MarketFirst Fortnightly Report December 20, 2013 Pension Funds: Emergence of A New Institutional Investor: Foreign Institutional players:

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1 MarketFirst Fortnightly Report December 20, 2013 Pension Funds: Emergence A New Institutional Investor: In last two decades, Indian economy has gone through many changes and evolved as one the fastest growing economies in the world. A growing economy needs continuous flow resource and capital for investments. This has led to the development capital markets in India. Since then, the capital market has gone through various development phase which include screen based trading, dematerialising shares, faster settlement and very important, establishment SEBI as a market regulator. While market went from the various developments, the investor dominance continues to remain the same as large part the market is dominated by Foreign Institutional Investor (FII) and in turn foreign capital. We believe the recently approved PFRDA bill will help in reducing that dominance, albeit in long term. Foreign Institutional players: During the period liberalisation India economy, Indian Government had allowed the foreign capital in India. The FIIs saw opportunity in the newly opened up economy and this resulted in continuous flow the capital by way foreign direct investment and Portfolio investment. The FII flow which started as just Rs.4.27cr in FY93 moved to amount more than Rs.1lakh crore in FY10. During this process, the FII became one the largest segment in the Indian capital and along with that their dominance in the market increased. While it is good and desiredd by any economy to have foreign participation, sometimes it has negative impact too. We have seen the ill effect the same when large outflow large FII money resulted in sharp correction in the equity markets. Impact Capital Flows on Current Account Deficit and Fiscal Deficit: It s is conventional wisdom that a stronger economy attracts larger amount the foreign capital. But it has a different impact too. Indian economy is import dominated resulting into continued and persistent current account deficit. Large part the deficit is getting financed through the flow foreign capital. For e.g. during FY13 CAD was USD 88bn and this approx USD 26bn was got financed by FII flow. A

2 reduction in the foreign capital flow coupled with increase in CAD may lead to deficit resulting in impact the Forex reserve and results in currency depreciation. This is a vicious cycle. A depreciating currency means large import bill which further balloons up the CAD. Impact the widening current account deficit also leads to higher fiscal deficit as the fuel subsidy bills goes up and results into a situation economic imbalance. Thus, FII flow is important for Indian economy but having said that, Indian economy need a new and different breed long term institutional investor which may also play a larger role in Indian equity markets along with the FIIs. Need for an Alternative: Apart from other parameters, Foreign institutional investors decides their country exposure based on size the market capitalisation. At the present market capitalisation, it seems that the flow has reached to its optimum level. To grow from here, market capitalisation has to be increased. This means more corporates getting listed, dilution government holding in PSUs and reduction in the promoter holdings. While in the long term FII flow may help to absorb the equirement capital, in the medium term, India will need and must create a breed domestic institutional investors who can provide capital both on long term as well as short term basis. At present, domestic institutional investor is dominated by largest insurance company and various mutual fund players. In its early stage development, Mutual Fund industry was expected to become a dominant player as it was channeling good amount retail investor savings to the capital market. But it didn t pick up because strict regulatory norms and lowering commission. ULIP plans Insurance companies which were growing at decent pace faced similar hiccups. Both MF & ULIP plans are facing redemptions pressure over the last several quarters. This has led to need to for creation a widely acceptable mechanism or institution which can create a long term pool investible money by sourcing funds from the larger public in the domestic market. National Pension Scheme: Creation a new Institutional investor: Indian Parliament has passed the much awaited PFRDA act which paves the way for institutionalising National Pension Scheme (NPS). One key motivation for India to reform their pension systems has been the expectation that these pension funds would play a dynamic role in the development capital markets, fostering private sector savings and reducing the cost capital for corporations, in the context a broaderr strategy to achieve more developed, market oriented financial systems. Since pensioners

