According to what the labour ministry (which manages the EPFO) has said, equity investments will commence in July and the equity exposure will gradually go up to five per cent by the end of the financial year. According to the finance ministry's new norms, five per cent is the minimum equity exposure that EPFO must have. This can go up to a maximum of 15 per cent.

As one would expect, there is no shortage of people who are loudly proclaiming that the government is forcing EPFO to gamble away the hard-earned savings of crores of employees. Writers of news stories seem spoiled for choice when they look for the apparently obligatory quotes from trade unionists and left politicians on the terrible fate that awaits retirees now that EPFO will start doing 'satta' with savings.

While one can't expect anything else from this lot, I'm surprised at how widespread the underlying sentiment is. From the fear mongering that is going on, one would think that that the EPFO will immediately deploy its entire corpus to leveraged day trading in derivatives. In fact, I actually came across an article on this issue from an otherwise balanced publication with the hashtag #financialderivatives!

That's an extremely misleading piece of misinformation. The small amount of equity exposure that EPFO funds will have are limited to Exchange Traded Funds (ETFs) which mimic a market index. ETFs share none of the high-risk characteristics of derivatives. In any case, this name-calling always avoids the main point of the logic of equity investing for PF funds.

The return offered by the EPFO is far too low to give any kind of realistic return over and above the inflation rate. Constrained by the fixed income investment mandate, the returns have barely kept pace with inflation. When you take rising prices into account, fixed income returns are the worst form of retirement savings. They ensure, without any doubt whatsoever, that the saver will just get back the actual value that he or she invested, without any gains whatsoever.

The risk that critics talk about are based on the casual impression of volatility. Equities may be volatile, but over any investment over a few years, the volatility gets more than compensated for by returns. Take the last ten years, for example. One lakh rupees in EPF have increased to R2.48 lakh. However, one lakh rupees in a Nifty ETF would have been R3.9 lakh rupees. Do note that these ten years have seen the worst financial crisis in a generation as well as a long period of stagnation. This kind of a difference between returns would make the difference between a saver starting retired life in prosperity versus always struggling to make ends meet.

But of course, this is not actually going to happen. The actual quantum of equity exposure is utterly useless. The norms say that the EPFO must invest between five and fifteen per cent of incremental investment in equity ETFs. No assets will be taken out of fixed income and then redeployed into equity. At this rate, it could take a decade or more (depending on the rate of withdrawal and the differential between equity and fixed-income returns) for the equity exposure to reach five per cent or more. And even then, a five per cent exposure is the worst of both worlds.

When the equity markets drop, the usual suspects will cry themselves hoarse about the losses, but when the markets rise, the tiny exposure to equity means that gains that are meaningful to savers will be hard to come by. Equity exposure will not serve the purpose unless it is at least in the 30 to 50 per cent range. That might sound like sacrilege in the context of the EPFO, but equity exposure of that scale is already available in some of the plans of the National Pension System (NPS). And that actually points to the logical solution to India's retirement savings mess--dissolve the EPFO and merge it into the NPS.