­fits—de­duc­tions under sec­tion 80C of the Income Tax Act, sub­ject to a lock-in pe­riod of three years. This was not in­cor­po­rated in the in­terim bud­get an­nounced on Fe­bru­ary 1, 2019; it is likely to be in­cor­po­rated in the up­com­ing full bud­get,” says Kas­turi­ran­gan.

As of now, mu­tual funds cer­tainly do look like the bet­ter op­tion.


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