We have, over a series of articles, explained how you can asset-allocate in the NPS, when and how to use the Tier II NPS, how NPS is taxed at various stages. We had also done an analysis on performance and which the best NPS fund managers were. But that analysis was close to a year ago. More importantly, your asset allocation decides which fund manager really suits you the best.
No, we’re not updating that article. We’re doing much more. We have developed a comprehensive NPS product – and likely the only one of its kind – that tells you how to get your NPS asset allocation correctly and who the best NPS fund manager is for that allocation. This NPS Fund Manager Ranking tool covers both Tier I and Tier II NPS.
In this article, we’ll explain why asset allocation matters in NPS fund manager decisions and how this tool can help you.
The NPS can be an efficient vehicle to save taxes and invest in low-cost market-linked products for your retirement, especially if you are in the higher tax brackets. Returns from NPS have been above average and particularly good in the debt categories, compared to debt mutual funds. You can find the performance of NPS fund managers here.
Quick recap on the NPS
Just so that we’re all on the same page here, there are two options in the NPS – Tier I and Tier II. Your Tier I account is the primary, tax-saving (or retirement, if you’re a big NPS investor) vehicle. The Tier II account is a more liquid account with flexibility to take your money out at any time. It does not enjoy tax deduction like Tier I does. Moreover, Tier II does not have a lock in for non-government employees (read more about Tier II here). However, you cannot have a Tier II without a Tier I account.
Next, consider the asset classes – Equity, Corporate Debt, Government Debt, and Alternative. You need to allocate between each of these; you can either choose auto asset allocation that the NPS fixes, or you can choose your own allocation, subject to limits (more on this later and in this article)
NPS fund managers and asset allocation
Now, let’s take fund managers. You cannot hold your money with multiple NPS fund managers; i.e., you cannot have one manager for Equity and another for Corporate Debt and so on. Hence, when you choose a fund manager, it is important that they are good at managing the asset that is dominant in your portfolio. Why?
Because all NPS fund managers (PFM or pension fund manager) are not uniformly adept at managing the equity, corporate debt, and government debt. That is, one PFM scores well at delivering above-average and good returns in Government debt but then be a sub-par performer in Equity. For example, LIC as a PFM does very well in Government Debt over longer-term periods. In Equity, though, its consistency is the poorest of the PFMs over longer-term timeframes.
Therefore, if your NPS asset allocation is overweight on Equity, and you choose LIC as your PFM, your overall NPS returns is likely to be lower than what it could ideally be. But if you were overweight on Government Debt, then your returns would be more optimal. Similarly, if your allocation is skewed towards Corporate debt, then you need to ensure your NPS manager’s performance in Corporate debt is consistent.
This is the first aspect that we’ve built into the NPS Fund Manager Ranking. We first get your asset allocation in order to assess how different PFMs would perform. And if you don’t know what your asset allocation should be, that’s built into the tool as well! Let’s explain.
Asset allocation tool
The first stage in the NPS Fund Manager Ranking Tool is the asset allocation (whether its Tier I or Tier II). So we provide you with 2 options:
Option 1: A questionnaire that helps you figure out what asset allocation will work for you. This is only for Tier I. This is because Tier II more or less works, conceptually, like a mutual fund portfolio where you asset-allocate based on your timeframe and goal.
Option 2: Input your own asset allocation. This is for Tier I and Tier II.
Let’s take you through the steps now.
See the image below, which is Step 1 in our tool. For Option 2 explained above, choose Yes below and go right ahead with getting the PFM rankings. But if you’re new to NPS or want the asset allocation that’s right for you, choose No.
You will be taken to a series of questions, post which you will be provided with a suggested allocation. These questions and the scoring algorithm we use are not based simply on your age or risk profile – we also combine the purpose behind your NPS investing, and take into account how the NPS itself performs in Equity, Corporate Debt and Government Debt compared to other available products, and your investments in them. So let’s look into how we do this.
