Why you should avoid equity (scheme E) in your NPS portfolio!

image of a hand indicating stop to signify why you should avoid equity scheme E in your NPS portfolio!

Published: May 22, 2020 at 10:37 am

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The NPS has a portfolio management fee of 0.01%. There is an additional custodian fee of 0.0032% and various transaction fee applicable on the investment amount (much like an airline charging extra for the seat, leg space and food). Nonetheless, a fee of 0.01320% is not only enticing but also leads one to assume we would be investing in an index fund at least in the equity scheme (type E). Is it the case? Here is why you should not include any equity in your NPS.

At 0.01%, the NPS fee is comparable to that of the Bharat 22 ETF. A Nifty ETF is five times more expensive. A Nifty index fund is ten times more expensive. So it is natural to assume, “if invest in NPS E scheme, we would be investing in a low-cost index fund”.

First of all, what is the benchmark index for the E scheme? Even basic information like this is hard to find! Let us assume it is either Nifty 50 or Nifty 100. It is quite easy to check if a fund is tracking the index or not. According to the April 2020 factsheet, the NIfty 50 holds 11.54% of Reliance Industries and 10.56% of HDFC Bank.

UTI Nifty 50 Index fund holds 11.56% of RIL and 10.58% of HDFC Bank.  HDFC Nifty 50 Index fund has 11.54% and 10.56% of these stocks respectively. Not bad at all.

According to the April 2020 factsheet of SBI Pension Fund, it is Tier 1 Scheme E has 7.74% of HDFC Bank and 7.75% of RIL. Maybe it is tracking the NIfty 100? No, because the fund has only 61 stocks (should have pointed this out first, but counting stocks in a PDF file is hard)

Now, the NPS Trust released return data regularly but does not mention what the benchmark is! After looking at the returns of 228 indices, the closest match I could find to the 1-year return shown below is S&P BSE Sensex 50 – TRI.

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Pension FundReturns
1 Year
Birla Sun Life Pension Management Ltd.-13.76%
HDFC Pension Management Co. Ltd.-14.80%
ICICI Pru. Pension Fund Mgmt Co. Ltd.-18.04%
Kotak Mahindra Pension Fund Ltd.-16.29%
LIC Pension Fund Ltd.-19.64%
SBI Pension Funds Pvt. Ltd-17.29%
UTI Retirement Solutions Ltd.-17.89%
Benchmark Return(?) as on 15/05/2020-16.56%

However way we look at it, the NPS E Schemes are not index funds! They are low-cost actively managed funds and that is precisely the reason why you should not invest in them.

If you want proof over longer periods of time, check NPS equity schemes underperform Nifty, Nifty 100: time for passive approach?

The NPS is a close approximation to a black box. The investment strategy is either unknown or hard to locate; The same for the scheme benchmark. Historical NAV is hard to source; Some pension fund manager sites like LIC give an error when you try to access; The whole framework is a complete mess.

Under these operating conditions, the PFRDA would be better off with a simple index fund instead of going the active way and not paying the firms enough for it! Investing in a low-cost active fund with an unknown strategy is a terrible idea.  They simply do not have the incentive to outperform especially when there is no star rating to worry about and no one is really looking closely.

What should investors do?

  1. Avoid the NPS if you have a choice: EPF vs NPS: Should you shift to NPS because the govt wants you to?
  2. If you do not have a choice (like me): minimise E scheme exposure as much as possible – ideally zero. Use a combination of gilts and corporate bonds. In my case, I have a default 15% E scheme exposure which I have left alone due to inertia. See: Ten years of investing in the NPS: Performance report
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    1. Can I invest 100% in GOI BONDS? Investment Rs. 4000/= p.m.
      Which Pension Fund is suitable for this type of investment,if it is allowed. Please guide.

  1. Have you considered the additional tax saving in NPS? Considering an average 20% tax in an year, I would assume NPS far exceeds in realized returns?

  2. It took me 2 minutes to find out PFRDA guideline to equity investments and the benchmarks used by individual fund houses.

  3. Post changes in the PFRDA investment regulation vide circular No PFRDA/2015/PFM/08 in September 2015; company has changed the fund
    management strategy of the equity schemes. Due to this change, the benchmark of the scheme has been changed from Nifty 50 to Nifty 100 TRI
    effective from October 01, 2015. hence since inception returns is not comparable with Benchmark returns. The benchmark return mentioned
    above represents the return of existing scheme benchmark, which is Nifty 100 TRI .

    Found for HDFC pension manager. I think NPS equity is good option.

  4. You have no where mention that how much Tax one can save while investing in NPS. NPS is a pretty gud option from my point because even if a individual is in 20% tax bracket he can anywhere save 10-15k annually by Investing 50k in NPS….and going by the returns NPS has given which comes approx 10% it is not at all a bad option

  5. Thank you for clearing this misconception that NPS (E) option was a low cost index option.

    I am planning to activate NPS Tier 2 purely as a long term (10+ years) debt (C + G only) allocation, after seeing the recent risks in the MF Debt space (FT issue and others). Do you recommend such a action?

  6. Dear Sir,

    On Value Research website, NPS data is available to review. You can filter by Tier, by plan and by AMC. You can choose time range between 6 months, 1 year, 3 year and 5 year to review performance.

    When compared to past 5 five year performance of NPS Tier 1, Equity scheme in VR website, out of the 7 AMCs, 6 AMCs have data (ABSL was not part of NPS earlier hence not available).

    Out of the 6 AMCs that have data, 3 AMCS have given returns that is comparable to a Nifty 50 Index fund with a minor variance of 20bps (reference used is ICICI Nifty 50 Index direct plan), 1 AMC has out performed by ~75bps. 2 AMCs have failed to out to out perform Nifty Index fund. Of the 2 AMCs, one missed by ~75bps and 1AMC missed by a wide margin of ~200bps.

    Use case to illustrate: Someone having INR 50,000/- as ‘Basic’ component of their salary choose to contribute 10% of their Basic to NPS per month and also choose to additionally contribute INR 50,000/-, would end up contributing INR 1,10,000/- to NPS annually. With a 20% tax slab, they gain INR 20,000/- as tax breaks. If they choose an alternate investment option for this INR 1,10,000/-, they miss out on the 20% returns they get in the form of tax breaks.

    Request you to consider various such use cases of NPS subscribers and call out merits and demerits of investing in NPS. This way, we would be able to make more informed investment choices.

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