The Employees' Provident Fund Organisation (EPFO), which manages the retirement savings of over 60 million subscribers in India, has decided to modify the redemption policy for exchange-traded funds (ETFs) in a bid to boost returns for its subscribers and shield its income from market volatility. The decision was taken at a recent meeting of the Central Board of Trustees (CBT), the highest decision-making body of the EPFO, held in New Delhi. Under the new policy, the EPFO will redeem its ETF investments in a phased manner instead of selling them all at once. This will enable the EPFO to take advantage of the fluctuations in the stock market and sell its investments when the prices are favourable, thereby enhancing its returns.
The EPFO started investing in ETFs in August 2015 and has since then allocated a substantial portion of its corpus to this asset class. As of March 2021, the EPFO's investment in ETFs stood at Rs. 1.86 lakh crore, accounting for about 15% of its total investible corpus. However, the EPFO has been facing criticism from some quarters over the performance of its ETF investments, which have lagged behind the broader market indices in recent years. This has led to calls for the EPFO to review its investment strategy and take steps to enhance its returns. The new policy of redeeming ETF investments in a phased manner is seen as a step in this direction.
The EPFO will now sell its ETF investments in tranches of up to 5% of its holding in a single ETF in a single trading session. This will allow the EPFO to take advantage of the liquidity in the market and sell its investments without causing any significant impact on the market price of the ETF. In addition, the EPFO has also decided to increase its investment in ETFs that track the Nifty 50 and the BSE Sensex, two of the most widely tracked stock market indices in India. The EPFO will now invest up to 15% of its incremental corpus in these ETFs, up from the earlier limit of 10%.
Some experts have called for the EPFO to consider investing in a broader range of ETFs, including those that track mid-cap and small-cap indices, to diversify its portfolio and reduce the concentration risk. However, some critics have raised concerns over the volatility and risks associated with ETFs, especially during periods of market turbulence. They have called for the EPFO to adopt a more cautious approach and invest a larger portion of its corpus in fixed income securities such as bonds and debentures.
To improve returns for its subscribers and shield its income from market volatility, the EPFO has also proposed to increase the minimum holding period of ETF units to "over four years" before they are redeemed, up from the current four-year period. The EPFO may also link the return threshold of ETF units to government securities, where the holding-period return of the units that are proposed to be redeemed should be at least 250 basis points more than that on the 10-year benchmark government security. Another suggestion is to benchmark ETF returns to historical long-term averages, where the holding period returns of the units to be redeemed should be above the average five-year returns of the past 10 years based on the Nifty or Sensex.
To shield redemptions from short term market volatility, the EPFO has also proposed spreading the period of redemption to a daily basis, instead of a shorter period of time. The amendments are expected to smoothen the internal rate of return and maximisation of capital gains on redemption of ETF units.
In conclusion, the EPFO's decision to revise its redemption policy for ETFs comes at a time when the Indian stock market is witnessing a surge in investor interest, driven by a combination of factors such as a robust economic recovery, supportive government policies, and ample liquidity. The move to increase the holding period for ETFs is aimed at promoting a long-term investment mindset among EPFO subscribers and reducing the volatility of its investments. While this may result in lower liquidity for the ETF market in the short term, it could lead to more stable and sustainable returns in the long run. Overall, the EPFO's decision reflects a prudent approach to managing its investment portfolio and aligns with its objective of providing stable and secure returns to its subscribers.
The author is a Chartered Accountant with 2 decades of experience into Accounting, Taxation, Auditing, Risk & Compliance, Credit Controls, Due diligence. Currently, the author is the founder and managing partner at RRL Global services.
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