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Giving provident funds an equity boost
Manish Jaiswal – Senior Director
July 31, 2015
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
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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Agenda
2
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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
3
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
Currency
9%
Population aged 0-24
2050
2045
2040
2035
2030
2025
2020
Provident and
pension funds
12%
2015
Deposits
59%
Life Funds of
LIC and
private
insurance
companies
17%
Demographic trend
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
2010
Shares,
debentures*
3%
(Population in thousands)
Components of household savings in 2013-14 (in %)
Working age - population aged 25-59
Population aged 60+
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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
14.00%
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12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
1990
1994
1998
Retail inflation rate
2002
2006
2010
2014
PF return
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Long-term investment avenue needed for inflationadjusted 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
Standard deviation (daily
rolling)
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
10 years

Volatility of S&P BSE Sensex reduced over the long term
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15 years
20 years
25 years
30 years
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
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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
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
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

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
^ Equity returns assumed at 15% annually
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