PFS CAN NOW INVEST IN STOCKS, MFS

In a dramatic decision that could liven up the capital market, the government has, for the first time, directed non-government provident funds (PFs) to invest in stocks.

PFs, superannuation funds and gratuity funds have been told to put 5% of their fresh inflows into equity shares. Over and above this, they have been given the option to invest another 10% in equity-linked mutual funds.

This could make available around Rs 1,500 crore fresh investments in shares every year.

However, PF brokers and fund managers said the figure could eventually turn out to be much more, since 20-25% of investments by various PFs are maturing over the next 2-3 years.

The new guidelines, outlined in a finance ministry notification issued on Friday, will be effective from April 1, '05, subject to a clearance from the labour ministry, as far as PFs are concerned. The notification has said that PFs can directly invest in only those shares where debt instruments floated by the company have an investment grade from at least two credit rating agencies.

Non-government PFs, super annuity and gratuity funds which can take advantage of the new rule manage around Rs 1.5 lakh crore. It will, however, not affect government PFs, ie funds belonging to state agencies and public institutions, which are under the purview of Government PF Act 1925.

Does the change mean that the PF rate, currently at 8.5%, will not be touched? "We have not yet decided on the rate," said UK Sinha, joint secretary, capital markets division, ministry of finance. Sections in the EPFO, which regulate most PFs in the country, said they were not comfortable with the changes.

Interestingly, the notification has also opened up a short-term investment avenue for PFs in the money market. A maximum of 25% of the incremental flow can be deployed under the 'collateral borrowing and lending obligation'. Here, PFs can invest money for the short-term - usually overnight to 14 days - where the borrower pledges government securities with the Clearing Corporation of India.

"While an equity option would help PFs get a better return, there are risks and handling them needs some expertise. The PF trustees who have been typically risk-averse, need to change their mind-set. Convincing the trustees will take some time," said Pradeep Madhav, executive vice-president, IDBI Capital Markets, which manages the Coal Miners' Fund - one of the biggest PFs in the country.

Besides, PFs would also have change their opaque style of functioning, which resulted in money surreptitiously finding its way to equities in the hands of agencies like Hometrade.

Apart from new inflows, the ministry communiqué said, "Any money received on the maturity of earlier investments reduced by obligatory outgoing shall be invested in accordance with the investment pattern prescribed in the notification." Since a chunk of bonds held by PFs are maturing by '07, a part of the amount could be deployed in equity.

According to Dara Mehta, MD, Darashaw & Co, which is an advisor to several PFs, "It would gradually enable long-term, stable investment flow to the capital market."

One of the concerns of the PF sector, which has been badly hit by the drop in interest rates over the past five years, was where to put this maturity money in the absence of good investment.

At present, PFs are required to invest predominantly in bonds and debt instruments. Some leeway was given two years ago when they were allowed to invest 25% of the corpus in gilt mutual funds.

Currently, they can invest 25% in government bonds or gilt MFs, 15% in state-guaranteed or central-guaranteed bonds, 30% in bonds floated by PSUs, public FIs, and of the balance 30%, 10% can be invested in investment grade corporate bonds, and 20% in any of the first three categories.

As far as new inflows are concerned, from April 1, PFs will have to put 25% in gilts and gilt MFs, 15% in state and central government-guaranteed securities, 25% in PSU/PFI bonds, term deposits of PSU banks up to three years, and short-term money market lending, 30% in any of the above three categories (or 10% in equity MFs and 20% in any of three categories) and 5% in direct equities.

At present, PFs can invest in bank FDs for less than one year.