There’s no dearth of mutual fund (MF) advocates in the asset management space. However, Sumit Shukla, managing director and chief executive of Axis Pension fund, does not fit into that universe. Shukla has been eschewing MFs in favour of lesser-known investment products for his retirement kitty. His favourite is the tier-II National Pension Scheme (NPS) funds.
As per available data, MFs command over ₹55 trillion in assets and traditional NPS tier-I funds have assets worth Rs1.75 trillion, while NPS tier-II funds only have Rs5,435 crore under its hood. To be sure, an NPS tier-II account is similar to NPS tier-I sans the tax benefits. The only advantage tier-II accounts have over tier-I is that holders can redeem the funds anytime. For now, Shukla is putting a chunk of his savings in tier-II funds with an aim of switching to the more tax efficient structure of tier-I as he nears his retirement age. Unlike equity funds that are taxed at 10% of the capital gains (held for more than one year), NPS offers a tax free systematic withdrawal facility of 60% of the corpus from age 60 to 75.
Tier-II account has other things to boast. It charges a meagre 9 basis points as fund management charge. This is way cheaper compared to the average expense ratio of mutual funds. It also allows subscribers to change fund managers and shift between asset classes such as equity, government bond fund and corporate fund without any additional charges.
“I am getting the average returns of MFs at a much lesser cost,” said Shukla, who is the former chief of HDFC pension fund. “The average IRR (internal rate of return) of NPS funds is 12%”
Shukla is aiming to build a corpus of Rs5 crore in his NPS account. If he manages to do that, he will be able to withdraw Rs4 lakh every month without touching his principal amount till he turns 75. This is assuming a 12% return on the account every year. After 75, he can withdraw 60% of the corpus as a lump sum. The remaining 40% has to be compulsorily invested in annuities.
Shukla agrees that there is an ambiguity on how tier-II funds are supposed to be taxed and there is no mention about it in the Income Tax Act. In a press meet in January this year, Pension Fund Regulatory and Development Authority chairman Deepak Mohhanty told journalists that this ambiguity will be cleared soon. There has been no official statement since.
“I think the low cost structure and the returns are worth it,” said Shuka although he agrees that there need for clarity on how tier-II accounts should be taxed on redemption. “I also want to have skin in the game,” he added.
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Asset mix
Shukla’s portfolio is skewed towards direct stocks as he received stock bonuses from his present and former employer. Due to this, nearly 45% of his portfolio is in direct stocks even though he’s not allowed to invest in direct equities. He has 5% in various equity mutual funds, 7% in NPS tier-I and about 3% in NPS tier-II funds. Although his savings in NPS tier-II is small compared to MFs, he’s now started putting in incremental savings there.
He also has a mix of sovereign gold bonds, employee provident funds and debt mutual funds. This forms roughly 20% of his portfolio and the remaining 20% is invested in real estate. “Sovereign gold bonds have done well for me as gold prices have gone up but properties have not yielded much,” said Shukla, who says he’s now planning to sell some of his real estate.
Although Shukla has a house of his own, he thinks its better to stay in a rented accommodation than to own one. “I have a few friends who bought big houses for huge sums of money but now their children have gone abroad. Even though they don’t need that much space now, they cannot move to a smaller house.”
Shukla doesn’t have any international investments because he believes that there are enough growth opportunities in India compared to abroad. “It’s like Shewag telling Gilchrist that he will never play outside as the money is too small. Why go abroad when the opportunity is more promising here.”
Lessons from childhood
Shukla recalls a harrowing experience from his childhood that left an indelible mark. He was studying in class X when his father suffered a major stroke , slipped into a coma and had to be hospitalized for some time. Though his father recovered from this trauma subsequently, he had to be hospitalized multiple times and this took a toll on their family finances. It did not help that his mother was a housewife. Shukla says he can never forget the financial hardship that his family faced then.
“That bitter experience convinced me about the need for medical insurance,” says Shukla. Later, he bought an expensive medical cover to insulate him and his family from such unforeseen events. He now has a family floater health plan with a sum insured of Rs.1 crore.
He also nudged his wife to start her own business. “I didn’t want my wife to go through what my mom had faced because she was a housewife. I keep telling her about this and pushed her to start her own business. God forbid, if something happens to me, she can at least sustain herself.”
Mint’s take
While NPS tier-II offers funds at a lower expense ratio and allows switches between fund managers and asset classes for free, it might not be able to offer the variety that mutual funds do. There is only one type of equity funds in the NPS structure and they are limited to the top 200 stocks. So risk takers might prefer other alternatives. But more importantly, it is unclear how tier-II funds are taxed at the time of redemption or when it is transferred to a tier-I account. It is advisable for people to wait for official confirmation on how tier-II funds will be taxed and then take an informed call. NPS tier-I, however, is a great value proposition from a retirement point of view due to its low costs, tax efficiency (60% tax free on retirement) and its potential to benefit from the compounding power of equity.