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Most of the people in India have to create their own retirement corpus in absence of social security system in the country. We need a robust system which can provide decent returns to meet old age security. New Pension System was supposed to do this but has failed. By making NPS more flexible, the government can take right step in this direction
The National Pension System (NPS) was started with an objective to provide a pension solution to government employees after the central government decided to do away with pension facility to these employees. Initially started as a scheme for government employees, it was opened for all individuals. More than three years have passed since this system was opened to general public, however, it has failed to generate the kind of participation from individual investors that it should have. Though the blame is put on lack of adequate marketing and positioning of the scheme among corporates, there are certain changes in the NPS which can definitely make it more attractive. Here are three changes which can make the pension scheme more attractive for potential subscribers of the scheme. Let us look at these three changes:
Changes in Investment choice: Individuals opting for NPS have two choices of making investments which are called as active choice and auto choice. Under both the choices, an individual can invest in:
Asset Class E - investments in predominantly equity market instruments.
Asset Class C- investments in fixed income instruments other than government securities.
Asset Class G - investments in government securities
It is surprising that there is a cap of 50% on investment into Asset class ’E’ for all age groups starting from the age of 18. People in the age group below 35 years should be given a choice to deploy higher percentage of contribution in equities as their risk appetite is generally high. Coupled with this is the fact that people in younger age groups have more time which can help investments made by them overcome challenges related to vagaries of return in the stock market. Also, there should be a flexibility given to individuals to reallocate funds subject to some charges.
Know more: What ails the New Pension Scheme?
Broaden the scope of vesting choice: As per the current vesting criteria, any individual who decides to withdraw pension wealth before the age of 60, can withdraw maximum of 20% of such wealth and remaining 80% has to be invested in a life annuity with any IRDA (Insurance Regulatory and Development Authority) regulated insurance company. The details are given in the table below for other types of withdrawal.
Why should there be a limitation of investments with IRDA-regulated life insurance companies only? The returns offered by these companies on annuity schemes are not great anyways. Why not include other entities like banks and post offices which currently offer monthly return plans for investors. These entities are also regulated by the government and will offer more choices to the investors.
Change in investment guidelines: As per PFRDA (Pension Fund Regulatory and Development Authority) guidelines on investment under NPS, there is a limitation put on the equity shares in which investment can be made. The guideline says, “The investment in this asset class would be subject to a cap of 50%. This asset class will be invested in index funds that replicate the portfolio of either BSE Sensex or NSE Nifty 50 index. These schemes invest in securities in the same weightage comprising an index”. It is true that the companies forming part of Sensex and Nifty are probably the best companies in terms of track record, corporate governance and historical performance. However, by limiting the investment scope in these companies, there is an indirect cap put on the growth potential of equity part of investment. The investment guidelines should be broadened to include at least top 100 companies (aligning this with appropriate index) so that investors could benefit from growth of these companies.
It is an open secret that most of the people in India have to create their own retirement corpus in absence of social security system in the country. Need of the hour is to create a robust system which can provide decent returns to meet old age security. By making NPS more flexible, the government can take right step in the right direction.
To read more articles by Vivek Sharma, please click here.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
Momentum is a great strategy until it isn’t and the timing of these strategies has not been very accurate especially in a market dominated by risk on, risk off
In the US and Europe a small black bird called a starling will in the evening form large flocks of over a thousand birds. These flocks will move, turn and swirl in amazing coordinated ways. It seems as if their rapid movements might result in collisions but it never happens. Fish in large schools can exhibit similar behaviour. Both the flock and the school can create fantastic ever-changing shapes in a moment and each seem to be exhibiting some sort of incredible collective intelligence and purpose. The reality is that each animal is just reacting according to what it sees in its immediate space without a thought for the larger movement of the flock.
In a similar manner markets across the world will often gyrate from highs to lows in short periods. Certain stocks gain favour or cachet and soar to wildly optimistic price earnings ratios. This is the process of momentum. Often it just seems like a bunch of wildebeests blindly traversing the Serengeti, but there are studies that have determined that the process does actually produce a profit. Since the 1980s, studies have consistently found that stocks which have performed well in the recent past will do so for some time. This effect has been around for much of the 20th century. The effect tends to work for the best performers over the past 12 months, but not for longer periods of three to five years.
This effect seems risky and irrational. If a specific share or even a class of assets performs far beyond its peers or historical norms, it is likely way overvalued. As such eventually the shares may revert to mean in a very dramatic way.
According to one of the most famous or infamous theories in investing—the Efficient Market Hypothesis (EMH)— momentum should not occur. According to the EMH, the price of a financial asset reflects all available information that is relevant to its value. For example if the price of an asset was too low, knowledgeable investors would buy it and make a profit. If a particular stock was overvalued, then the stock would be shorted or sold and it would return to its true value.
One of the main objections to the EMH is that it does not account for bubbles often created by momentum. If a stock has momentum, it could become way overvalued. This usually occurs with high-flying tech stocks. A good example of momentum is the dot.com bubble. A recent example would be Netflix. The stock increased an astonishing 500% over 19 months between January 2010 and July 2011 before returning to near its 2009 valuation in November 2011, four months later.
The real issue with momentum presently is that almost ideally suited to use as a mathematical strategy. Other strategies like value investing, favoured by Warren Buffet, rely on something that theoretically cannot happen in an efficient market, uncovering information that no one else has. But the problem with this method is that finding information, or perhaps more precisely making better assumptions about given information, is not something that can be delegated to a machine. On the other hand machines are very good a watching other machines trade and can determine momentum. As a result it is a favoured strategy of high speed traders who dominate 70% of the market in equities. It is also favoured by quants.
Momentum almost by its very definition takes advantage of a movement created by other people. To take advantage of this the quants designed strategies that reflected a trend movement. So it is hardly surprising that many of the strategies were very similar. Momentum is at some level irrational. Despite the fact that analysts and pundits are happy to come up with a plethora of reasons why a given stock or asset class should continue to grow, all of these reasons are based on assumptions, some of which are extensions of historical movements. But history does not repeat itself. As they say, momentum is a great strategy until it isn’t and the timing of these strategies has not been very accurate especially in a market dominated by risk on, risk off.
Investors themselves have not helped. With inadequate information about many strategies, they tend to pick money managers who have been successful in the previous quarters. To attract clients money managers eschew a strategy based on analysis of either stocks or economics and herd toward previous winners.
The real flaw in both momentum strategies and EMH has to do with information. EMH assumes that all information is known. This assumes that all players are honest and reveal everything. In contrast, a momentum strategy assumes that the environment will have no impact on the trend. Both assumptions are absurd. One thing that investors can count on is that over time information will provide investors with very large and sometimes very unpleasant surprises.
To read more from William Gamble, please click here.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)