1. Role of equity in retirement planning
Jiju Vidyadharan
Director
Funds and Fixed Income Research

2. Key Messages
Low penetration and inadequacy of savings represent twin challenges in Indian retirement space New investment options seek to address challenge of inadequacy Equity integral to global pension funds; suitable for long term Case for professional managers?

3. Twin challenges in retirement space
Atal Pension Yojana (APY) - a hybrid direct benefit plan – introduced to bring a large number of people in the lower strata of society into the pension fold
EPFO formed for the organised sector
NPS opened to public
1952
2004
2009
2010
2015
Government launches NPS to move government employees, joining from 2004, to the defined contribution format with market-linked returns
NPS Swavalamban launched to extend pension coverage to the unorganised sector and poorer strata of society
Insurance and mutual fund products have had limited success; India’s joint family system has historically been unsaid pension net Out of 11 crore retirees, only 0.5 crore covered under private pension Bias towards investments in fixed income securities has meant that returns are limited, and often inadequate to see one through sunset years

4. New investment options
Provident funds now have a wider set of investment options; at least 5% to be deployed in equity New options offer opportunities to generate higher returns
Product
Complexity of Structure
Risk/Return
Infrastructure Bonds (Banks)
Low
Medium
Infrastructure Bonds (Others)
IDF NBFC
Basel III Tier I Bonds
Equity, Index funds and ETFs
High
CMBS
RMBS
ABS
IDF MF
REITs
InvITs

5. Equity integral to global pension funds (1/2)
30 percent average allocation to equity across OECD countries
Country
Investments (Billion $)
December 31, 2014
Asset allocation (%)
Equities
Bills and bonds
Cash and deposits
Other *
United States
14,460
48.9
34.2
0.9
16.0
United Kingdom
2,685
21.8
37.3
3.0
37.9
Australia
1,639
50.0
8.8
17.7
23.5
Canada
1,298
30.1
35.6
3.8
30.4
Netherlands
1,282
38.8
42.5
2.7
15.9
Japan
1,221
9.7
36.9
5.7
47.7
Switzerland
788
29.4
7.2
29.2
Germany
236
4.5
53.4
3.5
38.5
Mexico
182
23.3
75.8
0.8
0.1
Chile
165
40.3
58.7
0.3
0.7
Israel
154
6.8
71.7
5.3
16.2
Denmark
152
60.2
23.7
Italy
131
19.7
48.7
3.2
28.4
Finland
126
31.0
3.6
26.6
Spain
122
10.7
64.0
14.8
10.5
Source: OECD Global Pension Statistics, OECD Pension Survey 2015,* "Other" category includes loans, land and buildings, unallocated insurance contracts, hedge funds, private equity funds, structured products, other mutual funds (i.e. not invested in cash, bills and bonds, or equities) and other investments.

6. Equity integral to global pension funds (2/2)
A similar trend within non-OECD countries
Country
Investments (Billion $)
December 31, 2015
Asset allocation (%)
Equities
Bills and bonds
Cash and Deposits
Other *
Brazil
251
25.6
54.9
0.1
19.4
Hong Kong (China)
110
61.1
21.7
13.1
4.1
Russian Federation 71
8.7
64.0
22.2
5.1
Colombia 64
27.6
48.5
3.1
20.8
Peru 38
61.8
11.3
5.3
Nigeria 27
12.0
70.4
12.6
5.0
Thailand 26
16.7
52.1
30.3
0.9
Croatia 11
22.7
72.5
4.4
0.4
Namibia 10
68.9
20.9
6.7
3.6
Kenya 9
26.0
38.1
6.2
29.7
Dominican Republic 7
0.0
78.2
21.8
Costa Rica 6
1.8
98.2
Romania 5
20.4
75.7
4.0
Bulgaria
18.7
64.9
12.1
4.3
Liechtenstein 4
29.4
43.0
6.3
21.4
Source: OECD Global Pension Statistics, OECD Pension Survey 2015,* "Other" category includes loans, land and buildings, unallocated insurance contracts, hedge funds, private equity funds, structured products, other mutual funds (i.e. not invested in cash, bills and bonds, or equities) and other investments.

