Is the NPS Equity Scheme an index fund?

A common misconception among investors is that the National Pension Scheme (NPS) schemes are passively managed like an index fund. This is incorrect. In this article, we discuss the investment policy of NPS Equity (E) schemes as approved by the pension fund regulatory and development authority (PFRDA).

The norms can be found on the public disclosure page on each pension fund manager’s website. This is a welcome move, as it was hard to determine the benchmark a few years ago. We shall use the investment policy of HDFC Pension for this article.

The top 200 stocks by market capitalization in either the NSE or BSE is the broad stock universe of the NPS. Some pension fund managers use BSE 200 TRI or NSE 200 TRI as the benchmark, and some use BSE 100 TRI or NSE 100 TRI.

NPS equity schemes (tier 1 and tier 2) are actively managed large and mid cap mutual funds. The investment objective is to optimise returns.

Where can NPS Equity Schemes invest?

1. Top 200 stocks in terms of full market capitalization listed in the NSE or BSE
2. Sensex or Nifty 50 Exchange Traded Funds (ETF’s)/ Index Funds
3. Equity mutual funds (not more than 5%)
4.  ETFs that are constructed specifically for the disinvestment of shareholding of the Government of India
5. Exchange-traded derivatives for hedging, regulated by SEBI, having the underlying of any permissible listed stock or any of the permissible indices, with the sole purpose of hedging (not more than 5%)
6. Initial Public Offering (IPO), Follow on Public Offer (FPO) and Offer for Sale
   (OFS) of companies, approved by SEBI. IPOs with market capitalization at the
   lower end of the IPO band higher than the market cap of the 200th stock are eligible for participation.

This “flexibility” and vague investment strategy is one of the main reasons investors avoid NPS or at least avoid NPS equity schemes.

At the very least, investors must question how effective these schemes are in beating BSE 200 or the NIfty 50 and how consistently they manage to do this. In the coming weeks, we shall take up each NPS equity scheme and analyse its performance consistency.