InvestorQ : Was the EPFO right in getting into equity ETFs or should have just stayed on in debt instruments only?
Archita Jajjoo made post

Was the EPFO right in getting into equity ETFs or should have just stayed on in debt instruments only?

Answer
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Niti Shenoi answered.
2 weeks ago


This issue has been discussed time and again in the past and there are two aspects to understand on this debate. Firstly, equity is still the best asset class over the long term and secondly, debt yields are too low and will probably trend lower than this.

Compare how the yields have fallen in India in the last 15 years. In the past, returns on debt used to be around 10-12% so the EPFO could actually afford to pay higher returns to the PF holders by just investing in debt. That is not possible any longer.

Rates are already at their lowest ever and that is not good news for debt investments. That is the reason the EPFO has had no choice but to go for equities via the ETF route, which is a relatively safer way to participate in equities.

That is also the global trend. Globally, long term liabilities are always matched with equity assets which means short term fluctuations are par for the course. In this case, the negative returns on equities are magnified due to the low level of returns on debt.

Clearly, there is no rethinking and equities are a must in any EPFO portfolio. Provident funds and pensions represent long term liabilities and only equities have the potential to generate above average returns in the long run despite negative yields, at times, in the short run.

The EPFO must not only persist with equities but also adopt a dynamic approach. That would mean a P/E benchmarked approached wherein EPF automatically invests more in equities when valuations are lower and vice versa, to get the best impact of markets.

Investors and the government must appreciate that in the current context, 9% assured returns with zero risk is impractical. The focus must be on equities and the focus must be on the long term where above average returns are possible on equities.

One option is that the EPFO moves towards a more dynamic reward structure wherein the assured component is lower. Variable returns can be benchmarked to market so that investors get the best of the market in the long run. That would be a saner approach.