Chapter 03 · The national pension system
Equity, corporate debt, and government debt
Inside the NPS you do not pick shares or bonds. You pick an asset class, and a pension fund manager implements it. The main classes are equity, corporate debt, government debt, and a smaller alternatives bucket. This chapter says what each class is doing in a retirement account.
Equity is the growth engine and the swing
The equity class holds shares, within the large, liquid universe the rules allow and within a cap on how much of your account may be equity. The cap itself has been a function of age in the automatic lifecycle options, and the active-choice caps are set by the regulator and have been revised. Look up the current cap rather than quoting a number from memory. What will not be revised away is the behaviour: equity will fall, sometimes by a lot, in a year when you would have preferred it not to. In a retirement account that has twenty-five years to run, that fall is the cost of owning businesses. In an account that will be withdrawn in three years, the same fall is a reason the equity share should already have been small. The years, not the recent return, set the share.
Corporate debt is lending to companies
This class earns a yield by lending to companies and bearing the chance that a company does not pay. It swings less than equity and more than government debt, and it can have a bad year when credit is being repriced, even if the stock market is calm. It is not a fixed deposit. The NAV will move.
Government debt is the rate risk without much credit risk
This class lends to the government. The credit risk in rupees is the smallest you can take in the bond market, and the interest-rate risk is still there. A year in which yields rise will mark this class down. A year in which yields fall will mark it up. Holding it is how you damp the account, not how you freeze it. As retirement approaches, a larger weight here, or in the lifecycle option that does that shift for you, is the ordinary way to stop a single equity year from deciding the balance you will have to turn into income.
The alternatives bucket
A further class, often labelled for alternative investments, is allowed only up to a modest cap. It exists to let the manager hold instruments that do not fit the first three classes. Modest is the correct expectation. This is not where a retirement account becomes adventurous. If you do not understand what the manager is allowed to hold, set the weight to zero. You are allowed to refuse a class.
| Class | You are accepting | A mistake to avoid |
|---|---|---|
| Equity | Business risk and large temporary falls, in exchange for long-run growth | A heavy weight in the last few years before you need the money |
| Corporate debt | Credit risk and some rate risk | Calling it ‘safe income’ |
| Government debt | Rate risk, with little credit risk | Selling the class after one bad yield year, having bought it for stability |
| Alternatives | Whatever the current permitted list contains, within a small cap | Using the cap just because it exists |
Active choice and lifecycle
Active choice means you set the weights, inside the caps, and you are responsible for changing them as you age. Lifecycle means you adopt a path that reduces equity as you get older, on a formula. Lifecycle is the right default if you know you will not revisit the weights. Active choice is the right default if you will. A third path — active choice that you never look at again — combines the freedom of the first with the neglect of neither, and is how an account ends up 75% in equity at sixty because that was the maximum when you were thirty-five.
What to remember
- You choose classes, not securities. The manager implements the class.
- Confirm the current caps. They have been revised and they depend on the option you picked.
- Equity is for the long stretch of the account. Government debt is the damper. Corporate debt still has credit risk.
- Set alternatives to zero unless you know what they are.
- If you will not rebalance, choose a lifecycle path rather than an active mix you then ignore.