NPS or National Pension System is a retirement saving scheme regulated by the Pension Fund Regulatory Development Authority (PFRDA). It has its own exclusive tax break under Section 80 CCD (1B) up to Rs 50,000 per annum. The NPS has seven different pension fund managers under it and three categories of funds – equities, corporate bonds and government bonds. The fund managers can invest either directly in equities and debt or through mutual funds. The latter route, however, has the potential to significantly add to investor costs.
What the rules allow
The NPS, as mentioned above, has three types of funds – equities, corporate bonds and government bonds. PFRDA investment guidelines issued in May 2017 allow pension fund managers to invest either directly in equities or in equity mutual funds (within a minimum 65% equity allocation). In corporate bond pension funds, the pension funds concerned can either directly invest in bonds or in debt mutual funds. This is also true for government bond plans but here there is a limit of up to 5% of the total portfolio for debt mutual funds. In other words, pension funds investing in government bonds must directly buy government bonds for 95% of their corpus rather than go through debt mutual funds.
The cost problem
The pension fund manager fees in the NPS are capped at 0.01% of assets under management. This is less than 200th of the 2-2.5% expense ratios incurred in mutual funds.
NPS does levy other charges like contribution and custodian fees but these are imposed by other intermediaries and not fund managers. Even adding up all the charges under the NPS gives a total which is much lower than an average mutual fund expense ratio, including that of direct funds. For direct plans of mutual funds, the expense ratio falls to 1-1.5%.
Permitting pension fund managers to invest through direct mutual funds ‘hides’ the actual cost of investment by adding the mutual fund expenses over and above the pension fund management fees.
Most NPS Pension Fund Managers invest directly in stocks and bonds and do not incur this additional cost of investing through mutual funds. However, the option to invest through mutual funds remains open to them all. In one case, namely that of Kotak Pension Fund, investment is being made through mutual funds for its equities plan. The half-yearly portfolio as of 30th September 2017 indicates an AUM of about Rs 124 crore, of which 99.4% is invested in equity mutual funds.
The money is invested in direct plans and none of these plans belongs to Kotak AMC. However, by going through mutual funds, another major layer of costs is being added. The mutual fund schemes chosen by Kotak also show a preponderance of large-cap funds. With the overlap of stocks in various funds, it also removes the benefits of diversification.
NPS fund manager fees fixed at 0.01% may be too low for the pension fund managers to make any profits. This may make it more cost efficient for them to invest in mutual funds rather than directly research and select stocks and bonds. However, this is not in the best interest of NPS subscribers and it adds another layer of costs to their funds. The sector regulator should consider removing the mutual fund route whilst raising the overall pension fund manager fees to more economic levels.