NPS needs more transparency to inspire customers’ trust
For a retail investment product that was designed to offer
retirement income to millions of people who lack options to invest for their
sunset years, the National Pension System (NPS) has everything going for it:
state-of-the-art architecture, lowest-cost model and a regulator entrusted with
the job to regulate as well as develop the market for the product.
Sadly, the product hasn’t really gained enough traction in
three years since it was launched in 2009. Troubled by the poor uptake of NPS,
the Pension Fund Regulatory and Development Authority (PFRDA) has taken a
series of measures to increase its footprint, but in doing this it seems to
have committed one cardinal error. As a regulator it has failed to uphold its
most fundamental role: of making full disclosures and enforcing transparency.
At least four out of six pension fund managers that handle
funds for the private sector at present have sub-contracted fund management to
mutual fund companies by investing in their index funds rather than creating
their own index funds. There are three fund options that NPS offers: government
securities, fixed income instruments other than government securities and
equities. In case of equities, in which you can invest no more than 50%,
investments have to be made in index funds that replicate either BSE’s Sensex
or the National Stock Exchange’s Nifty.
However, in doing so, they are well within rules. PFRDA
allowed them to invest through existing index funds of non-sponsored mutual
fund companies as pension fund managers claimed that the money they received
was not enough to invest directly in the indices. While PFRDA considered the
fund managers’ case of paucity of funds, it failed to tell NPS investors of
this little detour. The industry argues that it’s an interim arrangement and
once fund managers have sufficient corpus, which they do now, they would invest
through their own index funds.
But this interim arrangement is not without impact. To begin
with, with this discovery, NPS no longer remains the cheapest investment
vehicle. On the face of it, existing NPS investors pay an annual fund
management charge (FMC) of 0.0009% per annum, by far the lowest in comparison
with other market-linked products, but in reality, they incur an added annual
cost of the existing index funds. Index funds offered by mutual funds have an
expense ratio or an annual cost of up to 1.5% a year that gets reflected in
their net asset value (NAV). This makes NPS more expensive than index funds in
India.
The fact that NPS has become expensive, although
temporarily, is not the main worry. The worry is the lack of disclosure and
transparency. A temporary increase in the effective fund management cost does
not dent your returns significantly over a long investment horizon. For
example, with a fund management charge of 1.75% per annum in NPS in the first
five years, the FMC for NPS has been increased to 0.25% from November, and
0.25% subsequently for the next five years, an investor would still be better
off in NPS speaking purely from the cost point of view as compared with a
managed fund.
But it’s the lack of disclosure that dents the credibility
of the product that is still struggling to become popular and is competing with
other investment products that come with a better incentive structure for the
distributor. When I first interviewed the first chairman of PFRDA, Dhirendra
Swarup, who was instrumental in giving NPS its superior design, the one thought
that resonated throughout the conversation was that NPS would be a pull
product. In other words, it would not need the hard-sell of the distributor;
owing to its design, flexibility and simplicity, consumers will automatically
invest in the product. But in order to make NPS attract investors, full
disclosure and complete transparency are essential at each step and for every
little modification in the product.
Moreover, this is not the first time the problem of
transparency or disclosure has come to the fore. Last year, Mint Money tried to
work out numbers to see how the NPS funds had performed, but realized that
pension fund managers had not disclosed historical NAVs or portfolios on their
websites. When asked about the disclosures, they said the regulator had allowed
them to not disclose all data on the website. Some of the pension fund managers
have still not disclosed their portfolios on their websites.
Right now, PFRDA has an advantage of regulating a young
product suite. By addressing issues of transparency and disclosures, the
regulator will draw up robust boundaries for the product that will only go on
to inspire customers’ faith. Even as PFRDA has the dual role of regulating and
developing the sector, those roles needn’t be at loggerheads with each other.
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