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Which asset class to choose in NPS


September 24, 2020

When investing towards long-term goals such as retirement, your final returns are decided more by your asset allocation than by your choice of products or fund managers. That’s why one of the most important decisions you’ll make on your NPS account is this one – in what proportion you’ll divide your annual contributions between equities, bonds and the rest.   

NPS Asset classes

The NPS certainly doesn’t make your job easy as it throws many multiple-choice questions at you at every step. Here’s our simple guide to navigating the NPS asset classes. This will help you get the most bang for buck from your NPS account. 

Go for Active choice

When making investment decisions, allowing an autopilot to take over is tempting no doubt. But in the case of the NPS it can actively dent the size of your investment corpus.

On signing up, NPS requires you to choose between an Active and Auto choice to allocate between the four categories of assets on its menu – Equities (E), Corporate Bonds (C), Government Securities (G) and Alternative Investment Funds (A).

In Auto choice, your money is automatically divided between these assets at proportions pre-decided by the fund. These allocations are also tweaked with age, to reduce risks. There are three risk-based sub-options within Auto choice – Aggressive Lifecycle Fund, Moderate Lifecycle Fund and Conservative Lifecycle Fund in Auto choice. Each of these starts you off at a different E and C weight, which is trimmed each year until you attain the age 50. The table below shows how this works.

As the table shows, whichever risk profile you choose, the E allocation under Auto choice is highest for investors upto 35 years of age. Thereafter, it is compulsorily trimmed back every year until you hit age 50. The Corporate bond allocation too starts off at a high level and is tapered steadily each year.

While this formulaic approach may look like a neat way to manage your allocation across life stages, there are three significant disadvantages to it.

# 1 Impedes compounding: It doesn’t allow you to reap the benefits of compounding. To make the most of your equity investments, you need to stay invested in the asset class for 10 plus years.

  • The automatic rebalancing feature of the Auto choice starts trimming back your equity allocation right from year one.
  • The age (35) at which it starts reducing your equity holdings is also far too early. To reap the rewards of equity investing in your final retirement corpus, it would be best to retain a sizeable equity allocation until you turn 55 and use the next 5 years until retirement to gradually reallocate your equity positions. With Auto choice however, your E allocations would already be down to 16%, 12% or 6% by the time you’re 55!
  • The same problem exists with corporate bonds, which deliver excellent compounding benefits in India. But the Auto choice meddles with this too, by cutting back your C exposure right from age 35.

# 2 Not optimising earning capacity: By aggressively cutting back on your E and C allocations in your 30s, 40s and 50s, the Auto choice prevents you from ploughing significant amounts into these high-return assets when your career and earning capacity are at their peak. That’s again sub-optimal for your retirement corpus.

# 3 Robotic rebalancing: While periodic rebalancing between assets is certainly a good thing to smooth out returns in a long-term portfolio, it works best when it based on the relative performance of assets. It’s certainly a good idea to cut back on equities and add to debt when stock markets are soaring. But the Auto choice takes a robotic approach to the rebalancing and trims weights to equities based on age. You may end up reducing your equity exposure in a falling market.

We therefore feel that the Auto choice is too conservative with your allocations to equities and corporate bonds, the two assets that can really boost your long-term returns.

In the Active choice though, you are free to choose how to divide your money between various NPS assets subject to two basic restrictions – your total allocation to Alternative assets (A) cannot exceed 5% and your total equity exposure cannot exceed 75%.  

We therefore recommend that you go with the Active choice for its ability to ensure higher allocations to high-return assets.

  • If you have ten years plus left to retirement and the NPS is the key vehicle you’re leaning on, allocate upto 75% of your contributions to equities, 20% to corporate bonds and 5% in gilts.
  • If you have other equity options like MFs that you’re using towards retirement, you can opt for a 50% E allocation in the NPS and peg your C allocations at 30% and G at 20%.  
  • Keep a check on your equity allocations as you get closer to retirement. If your accumulated equity weights in NPS exceed 75% with less than 10 years to retire, tone down your incremental allocation to E and go with C and G.

