The greatest strength of NPS (New Pension Scheme) is its low cost structure. As per existing guidelines, investment management fee or fund management fee is capped at 0.01% p.a. The low management fee is partly due to low bidding by pension fund managers in order to shore up their asset under management (AUM). The other reason is that NPS corpus (especially the equity fund) has to be managed like a passive index fund. The cost of an index fund is much lower because there is little fund manager discretion exercise. To know more about NPS in general, you can go through this post.
Existing Cost Structure of NPS
Let’s look at the existing cost structure of NPS.
Investment management fee is a percentage of accumulated corpus. The fee (0.01% p.a.) is indeed low considering even the basic Nifty and Sensex index mutual funds in India have an expense ratio of over 1%. I do concede that the entire expense ratio is not the fund management fee. However, the difference is still quite big.
For every installment, there is an entry load of 0.25% of the transaction (Point of presence transaction charges). So, 0.25% goes straightaway and does not even get invested.
Revised Investment Guidelines for NPS
Recently, PFRDA, the pension regulator, revised the investment guidelines of NPS schemes for government and corporate sector and private citizens. Though there are minor differences between the two set of guidelines in terms of maximum exposure to different asset classes (Government Securities, Equity, Corporate Bonds, money markets and asset backed investments), the point to note is that active management of funds has been allowed.
A fund management fee of 0.01% p.a. is too low for active management and is certainly not sustainable from the perspective of the pension fund manager.
Contrast this with expense ratios of actively managed equity funds which range from 2-2.5% p.a. Again, expense ratio covers many charges other than fund management fees such as distributor expenses and administration charges. Still, even if you consider 1% of charges are due to fund management, it is 100 times the existing fee in NPS.
Why would an AMC want to be in NPS business with such fees?
PFRDA is about to invite bids for Pension Fund Mangers
Well, that is about to change. As per this recent Business Standard article, PFRDA is expected to invite bids for pension fund managers soon. The industry is demanding is fee of 1% p.a.
With the active management of funds allowed, the pension fund managers have a case for demanding higher management fees. At 0.01% p.a., they probably wouldn’t manage the fund actively even when it is allowed.
Though I am not sure of the bid outcome, I feel the bid will settle much higher than the current rate of 0.01% p.a. There is not much in the game of pension fund managers at 0.01% p.a.
So, the investment management fee is likely to go up. With it, NPS is likely to lose its low cost structure very soon.
Hence, the costs for NPS subscribers are likely to go up.
Double incidence of cost
As per the latest investment guidelines, Pension fund managers can also invest in mutual funds. In such a case, you will have to pay the actual mutual fund indirectly (in form of expense ratio) and pay pension fund managers for managing your NPS corpus.
For instance, if you select ICICI Prudential Pension Fund Management Co. Ltd as your pension fund manager and it invests your money in ICICI Prudential Focused Blue Chip Fund, you will bear the expense cost of MF scheme indirectly (expense ratio). Over and above that cost, pension fund manager will charge you a fee (by cancellation of units). Hence, for you, there is double incidence of costs.
I personally NPS subscribers will feel cheated if the pension fund manager simply takes the money and invests in a mutual fund. You can do that yourself. There is no need to pay a percentage of your corpus to pension fund manager to invest in a mutual fund.
Please note it is not that pension fund managers can invest only in mutual funds. They have many other options such as direct equities, ETFs, corporate bonds etc. Please visit these links for exact investment guidelines for Government and Corporate Sector NPS and Private NPS.
PersonalFinancePlan Take
The biggest problem of various financial services regulators and various select and advisory committees is that they always want to come up with a “One Size Fits All Solution”. That never works. Of course, you can have a product that provides insurance benefits, guaranteed investment returns and lifelong pension guarantee. However, such products are likely to be expensive (high cost structure). Insurance and investment dual products such as traditional insurance plans are a case in point. NPS was a fine product. I am not comfortable with EET tax treatment but that is not under the control of PFRDA. Under the revised investment guidelines, they have allowed investments in Real estate investments trusts too. I think they want to give NPS subscribers flavor of every asset class so that he/she never feels left behind. However, by trying to mean everything to everyone, they have quite likely comprised its greatest strength of low cost structure.
In my opinion, NPS should have been left to be passively managed. Those who wanted the benefit of active investing could have simply gone to equity mutual funds. That way, pension fund managers would have had a weaker case and the rise in the investment management fee would have been lower.
Well, PFRDA is yet to invite bids and the outcome may be quite different from what I am thinking.
Deepesh is a SEBI registered Investment Adviser and Founder, PersonalFinancePlan.in
10 thoughts on “NPS likely to get more expensive”
Investing online via CRA will not impose 0.25% ?
https://enps.nsdl.com/eNPS/LandingPage.html
I understood, I can invest every year online via the same above site without the load 0.25%. Please clarify
Also please explain, detailed procedure to apply NPS directly via CRA
Dear Sunil,
I am not a NPS subscriber. Hence, I am slightly challenged on operational issues.
I have used the information available online.
Would suggest you give it a try. You will find about the process and exact charges.
You can even register online.
Dear Sunil,
If you invest in NPS via eNPS, you eliminate the 0.25% charges payable to the intermediary/POP service provider. Pl use netbanking option and you will pay just 69 paise per transaction. The CRA will charge 5 rs + tax which is unavoidable. But the cost structure including all charges work out to 0.11% in my case. Of course this ratio will change as per contribution amount and frequency of contribution.
Thanks Ram for sharing this info. Very useful.
Also, on fund management fee – how it is calculated and what will be the impact on corpus accumulated
Fund management fee is charged as percentage of the fund corpus (typically on a daily basis).
You can go through my posts on direct plans of mutual funds to get an idea. Direct plans eliminate distribution costs (as compared to regular plans) which improves returns.
However, there is a minor complication in case of NPS.
FMC for index funds/ETF is low because there is little fund manager can do. Hence, the fee is lower. In case of active management, fund manager has to put in a lot of effort. That’s why FMC is higher.
However, active management can offer better returns too. Say index fund returns 12% (before FMC) while actively managed fund returns 16% (before FMC). Now, even FMC though FMC is higher for active fund, it will still give better returns. So, it is not easy to assess the impact on corpus.
Ram,
Thanks for the details.
If invest directly, then the charges will be fixed right? I am not sure why you have mentioned in terms of percentage!. Please clarify.
Also, for government employees no POP charges ?
This is an old post. E-NPS is a recent development.
Is it possible that management fees would stay same for G/C categories funds and increase only for to E category fund?
Can’t comment about this. We will find out.
Btw, fee currently is low even for debt funds.