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Giving provident funds an equity boost
Manish Jaiswal – Senior Director
July 31, 2015
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Agenda
When India ages, whither pension for all
High savings rate, debt-heavy asset allocation
The retirement industry too favours debt, but high inflation caps real returns
Long-term investment avenue needed for inflation-adjusted returns
Recent regulatory changes bring equity to the provident fund table
But a lot needs to be done
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When India ages, whither pension for all
Nearly 11 crore people are above 60 years; this will triple by 2050
– Every fifth Indian will be a sexagenarian by 2050 compared with one in 12 now
The joint family social security net is fast giving way to nuclear families
– From over five people per household in 2001, there were 4.3 per household in 2011
Out of 11 crore retirees, only 0.5 crore are covered under private pension
Fiscal cost could rise to 4% of GDP if pension coverage is not increased
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High savings rate, debt-heavy asset allocation
India’s savings rate, at 22%, is one of the highest in the world
– Financial savings account for 7% of total savings
– Less than 3% of financial savings is invested in the capital markets
Further, India is a young country
– Most of its population is less than 30 years old
– This is expected to remain so over the next couple of decades
The country’s asset allocation profile resembles a person nearing retirement – debt-oriented
Thus, it is imperative to reap the demographic dividend
0200,000400,000600,000800,000
1,000,0001,200,0001,400,0001,600,0001,800,000
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(Po
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Demographic trend
Population aged 0-24 Working age - population aged 25-59
Population aged 60+Currency
9%
Deposits59%
Shares, debentures*
3%Life Funds of
LIC and private
insurance companies
17%
Provident and pension funds
12%
Components of household savings in 2013-14 (in %)
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The retirement industry too favours debt, but high inflation caps real returns
The retirement industry in India primarily invests in debt instruments
– Provident funds (PFs) form 67% of the retirement sector’s corpus
– Since 1990, average retail inflation has been 7.25% resulting in real return of 3% for PFs
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
1990 1994 1998 2002 2006 2010 2014
Retail inflation rate PF return
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Long-term investment avenue needed for inflation-adjusted returns
Equity is the best bet in the long term
– Equity (S&P BSE Sensex) has returned 15% on average since inception^
– The risk of loss decreases as the investment horizon increases
Globally, too, equity is a preferred investment class for pension money
– As per OECD’s annual pension survey, large pension funds had, on average, 31.5% equity exposure, while public pension reserve funds had 30%
– Japan, with 23% above 65 years old, has over 11% equity investment in pension assets
– Canadian Pension Fund had 50%+ invested in equity in 2013
^CAGR 20-year rolling returns since 1979
10 years 15 years 20 years 25 years 30 years0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00% Volatility of S&P BSE Sensex reduced over the long term
Sta
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ard
dev
iati
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(d
aily
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Recent regulatory changes bring equity to the PF table
Ministry of Labour & Employment has permitted the request for allowing
equity in the PF investment basket
– It has allowed between 5% and 15% in the equity market as per the changed investment
pattern this fiscal
Exposing PF to equity would help align the long-term horizon of the
retirement corpus with the asset class
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But a lot needs to be done
^ Equity returns assumed at 15% annually
Limited equity exposure
– The proposed exposure of 5-15% of equities in PFs is not an optimum financial strategy
for a young population
– Overall portfolio should have 5% equity exposure by the 13th year if we start
putting 5% incrementally^
Pension penetration needs to grow exponentially and equitably
– Increase in pension coverage would aid financial inclusion
– Atal Pension Yojana is a step in the right direction but the benefit is insufficient
– The government needs to contribute to get a sufficient vesting corpus for the lower strata
– A healthy mix of defined benefit (DB) versus defined contribution (DC) needs to be
created
• DC plans for the upper and middle strata, and DB for the poor
– Retirement savings need to be mandated and provided with tax benefits
A robust retirement industry can also deepen and widen the capital markets
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