Regulations in the financial sector need to keep evolving as the market grows in depth, breadth and complexity. Think of this as the need for road rules and a traffic management system in a large metro—what worked 30 years ago cannot work today. It was possible to travel 5 km in Delhi without running into traffic lights or traffic cops 30 years ago as road traffic was thin. A malfunctioning traffic light today causes hours of traffic jams. As the traffic volume rises, cities resort to one-way traffic rules, higher parking fees and other measures to curb traffic in the city centre. Financial markets are similar; regulations need to keep moving to keep pace with the changing face of the market. Has the market changed? Yes, the size of the assets under management by the three large parts of the retail financial market—mutual funds (only retail), life insurance and the National Pension System (NPS)—crossed Rs34 trillion in FY 2017, up from Rs22 trillion just 3 years ago. Both the volume of money and the number of people on-boarding these products has risen sharply over the past few years. The share of household savings in financial products has been rising and now more than one-third of household savings find their way into financial products. In addition to the urban users of these products, a new category of investors are getting added through the Jan Dhan accounts. These are people who will be first-time users of many financial products as they move from cash, gold and real estate.
ICICI Prudential Mutual Fund’s new fund offer (NFO) of Bharat 22 exchange traded fund (ETF) is in the market this week seeking investor money for the government’s disinvestment programme. Looking through the document, I was struck with the expense ratio of this fund. At 0.0095% per year, this is the cheapest ETF in the market today. Understand what this cost means first. The expense ratio describes the price you pay for the facility of handing your money over to a fund manager and it is charged on your funds under management. For example, a Rs10 lakh corpus, with an expense ratio of 1%, will cost you Rs10,000 a year. You don’t have to cut a cheque for this cost since it is taken by the fund house out of your corpus—that’s why it is called net asset value, it is ‘net’ of costs. Expense ratios have a big impact on investor returns over a lifetime of investing. At 0.0095%, Bharat 22 will cost you Rs95 a year. Reliance AMC’s CPSE ETF (the first government disinvestment fund) costs 0.07% or Rs700 a year. A 2% managed fund expense ratio costs you Rs20,000 a year.
If in the 1950s somebody wrote a future finance story about India, they may not have predicted the market that faces a retail consumer today. Till the 1990s, your savings and investing decisions were dependent on the government. No wonder Indian households chose gold and real estate as saving sumps. The financial sector was a reflection of the overall direction of the economy. Costs were high, service poor in state-owned and run finance. But post 1991, change came suddenly to finance and this column maps some of those changes as India celebrates 70 years of political and 26 years of economic freedom.
RRR exit, hmmm. Brexit, meh. Shrugging off plenty of bad news, the Sensex hit an 11-month high this week. What’s going on? The story for India is the thickening of the retail equity pipeline, not directly in stocks, but through institutions such as pension funds and mutual funds. Sustained flows of retail money is coming in. And it is coming in a staggered manner. Indian household money has traditionally been in real assets such as gold and real estate, in bank fixed deposits (FDs) and to some extent in life insurance policies. The organised sector contributed to their provident fund, which again went into bonds and other fixed return paper. Think about the change in our own investing behaviour—we swore by FDs and Life Insurance Corporation of India policies, but are now die-hard SIPpers (investors into systematic investment plans of mutual funds). What changed?
Finance minister Arun Jaitley announced in the Lok Sabha on Tuesday that he will roll back the tax on salaried Middle India’s one true friend—the Employees’ Provident Fund (EPF). The Budget had proposed to tax 60% of the EPF corpus on retirement, leaving 40% tax-free. But if the 60% was invested in an annuity, it would remain tax-free; the tax will be paid on the income the annuity generates. The National Pension System (NPS) has retained tax-free status for 40% of its corpus. You can take 60% of your NPS corpus as a lump sum at age 60 and 40% must go to buy an annuity. Of the total NPS corpus, 40% will now be tax-free and you will pay slab rate tax on 20% of the corpus. If your NPS corpus is Rs.100, then your tax is on Rs.20. The annuity income is taxed at slab rate.
The controversy around Employees’ Provident Fund (EPF) began two weeks back, and not on Monday, when it was announced that the withdrawal rules will change. With effect from 10 February, a labour ministry amendment has capped what you can withdraw from your EPF corpus before you retire. Before 10 February, you could have withdrawn your entire EPF corpus if unemployed for more than two months. Before EPF portability, each time you moved jobs and got a new EPF number, you could clean out your PF money from the previous employer. The new rules allow you to withdraw your contribution and the interest on it before retirement, but the employer’s contribution is locked in till age 58. On Saturday last week, I accidently stepped into an ongoing conversation about the change in EPF rules on Twitter. Read the debate on my twitter handle @monikahalan on 28 February 2016 around this. People were angry at getting locked into the product and wanted greater flexibility.
It is a pattern now. Whether it is at a committee meeting or a conference where retail financial products are being discussed, the example of the National Pension System (NPS) keeps coming up to substantiate the argument that lobbyists make in favour of front-end incentives in retail financial products. Their argument goes like this: you can have the best product but unless there is an upfront commission, it will remain on the shelf. Look at the NPS, it has the best product structure, but retail participation is not there; it has failed. I’m always amazed by this argument. Because this is not the failure of the NPS, but of the market place. The ‘fault’ of the NPS is this: it is a good product in a bad market. I made this argument at the Second Pension Conclave organised by the pension regulator last week in Delhi.