NPS Asset classes: Avoid A, stick to E/C/G

The NPS allows you to distribute your annual contribution between four asset classes that go by the code names E, C, G and A. Before deciding how to do this though, it helps to know where your investments would go under each of these categories. NPS’ private fund managers are allowed to invest only in specific classes of securities defined by PFRDA’s investment guidelines within each asset class. Here are the permitted investments.  

Equities (E): Restricted mainly to the large and mid-cap shares. NSE/BSE listed stocks with market capitalisation of Rs 5000 crore or more, or shares traded in the derivatives segment. Upto 5% of this equity portfolio can be parked in equity mutual funds provided they too invest only in the above defined universe.

Corporate bonds (C): Listed bonds from companies, financial institutions, government-backed infrastructure players and banks, with a minimum residual maturity of 3 years. There’s a 10% leeway to invest in bonds with less than 3-year maturity. 90% of the corporate bond portfolio has to be in bonds rated AA or above, while upto 10% of it can be in bonds rated A to AA. Debt mutual funds that comply with these norms are eligible too. Term deposits of profitable banks are allowed, provided the bank has a minimum capital adequacy of 9% and Net NPA less than 4%. AT 1 bonds from banks are allowed upto a 2% limit.

Government securities (G): Central and State government securities or bonds guaranteed by them. Upto 5% of the g-sec portfolio can be parked in gilt mutual funds.

Alternative assets (A): Exotic assets like mortgage-backed securities, asset backed securities, units of REITs or Invits. All of these need to be rated AA and above by two rating agencies. SEBI registered category 1 & 2 AIFs, subject to a Rs 100 crore size and 10% limit.  Investments in AT 1 bonds of banks are allowed too.

In addition, funds are allowed to park upto 5% of their corpus in short term debt and liquid funds to manage liquidity in volatile times. 

As things stand, it is best for NPS subscribers to avoid asset A and to stick to E, C and G. Instruments like mortgage-backed securities or Alternative Investment Funds require the fund manager to put in a great deal of due diligence in product selection and these options are seldom available on tap, requiring the fund manager to park money in liquid instruments awaiting good opportunities.

Given the ultra-low management fee for NPS, it appears unlikely that the fund managers will put much effort into sifting through alternative assets. Presently, due to deployment challenges, the A portion in most funds seems to be parked in AT1 bonds from banks which are dicey propositions, and liquid and overnight mutual funds, which don’t offer much of a return kicker. (Check out the portfolios of different fund managers here)

On E, NPS managers stick mainly to the index and large-cap names in the market with a smattering of mid-caps. The NPS funds tend to be less actively managed than the open-end multicap, large and midcap funds of AMCs. However, the cost advantage arising from the ultra-low management fee of 0.01% helps the NPS equity funds still deliver reasonable returns to subscribers.

The table below shows that the Equity funds under NPS have delivered 8.4% to 9.9% CAGR over 10 years, which is quite comparable to the category averages of 7-9.5% for actively managed open ended large cap and large and mid-cap funds and betters the BSE200 ten year return of about 7% CAGR. The latest month-end returns for different assets are available here.

If you are shooting for more spectacular equity returns in your retirement kitty, supplement your NPS equity allocation with holdings in actively managed mid or small-cap equity funds, which have averaged 10-11% in the last 10 years.

Max out C 

Given their unadventurous stock choices and the tendency to be passive with their management, it can be debated if the E portion of the NPS is the best investment option you can have in the market for your equity money. Index funds and ETFs may offer you more variety at competitive costs.

But the debt options of the NPS score over most comparable fixed income options in the market including actively managed debt mutual funds. While the open-end nature and the race to top the return chart leads actively managed debt mutual funds to take on over-sized risks that often backfire, the buy-and-hold strategy and the high rating requirement for NPS-managed debt funds has made for a relatively smooth journey for subscribers.

The NPS debt funds feature an annual expense ratio of 0.01% compared to ratios of 0.20-1% for direct plans of Corporate Bond Funds and 0.20-0.80% for PSU& Banking Debt Funds and this too is likely to give a significant leg-up to subscriber returns.

The table below shows that the NPS C option has managed a respectable CAGR of 9.6-10.7% over ten years, beating even equities. 

