In a bid to improve returns for subscribers and shield its income from market volatility, the Employees’ Provident Fund Organisation (EPFO) has decided to modify the redemption policy for units of exchange traded funds.
The issue is understood to have been discussed at the recent meeting of the Central Board of Trustees of the EPFO and subsequently approved. The retirement funds manager proposed to increase the minimum holding period of ETF units to “over four years” before they are redeemed. At present, these units are redeemed at four years.
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Under its investment guidelines, the EPFO can invest between 5% to 15% of its proceeds in equities and related investments. It began equity exposure after the decision to invest 5% of its fresh accretion in equity through ETFs based on the NIFTY-50 and BSE Sensex in August 2015.
The limit has since been raised. The EPFO is looking to step up actual investments in equity to the 15% threshold.
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The EPFO may also link the return threshold of ETF units to government securities. Under the plan, the holding-period return of the units that are proposed to be redeemed should be at least 250 basis points more than that on the 10-year benchmark government security.
Another suggestion is to benchmark ETF returns to historical long-term averages. Accordingly, the holding period returns of the units to be redeemed should be above the average five-year returns of the past 10 years based on the NIFTY or Sensex. In order to shield redemptions from short term market volatility, the EPFO has also proposed spreading the period of redemption to a daily basis. At present, the redemption is done over a shorter period of time.
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Sources said the amendments would help smoothen the internal rate of return and maximisation of capital gains on redemption of ETF units.
Since ETFs do not provide for regular income and do not have a maturity period, the EPFO redeems ETF units periodically. The capital gains realised from this exercise is then treated as income and distributed to EPF subscribers as income.
The CBT, which is the EPFO’s apex decision making body, had in February 2018, approved the ETF redemption methodology. Under this, the redemption of ETF units was permitted only on the days when the current market net asset value (NAV) is not less than 5% of the average NAV for the last seven days. Further, the First In First Out (FIFO) principle was adopted while redeeming ETF units with the redemption to be carried out over 15 to 20 days.
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The EPFO announced an interest rate of 8.15% for subscribers for the fiscal 2022-23, which was just marginally higher than the 8.1% return it had given for the previous fiscal. For the interest pay out, it redeemed ETF units for the calendar year 2018 and is estimated to have raised `10,960 crore from the exercise.
Due to periodic redemptions of ETF units and reinvestment of only 15% of the redemption proceeds in ETFs, the share of equity investments in the total EPF corpus has been growing at a slow pace. As on January 31, 2023, investments in equity amounted to 10.03% of the proceeds and it is estimated that it may take another five to six years for the equity portion of the fund to reach the 15% mark.
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As on January 31, 2023, the EPFO had investment holdings at face value of about Rs 12.53 trillion, of which about a cumulative Rs 1.25 trillion was in equities and related investments.
