EPF should venture beyond stocks, bonds: It must enter private equity and real estate

The stock market slide is a warning to managers of retirement savings that investing in stocks is no short cut to decent returns. Its investment in stocks had brought the Employees’ Provident Fund (EPF) much higher rates of return, as compared to investments in government and private debt, whetting an appetite for ever-larger allocation of funds to stocks, right now capped at 15%. But with the equities market on the slide — Sensex closed 561 points lower on Tuesday — the EPFO reportedly wants to play safe, and park more money in safe harbour government bonds. Scurrying to safety is not an ideal response. Alarge corpus of over Rs 10 lakh crore allows the EPF to diversify its portfolio beyond traded stocks and bonds. It should consider private equity and real estate as well. Ditto for the National Pension System (NPS), open to civil servants who joined service from January 2004, and now to voluntary subscribers.

The real debate should be on whether EPF and NPS should undertake private equity and real estate investments on their own or allocate funds to well-run, established fund managers in these areas. The largest Canadian pension funds invest in the global PE market through a mix of fund and direct strategies. Direct deals that account for a rising share of their allocations are done independently or as co-investments and co-partnerships along with fund partners. The EPFO and the NPS should also create special situations fund to take advantage of one-off opportunities. With the insolvency and bankruptcy process underway, opportunities will open up to buy stressed assets that are being auctioned.

But this calls for fund management expertise. The EPFO must appoint professional fund managers, with a remuneration structure akin to Canadian pension funds’. It includes a reasonable basic salary, an appealing annual bonus and a liberal long-term performance bonus that accounts for the largest chunk of pay. Such a structure motivates asset managers, who have a stake in letting the assets grow, to take a long-term view of investments.