Between the C and G options, C is the better choice for subscribers looking to maximise compounding in the long run. The PFRDA’s high quality bar that actively discourages NPS fund managers from dabbling in unlisted and lower rated bonds and exotic instruments has helped the C portion of NPS reap the rewards of high corporate bond spreads while avoiding most of the credit accidents that debt MFs have suffered. Though a few NPS managers did suffer write offs from DHFL, they managed to avoid defaults related to the Reliance ADAG group, Essel and other dicey corporate names.

Given that returns on the C option rely more on interest accruals than capital gains, the C portion has also delivered a smoother journey to subscribers than G. Returns on G have tended to fluctuate based on rate movements in the market.

In the year ended June 2018 for instance, most gilt funds delivered negative returns on the spike in market interest rates. The G options of NPS delivered losses of between 0.41% and 1.68% for this one-year period. During the same period though, the C option managed to hold its head above water with one-year returns of 1.4 to 5.5%. This makes a good case for allocating more of your contribution to C than G until you turn 55, when you can move to a more defensive portfolio that favours G.

Takeaways

To summarise, here are six pointers to make the most of NPS asset choices:

  • Ignore Auto choice and opt for Active choice
  • Avoid A and stick to E, C and G
  • If you have 10 years plus left to retire, peg your equity allocations at 75% and corporate bond allocations at 30% to maximise returns
  • Check the share of E in your portfolio, every year, when you are less than 10 years away from retirement and reduce E contribution if the share exceeds 75%. In addition, begin switching to more defensive positions once you have 5 years left to retire.
  • The E part of NPS is rather conservatively managed. If you have a fair appetite for risk and plenty of time to retire, peg your E allocation at 50% and use actively managed mid and small-cap MFs to top up your retirement corpus
  • The debt fund options in the NPS offer excellent returns with limited volatility owing to their ultra-low fees, quality bias and buy-and-hold approach. Make the most of them.  
  • Have a higher allocation to C than G to max out compounding

Also Read : Who’s the best NPS Fund Manager?

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The information/ opinion/ views mentioned in research reports or by the RA are not meant to serve as a professional guide to the client or recipients of this Report. The research report, recommendation, or any other content published by the RA do not assure or guarantee any minimum or fixed returns to the client or recipients of the reports/ recommendations/ content.

Use of this information is at the client’s own risk. The client must make his/ her own investment decisions based on his/her specific investment objective and financial position and using such independent advisors as he/she believes necessary. The services rendered by the RA are on a best-effort basis. All information in the content or research report of the RA is provided on an as is basis. Information is believed to be reliable but the RA does not warrant its completeness or accuracy and expressly disclaim all warranties and conditions of any kind, whether express or implied.

While due care has been taken to ensure that the disclosures, information, and opinions given are fair and reasonable, PrimeInvestor Financial Research Pvt Ltd and/or none of its officers, directors, partners, employees, agents, subsidiaries, affiliates or business associates shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way whatsoever from the information/ opinions/ views contained in the research report and recommendations that form part of the Research Service, and/or mails, social media or notifications issued by PrimeInvestor Financial Research Pvt Ltd or any other agency appointed/authorised by PrimeInvestor Financial Research Pvt Ltd. Returns and performance figures mentioned in the research report represent past performance and should not be constituted to be future returns or guaranteed returns.

Any agreements, transactions or other arrangements made between the client and any third party named on (or linked to from) the Website are at your own responsibility and entered into at your own risk. Any information that you receive via the Website, whether or not it is classified as “real time”, may have stopped being current by the time it reaches you. Market price information may be rounded up/down and therefore may not be entirely accurate.

The purpose of these disclosures is to provide essential information about the Research Services in a manner to assist and enable the prospective client/client in making an informed decision for engaging in Research Services before onboarding.

History, present business and background: PrimeInvestor Financial Research Private Limited is registered with SEBI as Research Analyst with registration no. INH200008653. The Research Analyst got its registration on August 19, 2021 and is engaged in offering research and recommendation services.

Disciplinary history: There are no pending material litigations or legal proceedings against the Research Analyst. As on date, no penalties / directions have been issued by SEBI under the SEBI Act or Regulations made thereunder against the Research Analyst relating to Research Analyst services.

Details of the RA's associates: No associates.

