The Hidden Risks of NPS Debt Portfolio – Are you aware?

What are the hidden risks of the NPS debt portfolio? Whether the debt portfolio of NPS is always safe? How to manage the risk if it really exist?

Risks of NPS Debt Portfolio

NPS is one of the most popular pension products among Indians. Many of us invest in NPS with the hope of better returns, tax saving purposes, or assuming that it is the lowest expense product. However, have you ever checked the risk involved in NPS investment, especially in the NPS Debt Portfolio?

The majority of us have a wrong belief that a debt portfolio is safe as there is no equity exposure.

I have had this concern for many years and airing the same on social media often. However, as we concentrate only on returns and tax-saving options, such cautions will always take a back seat.

The Hidden Risks of NPS Debt Portfolio – Should you invest?

Before understanding the hidden risks of the NPS Debt portfolio, you must understand few terms of the bond market without which you can’t understand the risks of the NPS Debt Portfolio.

# Modified Duration

Bond prices fall whenever there is an increase in interest rate (and inflation) and vice versa. However, how much the bond price will fall? Modified duration is an indication of such a fall in bond price.

In simple language, the percentage change in the bond price per unit change in the yield to maturity. If you wish to know more about yield to maturity, then you can refer to my earlier post “Part 4 – Debt Mutual Funds Basics“. In fact, I have written a series of posts to understand the concept of debt mutual funds and writing continuously. You can refer to all those posts at “Debt Mutual Funds Basics“.

From this post’s understanding, let us assume that the NPS debt portfolio modified duration is 5.34 years, if the interest rate goes up by 1%, then the NAV of the portfolio will fall by 5.34%. Vice versa, if the interest rate goes down by 1%, then the NAV of the portfolio will go up by 5.34%.

If the interest rate goes down or up by 2%, then the price will fluctuate 10.68% up and down!!

In simple words, it indicates the volatility of the portfolio with respect to the interest rate movement. The higher the modified duration higher the interest rate sensitivity.

I don’t want to confuse you all by sharing the calculation method. For simplicity purposes for all investors, understanding this much is sufficient.

# Yield To Maturity (YTM)

Yield to maturity in simple terms what is the return on investment if you hold the bond till its maturity? As I mentioned above, I have explained this concept in detail in my post ” Part 4 – Debt Mutual Funds Basics“.

Do remember that this is a tentative return but not a guaranteed return. Even though the coupon is fixed, the maturity date is fixed, and the principal returns back for the fund manager, fund managers sometimes sell the bonds before maturity. If such selling happens, then obviously the yield that you are looking for today may not be available as returns. Mainly because the price of the bond changes on a daily basis based on interest rate fluctuations, credit risk, and default risk.

The YTM of the NPS debt portfolio may change if fund managers sell before maturity. At the same time, as bonds pay the interest on a regular basis, fund managers have to reinvest the same. The reinvestment risk always creates fluctuation on YTM.

Hence, in simple terms, usually higher YTM means higher risk.

# Average Maturity

Average maturity is the weighted average of all current maturities of the bonds in the debt portfolio. The weight is the percentage holding of each security in the portfolio. This tells the average time taken for all the securities to mature in the portfolio.

If the average maturity of a debt fund is five years, this means all securities, on average, will mature in five years. However, if you check each bond’s maturity, it might be different from five years.

A high average maturity indicates that a debt portfolio has securities that take a longer time to mature, while a low average maturity means the underlying securities have a shorter maturity.

Bond prices fluctuate based on the interest rate movement. I have explained this risk in my earlier post “Part 3 – Debt Mutual Funds Basics“. You can refer to the same.

The impact of interest rate fluctuation is higher for the long-term bonds than the short-term bonds. As the NPS also invests in bonds, the portfolio will obviously impact the returns of a portfolio.

Hence, knowing the average maturity of the portfolio is also an important indication of risk.

Considering all these aspects, I have collected all NPS Fund Managers Debt portfolio’s average maturity, modified duration, and yield to maturity data. This data is as of July 2023.

Fund House NameScheme C – Tier 1Scheme G – Tier 1
Average Maturity (Yrs)Modified Duration (Yrs)Yield to Maturity (YTM) %Average Maturity (Yrs)Modified Duration (Yrs)The link is provided to download. However, file wasn’t available..Strange but TRUE!!
SBI Pension Fund6.314.467.7213.447.537.46
LIC Pension Fund6.264.57.5213.97.647.3
UTI Pension Fund64.387.6912.827.217.31
HDFC Pension Fund5.384.167.7812.176.977.21
ICICI Pru Pension Fund6.334.447.8212.767.427.31
Kotak Pension FundLink is provided to download. However, file wasn’t available..Strange but TRUE!!
Birla Sunlife Pension Fund6.44.53Yield to Maturity (YTM) %11.317.17.38
Tata Pension Fund7.815.347.6412.097.267.3
Max Life Pension Fund7.395.137.6414.587.97.32
Axis Pension Fund5.253.927.6313.987.547.41
Fund House NameScheme C – Tier 2Scheme G – Tier 2
Average Maturity (Yrs)Modified Duration (Yrs)Yield to Maturity (YTM) %Average Maturity (Yrs)Modified Duration (Yrs)Yield to Matrutiy (YTM) %
SBI Pension Fund6.194.387.6314.577.737.47
LIC pension Fund6.14.397.5112.717.47.29
UTI Pension Fund6.174.377.5814.647.657.32
HDFC Pension Fund4.923.767.7111.16.677.22
ICICI Pru Pension Fund6.514.527.812.867.547.31
Kotak Pension FundLink is provided to download. However, file wasn’t available..Strange but TRUE!!
Birla Sunlife Pension Fund6.914.777.5612.397.327.37
Tata Pension Fund7.665.337.7612.67.517.33
Max Life Pension FundStrangely NOT AVAILABLE!! As fund is only investing in Birla Sunlife Liquid Fund and UTI Overnight Fund.6.774.987.28
Axis Pension Fund6.984.877.5212.877.557.35

You noticed that the average maturity years for Tier 1 Scheme C for all fund managers is 6.34 years. The average modified duration for Tier 1 Scheme C for all the fund managers is 4.54 years. The average YTM for Tier 1 Scheme C for all fund managers is 7.67%.

