Will the New Pension Scheme look like broker-run Portfolio Management Schemes under Yogesh Agarwal?
July 29, 2010
The new PFRDA chairman wants to make fund management fees flexible, hoping that investors will seek out the top performers! This bizarre idea for a retirement product rests on the chairman’s monumental ignorance of both the fund management business and the NPS
Yogesh Agarwal’s key reform idea for the New Pension Scheme (NPS) is to increase the incentive for fund managers who manage the schemes. Not only this, he wants the NPS opened up for all fund managers to bid in a free-for-all manner. He believes that these reforms will ensure that money will gush into NPS with the maximum money flowing into the best performing scheme. More players with better incentives will attract more funds from investors and ultimately benefit them. This utopian idea rests on a deep fallacy: free-market competition is good for all financial services including retirement products which have to be managed very prudently and cautiously, not for maximising returns.
In an interview to Business Standard today, Mr Agarwal said that he would free the fee structure, but not keep the game confined to six fund managers. He will put up proper criteria and any fund manager who meets that can apply and be approved to manage the NPS. The fund managers can then go to the investors, quote a fee based on their track record. He says, “Why should we have a uniform fee structure across fund managers? Investors will not mind paying a higher fee provided the returns are better.” He has set up a committee under former SEBI chairman GN Bajpai to debate these issues.
If this is Mr Agarwal’s idea of NPS reform and brief to the committee, it is based on shocking ignorance which will be disastrous for investors. Mr Agarwal simply does not understand either the fund management business or sound investment theory of retirement products, which is the bedrock of NPS.
First, his ignorance about assets versus performance. The fact is that over two decades of competitive fund management in India, it is clear that there is absolutely no correlation between higher performance and higher corpus. Investors simply do not know which is the top-performing fund management scheme and fund house, identify it and choose a particular fund — even when the fees are the same and are fixed by the regulator. Were that to happen, UTI Mutual Fund (UTI MF) would not have had one of the largest corpuses in the country since its performance is rather poor. Investors would run away in droves from UTI MF to Sundaram, HDFC, Reliance DSP BlackRock and others. It has not happened because there is very low correlation between performance and assets under management (AUM). Investors have to be continuously informed and educated about all of these issues, especially about which funds have the best long-term performance record, even though this information is freely available. In fact, it is now acknowledged that financial literacy in India is poor and everybody from SEBI to mutual funds, stock exchanges and depositories are spending significant sums of money on investor education.
This leads us to the second wrong assumption of Mr Agarwal. To make the scheme popular he wants to incentivise fund management companies and not the distributors. If fund companies could incentivise their own channels, they would have done so already and not been helpless in the face of fast-changing SEBI regulations. Assets of equity mutual funds are continuously flowing out since last August 2009 despite excellent performance of the majority of funds. If mutual funds have not been able stem the tide and attract money, how will they do it in NPS? It is the distributors who need to be incentivised in some way and if PFRDA cannot do that, like mutual funds, subscriptions to NPS will also dwindle.
The third reason why performance-based higher fees are a bad idea for NPS is that the investment mix in NPS is fixed and rigid. Some money has to go into index stocks in an agreed proportion, so also into bonds and government securities. This is based on the sound theory of portfolio diversification specially structured for NPS, which is a retirement product. But this also means that there will be no meaningful variation between one portfolio and another, if the schemes are managed as per the NPS document. Mr Agarwal perhaps does not know that variation in portfolio performance can only come from wide differences in security selection and market timing. Is Mr Agarwal saying that your retirement money will be put into small-cap stocks and subject to a fund manager’s market-timing skills? There is no way fund managers can outperform each other significantly at all under the current structure; it is unwise to say that one scheme manager will do better than another and all investors will suddenly flock to it and even pay more.
If Yogesh Agarwal’s views are put into action, the NPS may resemble a highly incentivised broker-run Portfolio Management Scheme with the same consequences — where a majority of investors have lost a significant chunk of their capital while the portfolio manager earned both fees and hefty brokerage.
Mr Agarwal’s comments in the interview suggest that he is unfamiliar with the fund management business (where fees are fixed) and the DNA of a retirement product like NPS, which has a specific structure.
Before Mr Agarwal tinkers with the NPS, shouldn’t SEBI be making fund management fees free, because mutual funds are more of a high-risk return product than NPS? Mr Agarwal is a career banker and has no experience in fund management. NPS can do with innate caution and prudence rather than endow it with the recklessness of fully incentivised, performance-linked hedge funds or portfolio management schemes. --Debashis Basu
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