EPF NEEDS EQUITY TO GROW.

Some arguments just don't die. Once again, we are hearing about the Employees' Provident Fund Organisation's (EPFO) plans to invest up to fifteen percent of its corpus in equity. We can also hear the alarm bells ringing about risking the hard-earned money of workers in stock markets. On the one hand we have an equity market in which international pension funds invest, so that their investors can get a better risk-adjusted return. And then we have our own retirement corpus of the working and salaried class that is steeped in ideas of the 1950s. 
International managers take the risk of putting the retirement savings of ordinary folks in distant emerging markets like India. They are required by the law of their land to act in fiduciary capacity. The penalties for wrongdoing is high. The processes and procedures for deciding how the money will be managed is far more stringent than what we have in India. The investment advisers and managers are paid based on the performance of their portfolios, and they would be very unwilling to take risks. They are therefore inclinced towards emerging markets, which offer better returns while reducing the overall risk of the portfolio.
That is the question one should ask the Ministry of Labour and Employment. Why cling to the world of the 1950s when the EPF Act was promulgated? The answer lies in the design of the EPF. Look at the annual reports of the EPFO and you will fins page after page of data and information about contributions, service and compliance. Search for information on the website, you will find the tremendous advances that have been made in all aspects of the service.
The EPF sees itself as the central government agency that strives for the right of the subscribers to know what the balance in their account is, take loans and advances against it, draw it on retirement, and ensure that the employer has contributed their share is promised. Pursue the long list of case laws, and most are about errant employers, penalties for not contributing, and lack of service. It is very difficult to find evidence for an organisation that sees itself as an institutional investor managing nearly Rs. 8 lakh crore of small investor's money, acting on behalf of its subscribers. There is only a safe-keeping, service and compliance orientation.
Another problem is that since the scheme was formulated in the 1950s, the treatment of contributions is as if they were only entitled to simple interest. The idea is to hold the money on behalf of the subscriber and pay an annual interest. The law requires controls on administrative expenses, and asks that all incomes to be taken into the 'interest suspense account'. At the end of each year, the Central Board of Trustees (CBoT) who are responsible for managing the money would recommend a rate of interest to be paid for the year. After the approval of the Finance Ministry, this rate would be announced and credited to the subscriber accounts.
If the CBoT decides to invest in equity markets, it should be able to earn an annual income and earn positive returns each year, so that it can be credited to members. The design just asks for an annual crop of grains that will be sown and harvested to a season. It has no scope for fruiting trees that can be grown with less effort, over a longer period, to yield good harvests. There is no scope to invest in a growth asset that will appreciate over time. There is no harvesting the benefit of diversification, using a small portion in equity to enhance return while reducing risks. There is also no concept of marking to market, declaring the current value of the investments, or allowing subscribers to know the appreciation in their portfolio. Nothing but pure realised interest income matters, not even the fact that bonds and debt securities also carry credit risk, and would require supervision and management.
The choice of managers to make the investment decisions is not based on performance, but on low cost. The mandate for the managers is for three-year period. But if an annual rate of return is declared, everyone assumes that all is well. 
Retirement planning is not about earning a constant rate each year. It is about being able to set aside money for a long period, allowing it to grow so that it gets an opportunity to appreciate in value. The investment objective is growth, but the EPF's investment portfolio is in income assets. A classic case of asset allocation that is not aligned to the need of the investor. Which is why the fifteen percent equity allocation is something the Ministry should push for, in the interest of delivering some growth in the portfolio. Investing in a large-cap index as the CBoT currently does with the five percent equity allocation, is a good start to introduce the benefit of equity to the subscribers. Slowly the orientation should change away from income to growth.
[Based on an article written by Uma Shashikant, Chairperson, Centre for Investment Education and Learning , published in Times of India dated 27th March, 2017 (Monday), p. 16]. 
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