Usage of Website Content: This Website is controlled and operated by the RA. All material, including research reports, recommendations, portfolios, ratings, lists of financial products, illustrations, statements, opinions, views, photographs, products, images, artwork, designs, text, graphics, logos, button icons, images, audio and video clips and software (collectively, “Content”) are protected by copyrights, trademarks and other intellectual property rights that are owned and controlled by the RA or by other parties that have licensed their material to us.

Except where otherwise agreed in writing with the RA, material on the Website is solely for the client’s personal, non-commercial use. Except as provided below, the client must not copy, reproduce, republish, upload, post, transmit or distribute such material in any way, including by e-mail or other electronic means and whether directly or indirectly and the client must not assist any other person to do so.

Without the prior written consent of the RA, modification of the materials, use of the materials on any other web site or networked computer environment or use of the materials for any purpose other than personal, non-commercial use is a violation of the copyrights, trademarks and other proprietary rights, and is prohibited. Any use for which the client receives any remuneration, whether in money or otherwise, is a commercial use for the purposes of these Terms.

The client may occasionally distribute a copy of a research report, or a portion of the same, from the Website in non-electronic form to a few individuals without charge, provided the client includes all copyright and other proprietary rights notices in the same form in which the notices appear, original source attribution, and the phrase “Used with permission from PrimeInvestor Financial Research Pvt. Ltd.”

While the client may occasionally download and store research reports or information from the Website for his/her personal use, he/she may not otherwise provide others with access to the same. The foregoing does not apply to any sharing functionality we provide through the Website that expressly allows the client to share Content or links to Content with others. In addition, the client may not use Content he/she has downloaded for personal use to develop or operate an automated trading system or for data or text mining.

The client agrees not to rearrange or modify the Content available through the Website. The client agrees not to display, post, frame, or scrape the Content for use on another website, app, blog, product or service, except as otherwise expressly permitted by these Terms. You agree not to create any derivative work based on or containing the research products and Content. The framing or scraping of or in-line linking to the Services or any Content contained thereon and/or the use of webcrawler, spidering or other automated means to access, copy, index, process and/or store any Content made available on or through the Services other than as expressly authorized by us is prohibited.

The client further agrees to abide by exclusionary protocols (e.g., Robots.txt, Automated Content Access Protocol (ACAP), etc.) that may be used in connection with the Research Services. The client may not access parts of the Research Services to which he/she is not authorized, or attempt to circumvent any restrictions imposed on your use or access of the Services.

As a general rule, the client may not use the Content, including without limitation, any Content made available through one of our RSS Feeds, in any commercial product or service, without our express written consent.

The client may not create apps, extensions, or other products and services that use our Content without our permission. The client may not aggregate or otherwise use our Content in a manner that could reasonably serve as a substitute for a subscription to the Website.

The client may not access or view the Services with the use of any scripts, extensions, or programs that alter the way the Services are displayed, rendered, or transmitted to you without our written consent.

The client agrees not to use the Services for any unlawful purpose. We reserve the right to terminate or restrict the client's access to the Website if, in our opinion, the client's use of the Services may violate any laws, regulations or rulings, infringe upon another person's rights or violate these Terms.

Prohibited content: The Website includes comments sections, blogs and other interactive features that allow interaction among clients and between clients and the RA. We call the information posted by or contributed by users “Contributed Content.” In the course of availing of the Research Services or uploading any post or comment on the Website, the client shall not post any Contributed Content that (i) contains nude, semi-nude, sexually suggestive photos, (ii) tends or is likely to abuse, harass, threaten, impersonate or intimidate other users of the Website and/or Research Services, (iii) is lascivious or appeals to the prurient interest or if its effect is such as to tend to deprave and corrupt persons who are likely to use or have access to the Website and/or Services, or (iv) otherwise violates, is prohibited or restricted by applicable law, rule or regulation, is offensive or illegal or violates the rights of, harms or threatens the safety of other users of the Website and/or Services (collectively “Prohibited Content”).

We reserve the right to cease to provide the client with the Research Services or access to the Website, or terminate your subscription, with immediate effect and without notice and liability, for violating these Terms, applicable law, rules or regulations and reserves the right to remove Prohibited Content which is in violation of these Terms, or is otherwise abusive, illegal or disruptive. The determination of whether any content constitutes Prohibited Content, violates these Terms, or is otherwise abusive illegal or disruptive, is subject to the sole determination of the Firm.

