India lacks social security

MF should drive the long term retirement solutions

Mutual funds can offer long term retirement solutions. Some structural changes and supporting tax structure can improve the existing offerings, which can emerge as a great solution to plan ones retirement.

It is a cliché to state that India lacks social security. Old age is a challenge, to be precise a financial challenge for many. The family system managed to push this problem below the carpet for generations. However, the emergence of nuclear families and high flying consumer inflation will surely bring this issue to the fore. Almost 25 years after embracing the liberalization – globalization - privatisation policy, it is high time our policy makers address this issue with some amount of seriousness.

In Union Budget 2014 we saw mention of mutual fund linked retirement plans, which made many believe that the finance minister is serious about the issue of retirement planning in India. However this year Finance Minister opted to remain silent on this issue, and MF investors have to wait for one more year. Mutual funds have to gear up for next year's budget by preparing a case for long term retirement solutions. However, before one goes into what changes are required in this space, it is better to understand how things are as of now.

The Need

For years Indians have saved money using traditional means such as employee provident fund, public provident fund and traditional with profit endowment life insurance policies. However, as inflation remains stubborn at high levels and interest rates are kept low, individuals need investment solutions that offer exposure to asset classes that beat inflation need equity. Existing debt focused retirement solutions run the risk of losing out in the long term due to inflationary pressures.

Extant Solutions

One may see today we have equity mutual funds and pension funds launched by mutual funds. These are good enough retirement planning tools. However, are they really adequate? Let us take a look at -

For any retirement fund asset allocation holds the key. Franklin Templeton and UTI Pension funds offer around 40% equity exposure, whereas Reliance Pension fund comes with a 75% equity exposure in accumulation phase. Fund managers do re-balance the portfolios from time to time. With every rise in equity markets the fund manager has to sell some shares and buy bonds. Also a fall in share prices, makes them sell some bonds and use the proceeds to buy shares. This has resulted in good risk-adjusted returns in the long term by UTI and Franklin Templeton funds.

But this static asset allocation may not be of much help to all investors.

Consider couple of situations- Suresh aged 23 years, takes his first job and wants to start planning for his retirement. Being young he can start with a high exposure to equity – say 75-80%. But does he get a product with that kind of asset allocation which will offer him retirement solution? Wait – don't jump for a balanced fund.

Ramesh is now 55 years and he knows he will retire at 60. He has accumulated some money over his working life and wants to invest in retirement fund. He should ideally invest up to 25% in equity? But does he get such a product? Wait – don't jump for a mutual fund monthly income plan that invests around 25% in equity.

The most important question is when both of them reach their retirement, allocation to equity should be around 10%. Should they keep jumping from one product to another? How many Indians really are that financial literate and how many can be so disciplined? Or should there be something tailor-made?

The Ideal Product

Catch any financial planner and ask for a retirement plan. He invariably suggests high equity exposure in early years of working life. As the individual ages and approaches his retirement age the asset allocation shifts in favour of bonds – why not launch a product on these lines.

For example – Retirement fund 2050. If launched today this fund will have a tenure of 35 years and may start with 65% equity, 10% gold and 25% bonds. Over a period equity exposure should go down and by 2050, the asset allocation should be 10% equity, 5% gold and 85% bonds. Thus, towards retirement most of the money will be in safer avenues.

If such a product is put in place there will be many takers for the same. More important is it even small investors who may not be savvy.

Policy Push

To make it a grand success, there is a need of additional regulatory push. Finance Ministry should take many decisions in this direction. First - proceeds from such a fund should be made tax exempt provided the money is kept in such a scheme for minimum ten years. This may not happen now, outside the purview of the finance bill. However this should happen in Union Budget 2016.

Contributions to such funds also should be made tax exempt. Fund houses may choose to launch one scheme for every five years. For Example - A fund house today may launch retirement funds maturing in 2040, 2045, 2050, 2055 and so on. Investors should be allowed to invest any time but exits should be allowed only at the time of maturity or with hefty exit loads and subject to tax.

Mutual fund houses can launch such schemes now and stick to the long term investing mandate. This will act as a means to push government to act on the much required regulatory push we discussed above.