ESIC funds for equities an overdue decision

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The Employee State Insurance Corporation (ESIC) has been authorised to invest up to 15 percent of its surplus funds in equities, through the vehicle of exchange-traded funds (ETF), much like its sister organisation, the Employees Provident Funds Organisation (EPFO). I say sister organisation because these are two social security organisations run by the Labour Ministry, despite being essentially financial services outfits. While the EPFO is a retirement savings body, the ESIC is a health and disability insurance provider. Unlike conventional insurers, it also runs its own health services consisting of clinics, hospitals and even some medical colleges.

Given the success that the EPFO has had with equity investments, it was inevitable that the ESIC would also dip its toes into equity investments, although, in fact, it took longer than it should have. In any kind of macro situation, it makes little sense to keep long-term money entirely in debt. The EPFO and the ESIC are the ultimate long-term investors, with their inflows and outflows quite predictable over years and even decades. For such investment funds to not take advantage of the growth potential of equities makes little sense.

The growth potential from equity exposure is now well-proven in the case of EPFO. A few months ago, Investment data about EPFO investments was tabled in Parliament a few months ago show that total investments in equity of Rs 1.59 lakh crore had grown to Rs 2.27 lakh crore, yielding a gain of Rs 67,619 crore. This does not tell us much about the returns, but the parliamentary answer also had some more details of the inflows over the seven years that the EPFO has started with equity.

Making some assumptions, I calculated that the equity returns over the period were at an annualised rate of 13.6 percent. This is excellent, especially because the bulk of the assets are in fixed income and will likely have generated around 6.5-7.5 percent return over that period. Despite their small share in the overall asset base, the 13.6 percent return is a decent counterweight to the weak returns of fixed income.

Looking at this sterling performance, the only surprise in the ESIC’s announcement is that the body will only invest 5 percent of its surplus funds in equities initially, and gradually raise it to 15 percent. One should point out that the EPFO has already gone through this trial and error, and there is no logical reason for this diffidence.

The Indian economy and stock markets are in excellent shape and staying out is wasting an opportunity. The funds available with ESIC have a direct impact on the healthcare provided to its members. With the enormous rise in chronic diseases, as well as the ever-higher cost of healthcare, the returns generated by ESIC take on a larger importance than in the past. Healthcare is an increasingly large and unpredictable cost for Indian savers. An organisation like ESIC being able to play a more robust role in handling this cost for its members would be of greater value in the future.

Traditionally, the objection to these bodies investing in equities came from the fear that money belonging to workers would be lost in ‘speculation’ when markets decline. Therefore, investment in equities was a strict no-no. It has taken years for the reality to sink in, that is, as long as overall grow this higher, volatility is fine. In fact, the higher growth will always come pre-packaged with volatility and if you want one, you must put up with the other.

In fact, what the data actually shows us is that the real risk lies not in the equity part but in the fixed income part. The fixed income component barely, if at all, keeps up with inflation. Under fixed income, the real (inflation-adjusted) growth of the corpus must be around zero. Far more than equity, that is what should be the bigger source of worry for the trustees of these bodies.