The first question pertains to your age group. This will help us limit or increase your equity exposure. If you are wondering if that is exactly what the automatic route in NPS does, it’s not really the case. The auto-choice in NPS starts reducing your equity exposure steadily after the age of 35. Your overall exposure to equity goes below 40% by the time you hit 45 years of age – even in the aggressive option. The equity is even lower in the moderate option and drops to less than 15% when you have the conservative mode.
In our opinion, limiting your equity exposure at such low levels when you are at your peak earning capacity can dent your retirement portfolio heavily. You can find more details about this in this article (How to plan asset classes for your NPS portfolio )
The second question is on your existing investments.In most cases, NPS will not be the only retirement investment you have. It is likely to be a part of your overall asset-allocated portfolio that may include mutual funds, stocks, provident funds and so on. Hence, your existing investments will play a role in determining your asset allocation in NPS too. This is because the NPS provides an edge over other products in some aspects, while in others, such as equity, other products may be a better option. We try to optimise allocations through this second question.
Next, we move on to your own risk capacity in questions 3 & 4. When you have high borrowings, your ability to take on more risk is diminished. Similarly, having more dependents too, reduces your risk-taking ability. We try to gauge this as well through the following questions:
The fifth question is about your purpose of investing in NPS. If you plan to have an NPS purely for the purpose of saving tax, then we suggest a slightly lower allocation to equity. As explained above, our assessment of NPS’s equity performance compared to other products suggest that equity funds, whether active or passive, are a good sight better than the NPS. You will therefore be better off going with those products for equity and make the best of tax benefits in NPS through corporate bonds and government securities where the NPS is particularly strong. However, if this is your primary source of retirement corpus, then we have provided a higher weight to equity to ensure you are invested in an asset class that delivers well in the long term,
The final question is a self assessment of your own risk level on a scale of high, medium and low. Even if your response to questions 3 & 4 – which is your risk taking capacity – suggests low risk, if you are intent on taking on more risk, we take that into consideration through this question.
While there are several permutations and combinations to arrive at your allocation, these questions will narrow it to one single desirable asset allocation for you.
For Tier II, of course, the above points don’t really hold as much weight due to their liquidity and because your timeframe can be any length. Approach Tier II asset allocation like you would with your normal mutual fund portfolio.
Fund manager ranking
If asset allocation is one output of the tool (if you need it), the main output is the NPS Fund Manager Ranking, ranked from best to least performing.
So how do we do this ranking? Well, that’s broadly captured in this article on pension fund managers. But, to explain very briefly, we look at performance consistency across timeframes, as well as other aspects such as ability to contain downsides, keep volatility in check (yes, there’s volatility in debt, too!), loss probabilities and so on.
Using these metrics, we assess the NPS fund manager performance separately in Equity, Corporate Debt and Government Debt. On top of this, we take the asset allocation derived above as the last input to build the rankings. The final fund managers ranks are then displayed.
For example, a higher equity allocation may provide you with a fund manager best at handling equity, while a higher corporate debt allocation may throw a different fund manager.
A half-yearly review will be done on the NPS fund managers performance and the ranks will be updated.
We’ve given a few illustrative examples below.
Let us give you a couple of choices on the tool and see how the asset allocation results can vary. Let us suppose I choose Tier I and need guidance on my asset allocation. I go about choosing the following options:
Your result, shown below, will tell you that the overall equity allocation is not high, despite your having a moderate risk tolerance and fewer commitments. A few factors leading to this is that you already have a higher allocation to equity outside NPS and you are saving in NPS primarily for tax. This means you are better off investing in equity outside of NPS.
Now let us take the same case of Tier I NPS and taking a guided approach to asset allocation but with different responses:
In the above illustration, you will see that the equity asset allocation has increased to 55% as we changed a couple of inputs. One, we have said that the equity allocation outside is below 50% and that we are not investing in NPS only for tax saving purposes. You will see that the equity allocation is higher than the 40% in the first illustration where your investments in equity, outside NPS, is already high.
Once you get this allocation, our tool will show you the best fund manager for your allocation and the reasoning for the same.
So do use the NPS Fund Manager Rankings if you intend to invest in the NPS and want to do it the most optimal way! The fund manager rankings are available for Prime subscribers only (both Growth and Essential).