As a sign of increasing confidence in the expansion of private pension systems in India, the Indian Ministry of Finance recently announced an increase in investment flexibility. This will be effective from 1 April 2009 for non-governmental provident funds, superannuation and gratuity funds.
In common with the practice in many developing countries, there have always been significant restrictions on how these funds could be invested, with a considerable bias toward local investments and toward government securities. This latest revision to the investment pattern gives a welcome expansion to the available universe of investment options and will give more flexibility for investment management within the revised ceilings available for different categories of investment.
The revised investment pattern is as follows:
Instrument
Revised investment pattern
(Investment pattern dated January 2005)
Government securities and mutual funds dedicated to government securities, regulated by the Securities Exchange Board of India (SEBI)
Up to 55%
( Minimum 40%)
Debit securities (issued by corporate bodies, including banks and public financial institutions); term deposit receipts (issued by scheduled commercial banks) and rupee bonds
Up to 40%
( Minimum 25%)
Money market instruments, including units of money market mutual funds
Up to 5%
(Previously not allowed )
Equities
Up to 15%
(Up to 5% )
Equity-linked schemes of mutual funds regulated by the SEBI
Up to 10%
Within the above instruments, it should be noted that investment in equities is limited to shares of companies for which derivatives are available on the Bombay Stock Exchange or the National Stock Exchange. However, this does cover more than 250 stocks, which would now be available. Concerning debt securities, these should have a duration of at least three years, and at least 75 percent of investments need to be investment grade. Bonds denominated in Indian currency and issued by multilateral agencies such as the International Finance Corporation, a member of the World Bank Group or the Asian Development Bank must also have a maturity of at least three years. The required duration for term deposit receipts has been changed from a maximum of three years to a minimum of one year. Overall, this is a significant extension of flexibility in creating a range of bond portfolios.
Apart from a specific limit on exposure to mutual funds, which is not to be more than 5 percent of the portfolio at any time, there are some further significant relaxations around trading and the monitoring of the investment pattern. While the investment pattern must be in place at the end of each year, movement is allowed during the year provided that each category does not exceed the investment pattern limit by more than 10 percent. Also, the entire portfolio can be treated as tradable and exposed to active management. Rather than the old limit of 10 percent of the portfolio being tradable, the only limit now is that the overall turnover ratio (that is, the value of securities traded during the year divided by the average value of the portfolio during the year) should not be more than 2 percent.
Funds will now have more flexibility to manage the assets held under pension schemes. Hence, investment decisions will become more complex. The trustees of the pension funds will need to be well informed about the investment options available in the market and also ensure compliance with the prescribed guidelines. Pension governance will become more important.
Around the world, much is written about the techniques and management of portfolios to get best outcomes and match the requirements of participants. The additional flexibility will allow Indian employers opportunities to improve their funds for the benefit of participants. Effort expended on considering how to take advantage of the additional flexibility should be very worthwhile.
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