Coming close on heels of ending the monopoly of SBI in managing EPF accounts, the government has now allowed private provident, pension and gratuity funds to invest up to 15% of their investible funds in the stock markets, one of the new financial sector reforms by the government.
This move is aimed at making the massive cash balances that provident funds sit on every December-January, in the absence of central government securities to park them in, history. In 2007-08, the EPFO had kept more than Rs 10,000 cr idle, as per a recent audit report. Incidentally, EPF’s earnings for 2007-08 are, therefore, only enough to pay 8.25% interest compared to 8.5% paid in the year before. The finance ministry’s new investment guidelines, that will become operational from April 1, 2009, can rectify this, going forward. The guidelines leave no room for provident fund managers to cite investment restrictions put in by government for lack of returns on the money put in by the 40 million organised sector workers as their retirement savings.
As per the new guidelines, the funds can soon directly invest in shares of companies on which derivatives are available in the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE). Currently, about 228 single stock futures are traded in the futures and options segment of NSE, with about 39 more to be added from the last week of August.
The other changes made in the investment pattern include merger of Central Government Securities, State Government Securities and units of gilt Mutual Funds into a single category and allowing investment up to 55% of their corpus, providing a flexible ceiling for various category of instruments instead of fixed investment ceiling as at present; providing new category of instruments, such as rupee bonds of multilateral funding agencies, money market instruments and permitting investment in term deposit receipts of not less than one year duration issued by scheduled commercial banks.
The new investment pattern also recognises the fiduciary responsibility of the trustees and the need for exercise of due diligence by them. It gives them greater flexibility in terms of a wider variety of financial instruments as well as greater freedom to actively manage the portfolio. Moreover, the trustees will have freedom to exit from a rated financial instrument when their rating falls below investment grade as confirmed by one credit rating agency. The trustees have also been given freedom of trading in securities, subject to the turnover ratio (i.e., the value of securities traded in the year divided by average value of the portfolio at the beginning and end of the year) not exceeding two.
Significantly, the new guidelines have raised the cap on equity investments from 5% to 15%. Although when the draft guidelines for such a move were made in September last year, the finance ministry had suggested doubling their capital market exposure from 5% to 10% while reducing their exposure to government securities from 40% to 35%.
Interestingly, very few of the funds allowed to invest in equities have even utilised their cap of 5% present currently. Even the funds, which do invest in equities, have an exposure of only 1-2%. Further, with the recent spike in bond yields, government securities as well as corporate bonds have been giving returns of over 9%. This is well above the returns of 8.5% which these funds are supposed to guarantee.
While the bouquet of investment options has been expanded, trustees have been made more explicitly responsible for investment decisions. However, sections feel since India is yet to get professional trustee companies in place, the new options may remain unused as existing trustees may shy away from taking hard decisions. While market participants have welcomed this proposal, the general perception is that a number of other regulations need to change to make equity investments viable. The main bone of contention is that of the guaranteed returns of 8.5%. In case the fund fails to throw up an 8.5% return, the employers are expected to provide for the rest.
Hence only time will tell, how many of the funds will take the risk to increase their exposure to equity, given the current volatility in the markets and the history of investments by such funds in the stock markets. However if they do invest, it will provide a much needed fillip for the stock markets.
This move is aimed at making the massive cash balances that provident funds sit on every December-January, in the absence of central government securities to park them in, history. In 2007-08, the EPFO had kept more than Rs 10,000 cr idle, as per a recent audit report. Incidentally, EPF’s earnings for 2007-08 are, therefore, only enough to pay 8.25% interest compared to 8.5% paid in the year before. The finance ministry’s new investment guidelines, that will become operational from April 1, 2009, can rectify this, going forward. The guidelines leave no room for provident fund managers to cite investment restrictions put in by government for lack of returns on the money put in by the 40 million organised sector workers as their retirement savings.
As per the new guidelines, the funds can soon directly invest in shares of companies on which derivatives are available in the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE). Currently, about 228 single stock futures are traded in the futures and options segment of NSE, with about 39 more to be added from the last week of August.
The other changes made in the investment pattern include merger of Central Government Securities, State Government Securities and units of gilt Mutual Funds into a single category and allowing investment up to 55% of their corpus, providing a flexible ceiling for various category of instruments instead of fixed investment ceiling as at present; providing new category of instruments, such as rupee bonds of multilateral funding agencies, money market instruments and permitting investment in term deposit receipts of not less than one year duration issued by scheduled commercial banks.
The new investment pattern also recognises the fiduciary responsibility of the trustees and the need for exercise of due diligence by them. It gives them greater flexibility in terms of a wider variety of financial instruments as well as greater freedom to actively manage the portfolio. Moreover, the trustees will have freedom to exit from a rated financial instrument when their rating falls below investment grade as confirmed by one credit rating agency. The trustees have also been given freedom of trading in securities, subject to the turnover ratio (i.e., the value of securities traded in the year divided by average value of the portfolio at the beginning and end of the year) not exceeding two.
Significantly, the new guidelines have raised the cap on equity investments from 5% to 15%. Although when the draft guidelines for such a move were made in September last year, the finance ministry had suggested doubling their capital market exposure from 5% to 10% while reducing their exposure to government securities from 40% to 35%.
Interestingly, very few of the funds allowed to invest in equities have even utilised their cap of 5% present currently. Even the funds, which do invest in equities, have an exposure of only 1-2%. Further, with the recent spike in bond yields, government securities as well as corporate bonds have been giving returns of over 9%. This is well above the returns of 8.5% which these funds are supposed to guarantee.
While the bouquet of investment options has been expanded, trustees have been made more explicitly responsible for investment decisions. However, sections feel since India is yet to get professional trustee companies in place, the new options may remain unused as existing trustees may shy away from taking hard decisions. While market participants have welcomed this proposal, the general perception is that a number of other regulations need to change to make equity investments viable. The main bone of contention is that of the guaranteed returns of 8.5%. In case the fund fails to throw up an 8.5% return, the employers are expected to provide for the rest.
Hence only time will tell, how many of the funds will take the risk to increase their exposure to equity, given the current volatility in the markets and the history of investments by such funds in the stock markets. However if they do invest, it will provide a much needed fillip for the stock markets.
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