InvestorQ : Is it true that the Employee Provident Fund Organization (EPFO) is going to allocate more of its money to equities from this year?
Dawn Cherian made post

Is it true that the Employee Provident Fund Organization (EPFO) is going to allocate more of its money to equities from this year?

Mitali Bhutta answered.
11 months ago

As per the latest recommendation made by the Finance Committee of the CBT, the total equity exposure upper limit may be hiked for EPFO from the current 15% to 20%. The base exposure level will stay at 5%, and only the upper limit will be hiked from 15% to 20%. That would mean more EPFO money coming into stock markets. EPFO is not currently permitted to invest in direct equities but it can invest through the ETF (exchange traded fund) mechanism, which is more passive. The final decision on this subject is awaited.

Where it stands is that the Finance Committee of the Central Board of Trustees (CBT) of EPFO has proposed raising equity exposure upper limit for EPFO to 20%. This decision still needs to be ratified by the Provident Fund Trustees and would be later put up to the Ministry of Finance for final approval. For instance, the trade unions have bene traditionally against the concept of EPFO investing in equities as it entails higher risk and could also lead to capital depletion of the hard earned savings of the employees.

Currently, the EPFO assets under management (AUM) is fairly imposing. With total EPFO AUM of Rs17,00,000 crore and having more than 24 crore member accounts, it is half as large as the Indian mutual fund industry in India. Each year, the EPFO sees an AUM accretion of approximately Rs230,000 crore to the corpus and close to 65 lakh subscribers are added each year to the EPFO list. So, numbers are surely mindboggling and it can make a significant impact on the equity markets overall.

There is a small catch here. The enhanced limit from 15% to 20% will only apply to the incremental corpus and not to the overall corpus. Consider the numbers.On an annual basis, the EPFO AUM accretion is Rs2.30 trillion. Now, an additional 5% would imply an extra Rs11,500 crore being invested in equity ETFs, which is large enough to make a meaningful impact on the equity markets. What is more important is that the EPFO money is stable money and is likely to stay invested for a very long time.

The decision is not hard to understand. EPFO has been challenged by falling income levels from its investment due to tepid returns on debt. To add insult to injury, the interest rates rising means yields going up and bond investments facing price depletion risk. For the year 2021-22, the EPFO declared an interest rate of just 8.1%, which is the lowest level of interest paid in nearly 40 years. The additional 5% in equities can ensure more alpha for the investors and ensure a better annualized yield for the provident fund investors.

The upper limit in equities has remained at 15% since 2017, so the proposed hike to 20% is a step in the right direction. Globally, long term money like provident funds and pensions are predominantly investedin equities and other risk assets, since risk is neutralized in the long run. The anomaly in India was that the long term funds of the EPFO were being invested in debt for ages. That was fine when debt was paying exorbitant returns, which is not the case any longer. Now, the only option for EPFO is to enhance exposure to equities.