3 save for the long run, pension funds (unlike other institutional or retail investors) are expected to be able to provide long-term financing to domestic corporations (fundamentally), as well as governments. Moreover, pensioners (by law) provide a steady flow funds for many years to pension funds, enabling the latter to be a stable source capital. Importantly, since pensioners are required to hold their investments in at least one pension fund until retirement, this gives stability to the system as a whole. The NPS scheme from general public have an option to invest in equity and in this way will allow the Pension fund to flow to the long term equity investments. A citizen can get access to the NPS by way the bank branches and the post fices. This way it has removed the logistic hurdle faced by the mutual fund industry. This way the pension fund can generate a large pool money for long term and eventually become a dedicated long term domestic institutional player. Globally pension funds are among the largest institutional investors and have AUM more than USD 24 trillion. Over a period time, these funds have gone through several reforms and becamee a big source capital aggregator and capital allocator in the global market. In the US pension funds invests 70 percent their corpus in equity related instruments. Over a period time more and more countries are setting up pension fund and these funds are becoming a vehicle for effective long term capital allocation in the global market. A list some Global Pension Funds: Country Japan Norway Netherlands United States South Korea Canada (Quebec) Fund Government Pension Investment Fund Government Pension Fund Norway Stichting Pensioenfonds ABP (ABP) Thrift Savings Plan (TSP) National Pension Service (NPS) Caisse de dépôt et placement du Québec (The Caisse, or CDPQ) Assets USD (in billions) USD 1370 USD 746 USD 363 ( Euros 281) USD 330 USD 270 USD 176

4 US(California) Malaysia Netherlands Canada Canada (Ontario) Brazil Ireland Source: Wikipedia California Public Employees' Retirement System (CalPERS) Employees Provident Fund Stichting Pensioen fonds Zorg en Welzijn (PFZW, formerly PGGM) Canada Pension Plan and CPP Investment Board Ontario Teachers' Pension Plan Caixa de Previdencia dos Funcionários do Banco do Brasil (PREVI) National Pension Reserve Fund (NPRF) USD 202 USD 130 USD169 (Euro 131) USD 183 (CAD 189) USD 130 USD 80 USD 30 In the domestic market, new pension reform may lead to strong AUM generationn by PFRDA. The existing etirement funds corpus is in range Rs trillion, which the Employees Provident Fund (EPF) makes up one-third the total, while the Public Provident Fund (PPF) and NPS account for about 2.5 per cent each. Most this money is invested in the debt instruments as per prescribed by the law. The New Pension Scheme is a thoughtfully constructed scheme and should be beneficial for all the stake holders. The has provided the scheme to the general public and made accessible the same by way the bank branches and post fices which covers all the nook and corners this country. The cost is lowest and trustee ship the money will remain with the Government agency. The subscriber invests a notional amount its savings and gets the benefit expertise management with a cost which is lowest among all the other investmentt management products. PFRDA has appointed prominent asset managers to manage the money which flow through the scheme. By design the product, the flow the money will be continuous and will remain for a significantly long term. Thus, it will provide the general house hold an arena long term reliable saving option and to the economy it will provide a long term flow capital. In this process, PFRDA should be able to pool a large chunk money for investment. Thus, it s a win win situation for all the stakeholders.

5 As per recent EY report on Indian Pension market, the AUM under pension funds may reach to the staggering sum Rs.1 trillion by This is a big amount and large part it is expected to be towards debt investment. But even a 10 per cent this money gets investment in equities; it will certainly build a large domestic institutional investor for the capital market. Being a large player, it will certainly provide the depth the market and will help in systematic channeling the household s savings to the resource equirement the investments in the growing economy. Conclusion: The Indian stock markets have really come age. Many developments have taken place in the last 15 years that make the markets on par with the developedd markets. The important featuree developed markets is the growing clout institutional investors and Pension funds are among one the. Post the passing the PFRDA bill, pensionn funds will become a potent force in the domestic market as they will be able to garner a large flow funds. The impact such large inflow into Indian equity markets will have a positive impact on the markets, and at the same time will lend a semblance stability to our markets. It may take some time to reach to the level the FII investments, but nonetheless it may pay a role a long term institutional player which may play a bigger role channeling small and long term savings and allocating the same capital in much more effective way so as to benefit all the stakeholders. Disclaimer Some the contents this document may contain statements/ estimates/ expectations/ predictions, which may be 'forward looking'. The actual outcomes could differ materially from those expressed / implied in this document. These statements, do not intend to provide personal recommendation to any specific individual or any investment needs an individual. The recommendations/ statements/ estimates/ expectations / predictions are general in nature and may not take into account the specific investment needs or risk appetite or financial situationss individual clients. Therefore, before acting on any advice or recommendations contained in this document, readers,

6 in their own interest, should consider seeking advice from any authorized and pressional investment advisorss or financial consultants.' The above data has been generated from sources in public domain. IndiaFirst Life Insurance Company Limited. Insurance is the subject matter the solicitation. IRDA Reg. No Address: 301, B Wing, The Qube, Infinity Park, Dindhoshi Film City Road, Malad (East), Mumbai