NPS likely to get more expensive

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