Funds under the National Pension System (NPS) have delivered stellar returns across all asset classes in the past year, exceeding their long-term averages. Equity (E) schemes posted an impressive 18 per cent return, corporate bond (C) schemes offered 9.4 per cent, and government bond (G) schemes delivered 10.4 per cent.
“Past year returns have been exceptional where all the asset classes outperformed their 3-, 5-, and 10-year returns by a wide margin,” noted Abhishek Kumar, a Securities and Exchange Board of India (SEBI)-registered investment adviser and founder of SahajMoney.com. However, investors are cautioned against basing their allocation decisions solely on these figures, as such extraordinary performances may not be sustainable.
Understanding the drivers of returns
Equity markets have shown remarkable resilience, with the Sensex recording an 8.7 per cent return year-to-date. Meanwhile, mid-cap and small-cap indices soared, delivering returns of 26.7 per cent and 30.6 per cent, respectively. This strong performance significantly boosted the returns of NPS equity funds.
In the debt segment, declining interest rates played a pivotal role. “Returns have been better than usual due to falling interest rates both internationally and domestically, as inflation started coming under control,” explained Vishal Dhawan, Chief Financial Planner at Plan Ahead Wealth Advisors.
Experts caution that such gains are unlikely to persist indefinitely. “Returns across all asset classes tend to revert to the mean sooner or later,” Kumar added, urging investors to temper expectations.
Equity allocation: Know your risk appetite
The NPS offers an active choice option, enabling investors to adjust their asset allocation. However, this flexibility must be exercised judiciously. “The decision on equity allocation should be based on the investor’s risk appetite and ability to handle volatility,” said Dhawan.
While equities have delivered robust returns, their performance can vary significantly over different market cycles. Younger investors can afford higher exposure to equities early in their investment journey, gradually reducing this allocation as retirement approaches. Dhawan recommends revisiting equity allocation every 5-10 years to ensure it aligns with life-stage needs.
Additionally, significant gains in equity may skew the portfolio. Deepesh Raghaw, another SEBI-registered investment adviser, advises rebalancing in such scenarios to maintain the desired risk-return balance.
Debt allocation: Matching time horizons to scheme types
Debt schemes under NPS require a deeper understanding due to the different risks they entail. Corporate bond (C) schemes are relatively stable as they hold shorter-duration bonds. However, they carry slightly higher credit risk compared to government bond (G) schemes.
“G schemes have minimal credit risk but are more sensitive to interest rate volatility due to the longer duration of the bonds in their portfolio,” explained Dhawan. He advises investors to choose between C and G schemes based on their investment horizon. Those with longer-term goals may find G schemes more suitable.
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New investors: Strategic planning for NPS
For those new to the NPS, understanding its benefits and constraints is crucial. The NPS’s low-cost structure and tax-free rebalancing feature make it an attractive option. “Taxes are only applicable at the time of exit, providing an advantage for long-term strategic planning,” said Raghaw.
However, investors must be aware of the limitations on withdrawals. The NPS permits only three partial withdrawals for specified purposes, each capped at 25 per cent of the investor’s own contributions.
Raghaw suggests treating the NPS as a component of a broader investment portfolio rather than a standalone solution. This approach allows investors to use the scheme strategically for rebalancing and to minimise tax liabilities.
Key takeaways for risk-averse and volatility-tolerant investors
Portfolios with higher equity exposure tend to outperform over the long term, but they come with increased volatility. Investors comfortable with market fluctuations may benefit from allocating more to equity. Conversely, those averse to volatility might prefer the auto choice option, which automatically adjusts asset allocation based on age.
Finally, experts stress that past performance is not indicative of future returns. “Select NPS funds with lower expense ratios and adequate Assets Under Management (AUM) for better long-term outcomes,” Kumar advised.
By aligning their debt-equity mix with their risk tolerance and investment horizon, rather than being swayed by recent returns, investors can build robust retirement portfolios with the NPS.
