Employee Provident Fund Organisation invests in Stock Market

For several years there was a debate whether Employees’ Provident Fund (EPF) corpus should be invested in stocks. Till now the EPF had invested its corpus in low risk and assured return investments, such as government bonds. Last year it was finally agreed that EPF corpus would be invested in equity markets and the Employee Provident Fund Organisation made an allocation of Rs 5000 crores for the Indian stock market and finally invested Rs 6,577 crore, or 5% of the investible surplus, in equities in 2015-16. Having tasted some success in terms of superior returns, the EPFO is now looking to invest beyond 5 per cent in equity. In this article I talk about the implication of Employee Provident Fund Organisation investing in the Stock Market.

Employee Provident Fund

Employee’s Provident Fund (EPF) is a retirement scheme for salaried employees. This fund is controlled by the Employees Provident Fund Organisation of India (EPFO). EPFO assists the Central Board in administering a compulsory contributory Provident Fund Scheme, a Pension Scheme and an Insurance Scheme for the workforce engaged in the organized sector in India. The schemes cover Indian workers as well as International workers (for countries with which bilateral agreements have been signed. It is one of the main platforms of savings in India for nearly all people working in Private sector Organizations. A company with over 20 employees is required by law to register with the EPFO.

As per Be Money Aware website: “A provident fund is created with a purpose of providing financial security and stability to elderly people. Generally one contributes in these funds when one starts as employee, the contributions are made on a regular basis (monthly in most cases). It’s purpose is to help employees save a fraction of their salary every month, to be used in an event that the employee is temporarily or no longer fit to work or at retirement. The investments made by a number of people / employees are pooled together and invested by a trust. Typically 12% of the Basic, DA, and cash value of food allowances has to be contributed to the EPF account.”

These funds across millions of employees in India are pooled together and invested by a trust. This generates an interest of 8% – 10%, which is decided by the government and the central board of trustees. The annual interest rate changes from time to time and is currently at 8.8%. In this way EPFO has over the years generared a huge corpus of Rs 8.5 lak crore which increases every year.

Employees’ Provident Fund Organisation takes ETF Route

Employees’ Provident Fund Organisation (EPFO), India’s state-run pension fund had a retirement corpus of Rs 8.5 lakh crore as of last year (2015) and made its first foray into the equity markets with an initial allocation of Rs 5,000 crore. The EPFO gets around Rs 1,00,000-1,20,000 crore as incremental deposits every year and the allocation for last FY was limited to 5% of incremental deposits. EPFO funds were invested through SBI Nifty exchange-traded fund (ETF) and SBI Sensex ETF managed by SBI Mutual Fund. Around 75 per cent of the funds were invested in NSE ETF and the balance 25 per cent in BSE ETF. This step was taken almost 60 years of existence of the EPFO. Global pension funds generally invest across the globe, including India in private equity, venture capital and public markets. But India’s Employees’ Provident Fund Organisation has so far been reluctant to even invest in Indian equities. Having said that, it is also true that many pension fuunds have gone bust also.

Employee Provident Fund Organisation invests in Stock Market

In 2015 however, the EPFO finally relented. Initially the Finance Ministry had given two options:
a. invest 1% of the estimated Rs 8,50,000 crore corpus in stocks
b. to allow 5% of incremental contributions to go into equities.

Option “b” was chosen. It was also decided that EPFO investment into the stock market could go as high as 15 per cent of the incremental deposit every year. In other words as per Finance Minisrty norms, potentially around Rs 15,000 crores can be invested in stock markets. Indian stock market size (market capitalization) is around Rs 11 crore crores, so the EPFO’s yearly foray in Indian stock markets would be worth 0.1% of market size. At this pace, after 10 years EPFO would not be more than 1% of Indian stoc market. Hence all those fears of EPFO flooding the money with excess liquidity is ill-founded.

What will happen instead is a good thing. Equities as an asset class have given goodd investments over the long term (20-30 years). EPFO being a retirement product is suited for long term equity investment, and could potentially give fantatsic returns to Indian middle-class who are the biggest contributors to EPFO. As per EPFO Commissioner KK Jalan: ““Studies have revealed that investment in markets have given better returns across the world. We are a long-term player and in long-term equity market behaves in a positive manner. They have always given a positive return (in long-term)”. Moreover, this will also help the government to control deficit, as otherwise the givernment has to use deficit funding (print rupees) to pay EPFO maturity proceeds, therby stoking inflation.

“The current EPF return of 8.75% is not enough in these days of high costs. Equity exposure with all safeguards would generate higher returns in the long term.” [Sushanta Sen, Principal Advisor, CII]

“Most salaried employees have limited means to invest in stocks on their own, so EPF investing a small amount in equities will be good for them,” [B.P. Pant, Secretary, FICCI.]

Some Facts about EPFO and it’s Equity Investments

  1. Currently only 5% of incremental amount in stocks and may increase.
  2. Equity investment will follow the index ETF route.
  3. SBI Mutual Fund is the fund manager.
  4. In April 2015, Finance Ministry issued a notification according to which EPFO may invest its corpus as follows.
    • 45-50%- Government securities35-45%
    • Debt securities and term deposits of banks
    • 5-15% equity market
    • Up to 5% Money market
    • Up to 5% Asset backed securities

    So investing in stocks is just a small part of the overall big picture.

  5. The 5000 crore of EPFO is much less than 60,000-70,000 crore of LIC.

EPFO Looking Beyond 5% in Equity

The EPFO had been planning to invest more than 5% of its incremental corpus in stock market. The increase in equity exposure may well be around 10% which would imply an annual investment of more than Rs 10,000 crore in equity, as against over Rs 6,000 crore last year. In September 2016, a notification was issued raising the EPFO investment limit of ETFs to 10 per cent from the current 5 per cent of its investible deposits. In a press statement, India’s labor ministry said: “Considering the good returns in ETF investment, the government has decided to enhance the investment from present 5 percent to 10 percent for the financial year 2016-17.”

As per BloombergQuint: “After the enhanced limit, up to Rs 13,000 crore of EPF monies can be invested in Exchange Traded Funds (ETF) benchmarked to the Nifty 50 and Sensex. SBI Mutual Fund and UTI Mutual Fund have been appointed as the asset managers for this amount.”

Conclusion

EPF is now officially in competition with NPS, National Pension Scheme, another retirement plan offered by the national government. However not all has been hunky dory. There has been stiff opposition from many EPF members, and trade unions, who do not consider equities as safe investments. Moreover, the EPF money belongs to employees and they should decide whether they want to invest in equity or not, and if so how much, similar to NPS. All said and done, EPF investment in Indian stock market is here to stay.

References

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A Few Last Words

Before making any investment decision, please contact your financial adviser.

I have provided this article for educational purpose only.

I hope you found this article on Employee Provident Fund Organisation invests in Stock Market useful. If you have something to add please leave a comment in the post. Please feel free to contact me.

Subhodeep Mukhopadhyay

I am a Management Consultant in the Education Sector. In my previous corporate career, I have worked in Banking, Private Equity and Software industry. I am an MBA in Finance/ Computer Engineer and enjoy doing equity research and financial analysis in my free time.

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