EPFO may enhance equity exposure to 20%

Is the EPFO becoming more equity savvy? If the EPFO has its way, then the total equity exposure upper limit may be hiked from the current 15% to 20%. Of course, the base exposure level still remains at 5%, but the upper limit will be hiked from the current 15% to 20%. That would mean more EPFO money into equities. Obviously, EPFO is not permitted to directly invest in equity shares but it can only make such investments through the ETF (exchange traded fund) route. But the final call on the same is yet to be taken.

As of now, what we know is that the Finance Committee of the Central Board of Trustees (CBT) has proposed raising the upper limit for equity exposure of EPFO funds to 20%. Now, the CBT is the highest executive decision-making body of the Employees Provident Fund Organisation (EPFO). However, the CBT can only suggest an increase in the equity exposure limit and the same has to be still ratified by the Provident Fund Trustees, who are the watchdogs that ensure that the interests of the millions of employees are protected.

This decision was communicated by the Minister of State for Labour and Employment, Rameshwar Teli, in reply to a written question raised in the Lok Sabha during the discussions. Remember, the EPFO AUM is huge. At nearly Rs17 trillion and with over 24 crore member accounts, it is nearly half as large as the entire mutual fund industry in India. In addition, there is an annual AUM accretion of Rs230,000 crore to the corpus of EPFO and nearly 65 lakh subscribers get added each year. So, numbers are surely mindboggling.

However, the increase in limits from 15% to 20% applies only to the accretion to the corpus during the year and not to the entire legacy corpus. But even that is a fairly large amount. For instance, on an annual AUM accretion of Rs2.30 trillion, an additional 5% would mean an extra Rs11,500 crore being invested in equity ETFs, which is a substantial sum and can have a meaningful impact on the equity markets. IT can also positively change the sentiments in the market, especially if a long term player is committing funds to equities.

The sense of urgency in the CBT to increase the equity exposure is not hard to fathom. The EPFO has been facing consistently falling income from its investment due to sub-market returns on debt and liquid assets. In addition, with interest rates rising and yields going up, most of the long term bond investments are also subject to price depletion risk. For the year 2021-22, the EPFO declared an interest rate of 8.1%, which is the lowest in nearly 40 years and that is where the additional 5% in equities can bridge the alpha gap for investors.

Currently, EPFO has been actively investing in equities since the year 2015. Its monies are largely invested in exchange traded funds (ETFs) on both the Nifty and the Sensex. While EPFO started investing 5% in equities in the year 2015, the equity exposure limit was raised to 10% in 2016 and again to 15% in 2017. Subsequent to that, due to the sharp fall in equities in 2018 and the tumultuous COVID period, there had been no further increase in the equity exposure. This will bring about an increase in equity exposure after 5 years.

In FY21, EPFO invested Rs32,071 crore in ETFs and on a cumulative basis, EPFO has till date invested Rs138,000 crore in equities via the ETF route. Even after considering the equity selling by EPFO last year, the AUM in equities still stands at Rs123,000 crore. Interestingly, the notional ROI on the equity investment stands at 16.27% as of the close of FY22 and that would be a huge source of alpha for the EPFO in a tough market. However, the last 2 years have also seen aggressive withdrawals from EPFO to fight the COVID liquidity crisis.

The decision is a step in the right direction. Globally, the very long term money like provident funds and pensions normally go predominantly into equities and other risk assets. That is because risk is auto managed in equities in the long run. For a long time, India had an anomalous situation where the long term funds of the EPFO was being invested in debt. That was OK as long as debt was paying exorbitant returns. That is not the case any longer. The only option for EPFO is to enhance its exposure to equities.