7. Debt orientation reduces efficacy of savings
Since 1990, average retail inflation has been 7.13%, resulting in real return of 3%
In that period, the S&P BSE Sensex has given 14% CAGR, giving a spread of 7%

8. Investment in equities suits Indian demography
India’s demographic dividend : currently, 44% of India’s population is working age
Estimated to become 48% by 2050
Long-term horizon suits young population
Calls for greater allocation to long-term asset class (such as equity)
Source: United Nations data

9. Equity – high potential in long term
Attunes to long-term investment nature of retirement planning
Return distribution positive and in double digits in long term
No negative returns if invested above 15 years; minimum return over 30- year rolling period is 13%
Volatility decreases with increase in investment horizon
Retirement planning is long term in nature, equity attunes to this long term horizon in terms of returns and risk
India’s young population (average age less than 30 years) also have a long term investment horizon
Average 30% is allocation to equities in OECD countries(Organisation of economic co-operation and development) whereas India has started investing in equity with 5% by EPFO. (EPFO being the largest in terms of AUM (8.5 trillion) as compared to NPS which has 1.2 trillion which invest upto 15% in equities)
Period 10 years
Scheme Name Mean Returns Standard Deviation Sharpe Ratio
CRISIL – AMFI Gilt Fund Performance Index 7.72% % %
CRISIL – AMFI Income Fund Performance Index 8.29% % %
CRISIL – AMFI Short Term Debt Fund Performance 8.34% % %
CRISIL – AMFI Liquid Fund  Performance Index 7.53% % %
CRISIL – AMFI Equity Fund Performance Index % % %
Daily annualised rolling returns since inception (1979) of S&P BSE Sensex considered across various holding periods

10. Equity allocation to incremental flow (%)
Case study: Benefits of equity allocation
Based on performance trends of the past 15 years, 5% allocation to equity may add about 1% p.a. to overall portfolio returns
2.5% in case equity allocation increases to 15%
Equity allocation to incremental flow (%)
Amount at the end of FY 15
(Rs lakh)
Overall return
(Annualised)
Nil
31.44
8.79% 5%
34.19
9.75%
10%
36.78
10.57%
15%
39.16
11.28%
Analysis shows benefits of long term equity investment in PF portfolio, if an incremental flow of 1 lakh per annuam from FY 2000 to FY 2015, the total invested amount of 15 lakhs rupees would have become 31 lakhs. However, if equity is considered for investment during the analysis period, additional corpus of Rs lakhs would have been added by 5% equity allocation. Similarly, additional corpus of Rs lakhs would have been added at 15% equity allocation.
Assumptions –
Rs 1 lakh incremental investments each year
Debt returns assumed to be EPFO-declared rate every year

11. Case for professional management
Given increasing complexities in investment options for retirement funds, professional management is an option for consideration
Investments can be routed through
Mutual funds
Portfolio management services (PMS)

12. Inherent benefits of professional fund managers
Professional management – A dedicated team helps better analyse investment opportunities in the market Research and credit function – An independent research and credit function aids investment Focused risk management – Imperative to manage inherent risks in the asset classes

13. Equity mutual funds offer options for active and passive participation
Passive funds include index funds and ETFs
Seek to replicate composition and performance of benchmark indices
Tracking error is the key metric for choosing the best fund
Active funds include large cap, diversified, small and mid-cap and theme funds
Seek to generate alpha over the chosen benchmark index
Risk-adjusted returns key metric for choosing the best fund

14. Active management may add additional returns
Large cap mutual funds* generated alpha of 3% per year over Nifty 50
14% annualised returns since April 2000^
*Represented by CRISIL – AMFI Large Cap Fund Performance Index
^ Inception of CRISIL – AMFI Large Cap Fund Performance Index

15. Thank you