You noticed that the average maturity years for Tier 1 Scheme G for all fund managers is 13 years. The average modified duration for the Tier 1 Scheme G for all the fund managers is 7.3 years. The average YTM for Tier 1 Scheme G for all fund managers is 7.3%.

You noticed that the average maturity years for Tier 2 Scheme C for all fund managers is 6.43 years. The average modified duration for Tier 2 Scheme C for all the fund managers is 4.54 years. The average YTM for Tier 2 Scheme C for all fund managers is 7.63%.

You noticed that the average maturity years for Tier 2 Scheme G for all fund managers is 12.27 years. The average modified duration for Tier 2 Scheme G for all the fund managers is 7.15 years. The average YTM for Tier 2 Scheme G for all fund managers is 7.32%.

NOW…What is the risk here?

Even if we assume that in both Tier 1 and Tier 2 C portfolios, fund managers perfectly avoid default or downgrade risk 100%, the interest rate risk is unavoidable both in C and G portfolios.

Hence, the concern for me at least (I know there are few who are fond of NPS as it helps them to save and risk is immaterial for them) is a subscriber who is aged 30 years has the same risky portfolio compared to those those the subscriber who is aged at 55 or 58 years.

Even though NPS claims that as you grow older your equity portfolio will get reduced and your debt portfolio increase (in auto choice), the debt portfolio due to its long-term bond holdings is highly risky to the interest movement.

When the modified duration of the portfolio is in the range of 4+ years to 7+ years, a 1% up and down in the interest rate will create up and down of around 4% to 7%.

Imagine someone is around 58 years old and suddenly interest rate falls by 1%, then even though his NPS portfolio is 100% in debt, due to such movement in interest rate, his portfolio may down by around 4% to 7%.

We all discuss or so-called financial gurus discuss the derisking of equity portfolios. Same way derisking of debt portfolio is also a MUST based on when we need the money.

What is the solution?

The solution is NPS fund managers have to create a separate debt portfolio, especially for those who may cross 50 years or 55 years or whose retirement is around the corner. In such a portfolio, NPS fund managers must hold short to medium-term bonds rather than holding high-risk long-term bonds.

How come a debt portfolio risk is the same for a young subscriber whose retirement may be after 20-30 years as the subscriber whose retirement is around the corner or within few years?

Even though you actively move your equity portfolio to a debt portfolio considering the short-term retirement age, you can’t avoid the risk of an NPS debt portfolio due to the fund managers’ long-term bond holdings.

When you invest in mutual funds, you have various categories of debt funds based on your needs ranging from overnight funds to gilt constant maturity funds. Based on when you need the money and your risk appetite, you can choose the funds. But in the case of NPS, RISK is uniform for all the NPS subscribers. This is strange but true.

As we were in the low-interest rate regime few years back, these portfolios generated wonderful returns. However, since currently we are in a high-interest rate regime due to high inflation, you noticed that 3 years returns for all fund managers are around 5% to 6%.

I know that NPS subscribers have the least role in this. However, before blind investing, understanding the risks is most important.

Never invest in NPS just because it helps you to save the tax, just because few middlemen preached the theory that it is the cheapest pension fund available (I have showcased that the costs are actually higher than what they highlight. For this, you can refer my earlier post “Charges of investing in NPS – It is not so cheap!!) and finally just because with an assumption that DEBT portfolio means SAFE (even though fund managers holding government bonds fully).

Understand the basics, if you still feel the risk is fine and it suits your requirement, then GO AHEAD and invest. But never invest BLINDLY!!

Note – An interesting thing that I noticed while digging for the data is that the Kotak Pension Fund website is not accessible for the portfolio data. Is it due to a bug or intentionally I am unaware.

The most interesting thing about the Max Life Fund manager’s disclosure of the Tier 2 C portfolio. Instead of holding the corporate bonds, the fund manager is holding Aditya Birla Sun Life Liquid Mutual Fund – Direct-Growth and UTI Overnight Fund – Direct Plan-Growth. The total holding is Rs.16,26,250 in these two funds (99.95%) of the total fund size. Is it because of the temporary parking or not I am unaware.

4 Responses

  1. Kotak websites of any of their Companies invariably never work. Even after years they have to continue the old and new version with no clue as to which works when and what features are provided in which..

  2. Dear Basu sir, will deferment with/without active contribution help here? also on reading your article, do you mean the best way to get good reward is by applying for Annuity when Interest rates are high? or hold it for few years until Avg. Maturity period for each fund house?

    1. Dear Subra,
      Deferment will not help here to reduce the risk. Sadly we can’t control the retirement age (even though we dream) and hence starting annuity exactly when the interest rate is high requires luck factor also. Average maturity period will not come down just because your retirement is round the corner. It is at NPS level they have to act and segregate based on short term, medium term and long term requirement of subscribers.

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