NPS Returns to Fall in 2014

The national pension scheme (NPS), floated by the Union government to manage pension corpus of more than Rs 55,000 crore of central government, state government and private sector employees, may post a drastic fall in returns for 2013-14. This would be in stark difference to the spectacular double-digit returns it generated in 2012-13.

The claim by the PFRDA-regulated NPS that they are the cheapest retirement option with the highest returns may take a big knock.

New-Pension-SystemLast year, NPS said their schemes, having the lowest fund management charge, had generated the highest returns in 2012-13.

According to fund managers of NPS, high bond yields this year would impact the returns for investors in the pension scheme for 2013-14.

As per the calculations done by Financial Chronicle with the help of an NPS fund manager, the weighted average returns for the government debt (G-sec) scheme for the private sector would be around 2-3 per cent for the year ending March 31, compared with 13.52 generated in 2012-13. Similarly, the corporate debt scheme would give 5-6 per cent return compared with 14.19 per cent in 2012-13, while the returns on central government and state government schemes would be in the range of 2-3 per cent compared with 12.39 per cent and 13 per cent, respectively, in 2012-13.

However, the only good news is that with the stock market doing well this year, the equity scheme for the private sector would give around 13-14 per cent return compared with 8.38 per cent in 2012-13.

Three fund managers told FC that high bond yields this year are to blame for the low returns on various schemes under NPS. For instance, the central government security maturing in August 2032 has a coupon rate of 8.32 per cent as on March 7. The trading price was Rs 92.12 on the National Stock Exchange (NSE). The weighted yield to maturity was 9.21 per cent. However, a year ago, the same security had a yield to maturity of 7.89 per cent as on April 18, 2013 with a price of Rs 103.42.

For beginners, the interest rate is inversely proportional to the price of a bond. If the yield of a bond goes up, its price falls. Alternately, if the bond price rises, its yield drops.

One fund manager who did not wish to be named said, “In 2012-13, the yields had fallen, so bond prices went up. Therefore, there were mark-to-market (MTM) gains in addition to interest income. From June 2013, the yields started rising. So, while interest income would be there, there would be more MTM losses.” Bond prices and interest rates are inversely proportional.

“Interest rate movements are cyclical and since NPS is a 20-year product, the losses get averaged out. With its lowest charges (compared with other pension products), NPS is likely to generate phenomenal returns over a longer period,” added the fund manager.

NPS was introduced by the Union government in January 2004 for new entrants and subsequently extended to all citizens from May 1, 2009. Last year PFRDA issued revised guidelines for registration of pension fund managers to manage NPS for private sector, under which eight pension fund managers have been registered so far — SBI Pension Funds, UTI Retirement Solutions, LIC Pension Fund, Kotak Mahindra Pension Fund, Reliance Capital Pension Fund, ICICI Prudential Pension Funds Management, HDFC Pension Management and DSP BlackRock Pension Fund Managers.

Under NPS, an investor can choose his fund manager and his investment option. In case he does not want to exercise a choice, his money will be invested as per the “auto choice” option, where money will get invested in various schemes as per the investor’s age.

NPS offers two approaches to invest money. The first one is an “active choice”, where individuals decide the asset class and their percentages. Asset Class E invests predominantly in equity market instruments; Asset Class C invests in fixed income instruments other than government securities and Asset Class G investments in government securities.

An investor can choose to invest his entire pension wealth in C or G asset classes and up to a maximum of 50 per cent in equity (Asset Class E). He can also distribute the pension wealth across E, C and G asset classes; subject to such conditions as may be prescribed by PFRDA.

The other option is “auto choice”, which offers an easy option for participants who do not have the required knowledge to manage their NPS investments. The funds will be invested in accordance with the auto choice option, under which the investment will be made in a lifecycle fund.

Here, a pre-defined portfolio will determine the fraction of funds invested across three asset classes. At the lowest age of entry (18 years), the auto choice will entail investment of 50 per cent of pension wealth in “E” Class, 30 per cent in “C” Class and 20 per cent in “G” Class.

These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in “E” and “C” asset class will decrease annually and the weight in “G” class will increase annually till it reaches 10 per cent in “E”, 10 per cent in “C” and 80 per cent in “G” class at age. Like the active choice, the investor must choose one PFM under the auto choice.

By Falak Naz