The Union Ministry of Labour has allowed exempted trusts to invest a minimum of 5 per cent and a maximum of 15 per cent of their incremental inflows in equities. The Employee's Provident Fund Organisation (EPFO) has said that it will invest about ₹5,000 crore in equities in 2015-16, which is 5 per cent of the ₹1 lakh crore inflow it expects this year.

The EPFO plans to invest in units of exchange-traded funds (ETFs) of Nifty and Sensex issued by SBI Mutual Fund on a daily basis in the ratio of 75 and 25 per cent respectively. And whenever there is a fall of 2 and 4 per cent or more in the market, the EPFO will invest the entire sum for the week or month respectively, on that day.

Investing in markets through index ETFs on a periodic basis is a passive strategy, which is generally recognised as being most suitable for long-term investors like pension funds.

However, increasing the investment during market falls, as planned, is tantamount to 'timing' the market, whose suitability to long-term investors is uncertain. Timing the market could increase the market risk and may transform the fund's investments from passive to (quasi) active investing.

So, how will this strategy work? We tested this through empirical simulation.

We assumed that ₹10,000 was invested on every trading day in the Nifty at its closing price for 25 years from July 1990 to June 2015, which we call option I (passive investment).

For instance, as the Nifty closed at 279 and 8,369 on July 3, 1990 and June 30, 2015, respectively 35.84 and 1.19 units of Nifty would be bought on those days.

In option II, quasi active investing — which the EPFO is said to be using — was tested out. Fresh investments were assumed whenever markets fell by 2 per cent to 4 per cent.

To illustrate, on September 4, 1990, the market closed at 392, down from 407 the previous day, which is a fall of 3.6 per cent. ₹40,000 is assumed to be invested as that is the amount available for the remaining four working days of that week.

In the same manner, on September 14, 1990, the market closed at 397 from 414 the previous day, a fall of 4.3 per cent. So ₹80,000 is invested as that is the amount available for the remaining eight working days. In this manner, ₹6.024 crore is presumed to be invested over 6,024 trading days in option I; the same amount gets invested over 4,823 days in option II.

Over the 25-year period, investment in option I accumulates 42,153 units as against 42,183 units of Nifty in option II (30 units more).

The value of these units as on July 1, 2015, at Nifty closing price of 8,453 works out to ₹35.63 crore and ₹35.66 crore respectively. Clearly, option II yields ₹2.57 lakh more. In terms of rate of return, option II gives a return of 12.6124 per cent as against 12.6111 per cent in option I.

As you can see, the difference between the two strategies is not all that significant. Although past returns are never a guide to the future, this illustration does provide EPFO investors with a perspective on the possible outcome of this strategy.