Lacking discipline to stay invested? Retirement funds are a good option

Others should invest in pure equity and debt funds, or go for EPF and NPS

The retirement fund category has 25 funds with total assets under management (AUM) of Rs 16,775 crore. The largest funds in this category are from UTI, HDFC, and Nippon India. The latest entrant is Union Asset Management Company (AMC).

According to the Securities and Exchange Board of India’s (Sebi) circular of October 2017, retirement funds fall under the solutions-oriented schemes category. Sebi’s only stipulation for them is that they should have a lock-in for five years, or until retirement, whichever comes earlier.

These funds have widely varying asset allocation. Some are pure equity funds with equity allocation above 90 per cent. Others are akin to hybrid funds, with equity allocation ranging from 18.8 to 82.5 per cent.

Enforce discipline

According to Association of Mutual Funds in India (Amfi) data, only about 46 per cent of Indian equity mutual fund investors stay invested beyond two years. The majority tend to bolt at the first sign of a market downturn or underperformance by the fund.

The compulsory lock-in can help such investors. “Due to the five-year lock in, the investor is forced to stay invested for this period, allowing his money sufficient time to grow,” says G Pradeepkumar, chief executive officer, Union AMC.  

Such labelled products also lead to mental slotting. “Investors who put money in a labelled fund are less likely to use it for other purposes,” says Arun Kumar, head of research, Fundsindia.com.

Stuck with an underperformer

The five-year lock-in can, at time, be problematic. “The investor could get stuck in an underperforming fund for a long period,” says Vaibhav Porwal, co-founder, dezerv.

These funds are also expensive. “Their regular plans tend to have high expense ratios,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi-registered investment advisor. Most of the regular plans have an expense ratio above 2 per cent, with the maximum going up to 2.69 per cent.

Besides the five-year lock in, there is little to distinguish these funds from open-end pure equity or hybrid funds. In terms of performance, too, it is hard to separate them. “Of the 25 retirement funds, 15 have been in existence for less than three years, so it is difficult to gauge their performance yet. However, their one- and three-year rolling returns are not very different, compared to equivalent hybrid or flexi-cap funds,” says Porwal.

Since they are active funds, the investor faces the risk of faulty security selection by the fund manager. They also don’t receive any special tax benefit.

These funds also don’t offer many of the features that a dedicated retirement product, such as the National Pension System (NPS), does. “In NPS, you are locked in until retirement (with only partial withdrawals allowed under special circumstances) to ensure forced saving for retirement. Here, the lock-in is for five years only, so the money could be used for other purposes. NPS has compulsory annuitisation which ensures an income stream for life. Here there is no such compulsion. Also, in NPS, either the investor controls the asset allocation or it is automatically determined by his life stage.”

In a mutual fund, the asset allocation can’t be changed inside one fund. In a retirement fund, the investor doesn’t control the asset allocation. The asset allocation does not depend on the age of the investor either. It is the same for a 28- or a 58-year-old. And if the investor uses a second fund to manage asset allocation, switching between these funds would result in a tax liability. NPS doesn’t have such issues.

Should you invest?

Investors, especially those who are new to equities and lack the discipline to stay invested for the long-term, could benefit from the lock-in in these funds.

Those who have an advisor to handhold them, or have the necessary discipline to stay invested amid volatility, can build their retirement portfolios using a mix of equity and debt funds (also Employees Provident Fund and NPS).

Those who choose to invest in these funds must do a lot of due diligence, given the long lock-in. “Ensure that the fund’s equity portfolio has a decent track record and check the debt portion for credit and duration risk,” says Kumar.