Provident funds in stock markets: 6 things to know

Provident funds in stock markets: 6 things to know

Prime Minister Modi’s government seems determined to make up for its mediocre performance in its first year in power. At least in the financial domain, new policy initiatives seem to be coming in thick and fast. The most recent of these has been the consent for Employees’ Provident Fund Organisation (EPFO) to invest a proportion of its assets in equity markets. 

 
Let’s examine the impact of this on equity markets: 
 
 1. Moving in-line with global trends: Provident funds help in securing their contributors’ retirement. Whatever people contribute to a retirement fund is cumulatively invested by it in financial assets for the long term. The return from these assets is used to repay their contributors upon their retirement. Given their purpose, such funds naturally invest most of their corpus in safe assets, such as government bonds. However, these assets offer limited growth potential. Therefore, most retirement funds, around the world, also invest a small proportion of their corpus in equities. These are riskier assets, but offer a better rate of return. 


2. Why EPFO matters: EPFO is one of the world’s largest funds. However, until now, it was not allowed to invest in equities at all. The new move will allow it to invest 1% of its corpus in equity markets in July itself. This percentage will be gradually increased to 5% by the end of this fiscal year. This will put the portfolio allocation of India’s state owned fund in-line with global peers. It must be noted though, that initially, the investment would only be in Exchange Traded Funds (ETFs). ETFs are a kind of equity funds, whose small denominations trade on the market like normal shares. 
 
3. Huge influx of money into equity markets: EPFO’s assets exceed $100 billion. 1% of this means approximately $1 billion. This is the amount that it would invest in equities just in the month of July. It would eventually go up to $5 billion by the end of the financial year. An infusion of this magnitude could prove instrumental for the markets in their present state. According to equity dealers, the news was the main reasons why Indian markets surged to a one-month high on Thursday. 
 
4. Reduced dependence on FIIs: Foreign investors have provided direction to our equity markets for a long time. They have pumped in an estimated $1 billion per month on average in Indian equities in the last two years. However, in recent months, Foreign Institutional Investors (FII) have been very cautious about investing in India. In fact, many of them have pulled out huge sums, causing a steep decline in share prices. The amount EPFO is expected to pump in next month is identical to the FII monthly average. If the scheme is successful, Indian could have a homemade solution to offset uncertainty brought in by FIIs. 
 
5. Long-term support to the market: Provident funds investment for the long-term. This is because people who contribute to them don’t pull out their contributions until their retirement. Consequently, Provident funds are not known to follow aggressive buying and selling strategies. They generally invest large sums in a company for long periods of time. This means that stocks of companies that receive large EPFO investments could display stable price trends for a long time. This could inspire other investors to invest in them and lead to huge price appreciation. 
 
6. Higher brokerage income: Last financial year, brokerages enjoyed one of their best periods in recent times as more and more people opened Demat accounts and started investing. As stock prices soared, so did brokerage fees. However, this year has not been that good so far. Shares have constantly tumbled. With EPFO entering the picture, good times could return for the brokerages that can corner a fair share of its business.
 
Happy Investing
Source:Moneycontrol.com