Pensions: the missing link for mutual funds in India

The success of India's opposition party in the state assembly election result earlier this month has injected some optimism into the domestic stock market, but fund managers point to this as short-term euphoria.

With a general election due next year, Indian stock prices could benefit further from hopes that the opposition, the Bharatiya Janata Party (BJP), might usher in a more stable government and reforms to tackle the country’s fiscal woes, say some market observers.

(For example, the government hopes to keep the fiscal deficit to 4.8% of GDP for the fiscal year 2013-14, but analysts doubt it will be able to do so.)

In the state assembly election on December 8, the BJP won three out of the four states: Chhattisgarh, Madhya Pradesh and Rajasthan. The Sensex benchmark stock index then hit an all-time high of 21,326.42 on December 9 on optimism that the BJP success would pave the way for victory by the party’s candidate for prime minister, Narendra Modi, in the upcoming general election in May.

However, asset managers say equities will only benefit long term if more pension money comes into the stock market via mutual funds.

Some argue that at least momentum is building in the right direction. “The discussion within the industry [around establishing retirement saving schemes to spark investment by pension funds] has garnered more attention among the various regulators this year,” says Puneet Chaddha, India CEO of HSBC Global Asset Management in Mumbai.

The funds industry as a whole wants to be able to create long-term pension plans with tax benefits for both salary earners and the self-employed small business owners who have no saving schemes of their own, he notes. The latter is estimated to account for some 80% of the nation’s entire workforce.

Very little Indian retirement savings are invested in long-term mutual fund products or equities generally. Only 0.3% of the country’s $200 billion in financial savings is invested in stocks. Some estimate that as much as 80% of the free-float of India-listed corporates are owned by foreign institutions. Gold and real estate are still the preferred assets for saving and investment.

What would channel more national savings into the stock market, argue asset managers, are regulatory changes to allow pension fund assets into mutual funds.

There are two main retirement saving options open to inviduals: the Employee Provident Fund Organisation (EPF) and the National Pension System (NPS).

The EPF is a mandatory scheme to which employees and employers must each contribute 12% of the employee's salary. It oversees the pensions of 85 million public- and private-sector employees, but is only allowed to buy government and corporate bonds and money market instruments.

The newer NPS, backed by the Pension Fund Regulatory and Development Authority (PFRDA) bill passed in September, is a voluntary defined-contribution scheme open to all individuals including the self-employed. Eight fund managers have been engaged by the PFRDA to manage members’ money.

But asset managers must form a separate pension fund division if they want to manage assets for NPS members; some say the low management fee – under 10 basis points – has dampened their interest.

Such impediments for asset managers are hindering growth of the country’s mutual fund industry, says Ashu Suyash, chief executive of L&T Mutual Fund. Their hands are tied as they cannot attract institutional equity business as sub-advisers of the country’s national pension schemes.

“Pension fund money is what gives the asset management industry predictable flow and longer-term customers and assets,” says Suyash. “If the government eventually allows pension money to flow into mutual funds, that could be the tipping point for the industry and we would also then see sustained domestic flows into the equities market.”

As at November 30, India’s asset management sector has a total AUM of 889,952 crores ($144 billion), according to the Association of Mutual Funds in India. Equities represent only 17% of the total, with the bulk of assets in income and money market funds.

Equity funds also saw the biggest year-to-date outflow in 2013, of 7,652 crores. The biggest inflow went to money market funds, at 139,901 crores.