Changes to Research Services: We are constantly endeavouring to improve the quality of Research Services provided to our clients. Due to this, the form and nature of the Research Services provided may change from time to time without any prior notice to the client. We reserve the right to introduce and initiate new features, functionalities, components to the Website and/or Research Services and/or change, alter, modify, or discontinue existing ones without any prior notice to the client.

Warranty and liability disclaimer: The Website, Research Services, and all the materials and services, included on or otherwise made available to the client through this Website is provided by the RA on an “as is” and “as available” basis without any representation or warranties, express or implied except otherwise specified in writing. Without prejudice to the foregoing paragraph, the RA does not warrant that:

  • This Website and/or Research Services will be constantly available, or available at all;
  • The information on this Website or provided through the Research Services is complete, true, accurate or not misleading; or
  • The quality of any products, services, information, or other material that you obtain through the Website or Services will meet your expectations.

The RA, to the fullest extent permitted by law, disclaims all warranties, whether express or implied, including the warranty of merchantability, fitness for particular purpose and non-infringement. The RA makes no warranties about the accuracy, reliability, completeness, or timeliness of the Website, Research Services, Content, Contributed Content, Services, software, text, graphics and links.

The RA does not warrant that this Website, Research Services, information, content, materials, or any other material included on or otherwise made available to you through this Website, their servers, or electronic communication sent by the RA are free of viruses or other harmful components.

Nothing on this Website constitutes, or is meant to constitute, advice of any kind.

Indemnification: The client:

  1. Represents, warrants and covenants that no materials of any kind provided by him/her will:
    1. Violate, plagiarise, or infringe upon the rights of any third party, including copyright, trademark, privacy or other personal or proprietary rights; or
    2. Contain libellous, Prohibited Content or other unlawful material;
  2. Hereby agree to indemnify, defend and hold harmless the RA and all of the RA’s officers, directors, owners, agents, customers/clients, information providers, affiliates, licensors and licensees (collectively, the “Indemnified Parties”) from and against any and all liability and costs, including, without limitation, reasonable advocate’s fees, incurred by the Indemnified Parties in connection with any claim arising out of any breach by the client of these Terms or the foregoing representations, warranties and covenants. The client shall cooperate as fully as reasonably required in the defence of any such claim. The RA reserves the right, at its own expense, to assume the exclusive defence and control of any matter subject to indemnification by the client.

Applicable law: This Website, including the Content and Contributed Content and information contained herein, and the provision of Research Services shall be governed by the Securities and Exchange Board of India, laws of the Republic of India and the courts of Chennai, India which shall retain exclusive jurisdiction to entertain any proceedings in relation to any disputes arising out of the same. As such, the laws of India shall govern any transaction completed using this Website.

Information gathered and tracked: Information submitted or collected on the Website or pursuant to the use of the Services is stored in a database. Specifically, we store the username, name, e-mail address, contact number, as submitted or collected on our Website or through the provision of the Research Services. We may use such information to send out occasional promotional materials, including alerts on new Services available, or other promotional and marketing material relating to our clients and customers.

In accordance with the Information Technology Act 2000, the name and the details of the Grievance Officer at PrimeInvestor is provided below:

Mr. Srikanth Meenakshi
PrimeInvestor Financial Research Pvt. Ltd., Registered office: 659, 4th Avenue, D-Sector, Anna Nagar Western Extension, Chennai 600 101.
Email: [email protected]

11. Mandatory notice:

Clients shall be requested to go through Do’s and Don’ts while dealing with RA as specified in SEBI master circular no. SEBI/HO/MIRSD-POD-1/P/CIR/2024/49 dated May 21, 2024 or as may be specified by SEBI from time to time.

12. Optional Centralised Fee Collection Mechanism:

SEBI has operationalized a centralized fee collection mechanism for IA and RA. Under this mechanism, clients shall pay fees to IAs/RAs through a designated platform/portal administered by a recognized Administration and Supervision body. This is an optional mechanism for the registered entities. At this time, PrimeInvestor has opted out of this fee collection mechanism. Therefore, all subscription payments for the Research Services will be through the modes as specified in Clause 5 of these Terms.

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