Every person who thinks about long term investment of his money wants to park it in a place which requires least of the attention and provides good returns with low risks. One such vehicle of investments is the government’s National Pension Scheme.
This blog post particularly discusses the advantages and the downsides of investing in the National Pension Fund Scheme’s Equity Class Tier-II scheme.
National Pension Fund Scheme (NPS)
A national pension fund scheme is a plan offered by the government through which people can contribute to long term saving (especially for post-retirement) through an NPS account opened through specified financial institutions. There are various categories in the NPS scheme in which people can invest.
Investing into Scheme E of Tier-II type National Pension Fund Scheme (NPS) for minimum of three years to get almost risk-free cumulative return above ten percent at end of three years. The investment can be done in bulk per year or via SIP.
Here are some reasons on why we chose NPS Tier II Equity Scheme from other options which may give better returns or have lower downside:
1. NPS funds have much lower operating costs than mutual funds while it takes away the headache of successfully investing into equities.
2. Mandatory investment of 50-70% of the corpus in bonds and government gilt papers make it the safest return wise. Equity mutual funds may give better returns but only during market upturns. Conversely, debt fund returns are much lower than Equity Oriented Tier II NPS in the long run i.e. over three years. Liquid or money market funds have the lowest downside risk but their returns barely cross 8-9%.
3. TIER-II -NPS principal amount gets tax deduction under 80C up to rupees 1.5 L.
4. Can change fund manager (PFM)or switch between active and auto choice of investment.
5. May get special benefit of additional savings under Section 80 CCD (1) in future.
6. Auto choice rebalances the risk profile automatically with age of contributor. It exposes him to lesser return downfall risks as he ages and his corpus compounds. This algorithm is in built in the Auto mode of NPS Tier II investment.
NPS vs Mutual Funds and Stock Markets
There are indeed plenty of mutual funds providing above 11-12% returns. However, none can claim to be totally downside free in their bad days. Debt funds were considered to be risk free savior of investment. However, recent debacles of NBFC behemoths like ILFS, DHFL and Reliance money have shredded this invincibility. Mutual funds or ultra-aggressive NPS funds (having equity exposure above 50% and below 75%), choose the best of debt papers and equities based on credit ratings. However, even AAA+ credit ratings have proved to be inadequate in guessing huge lapses in these companies.
Secured debts and underlying equities have crumbled, leaving their paper holders knocking doors of debt tribunal. However, maximum 50% equity type Tier II NPS has however proved to be resilient.
Let’s Talk About The Returns
Aggressive pension funds with maximum equity exposure of 50%, such as HDFC Pension fund, UTI retirement solutions have provided an excellent 3-year CAGR return of above 12%. ICICI Prudential, SBI, Kotak, LIC Pension fund, all selling aggressive Equity type pension funds within 50% limit, have provided average returns of above 11% over three years.
E-type equity funds under Tier-II NPS, can invest a maximum of 75% and minimum of 50% of their total AUM in markets related mutual funds. The rest has to be invested compulsorily in corporate bonds (providing a greater rate of interest than interest linked government bonds or gilts) and in government treasury bills, which carry the highest sovereign safety along with coupon rates just above the ongoing interest.
50% equity investment and rest 50% bonds and gilts investment combination in Tier II NPS- Active option provide the best market related income cushioned by perpetual positive and fixed income from bonds and gilts.
Balanced NPS funds have also given returned above 10%. Balanced NPS funds have equity, corporate bonds and gilt funds in 33.33% ratio each. Tier II E type NPS gives us the flexibility of deciding the ratio of investment into equity and into bonds, provided equity investment does not cross 75% of the total corpus.
The Scheme E (equity) - Tier II NPS or Equity category NPS – Tier II as investment can get the investor cumulative risk-free returns above ten per cent. But please note that the period for getting such returns cannot be less than continuous three years of premium payment via lump-sum or SIP.
The Other Classes Of NPS
Earlier, pharmacy stocks were considered to be the safest bet among Indian equities. They were invincible. The world cannot live without medicines and Indian pharma majors like Sun Pharma, Cipla, Lupin, etc. were major drug suppliers to US and Europe at lower costs.
However, Trump’s “America First” policy and tough FDA inspection and regulations have changed the scenario and pharmas are major laggards now.
Similarly, bond yields have shot up owing to underlying company risk profile increase. This has led to either lower selling price of bonds or mark to mark losses. Sometimes, the underlying company has defaulted leading to complete write-off of its bonds.
These factors have led to subdued return (below 9%) in conservative and ultra-conservative type of NPS funds. In short, debt papers have not provided the resilience investors expected.
Hence with all the downsides to the G Scheme or C Schemes, the returns on E Scheme Tier II active (50% Equity) are definitely sounder.