When we speak about investment there are various investment options available. Be it mutual funds, real estate, equity, precious metal or even commodity – an investor has got many choices. It is the investor who needs to decide which one to choose based on his risk appetite and alignment with financial goals. Earlier, we had seen that there was a tilt towards creating physical assets (real estate, gold, etc). However, over the period, awareness has increased for financial assets as well. With increased awareness many have started thinking about direct equity investments as well.
Many must be familiar with mutual fund schemes offered by asset management companies (AMCs). There has been an inclination towards the portfolio management service (PMS) offered by AMC’s, brokerage firms and even by a few independent portfolio managers. Such schemes are offered to high networth individuals (HNIs). Like mutual funds, even the PMS offerings are customised to suit one's understanding of risk and financial goals. With similar aspects in both, one would be wondering – is it better to go for PMS over the regular mutual funds schemes? Let’s try to find an answer to this.
Let us understand what is meant by Portfolio Management Services?
PMS is an investment service whereby its investors get the flexibility to tailor made portfolios. In simple terms, based on one's financial goals and risk appetite, portfolio managers tailor make portfolios to maximise the profitability. At one go it may seem to be like a mutual fund investment only. As based on our risk profile and financial goals, we select a mutual scheme and then get advantages of diversification along with professional management by experts. However, there is some difference. When one invests in PMS, investors actually own invested asset class in their name as against a mutual fund investor who owns units of a mutual fund scheme. In other words, in PMS investors are the direct owner of the asset and hence any volatility or movement would directly affect the holding.
However, in case of mutual funds – asset under management (AUM) is divided equally in units called as net asset value. Hence, the impact would be visible accordingly.
Types of Portfolio Management Services
In a broader classification, there are two types of PMS - discretionary and non-discretionary. In discretionary PMS as the name suggests, the portfolio manager chooses stocks and bonds as well as the timing of its buying based on his discretion. Majority of the PMS in India are of this type and are tilted towards managing equity-based portfolios.
Under non-discretionary PMS, the portfolio manager only suggests the investment ideas to the investor. Once the investor gives approval, the portfolio manager executes the trade on his behalf. Again this is not much different from the first type. Simply because the investment idea is generated by the portfolio manager only and investors just need to give an approval. If the investors were able to carry out their own research-why would one go to a portfolio manager? However, the advantage here is – many times the portfolio managers take higher risk and if no checks are put –losses may mount higher.
With both PMS and mutual funds offering the advantage of alignment with financial goals, one may think which one is better? There are simple factors (if analysed rightly) that would lead to an answer to this important query.
Minimum portfolio size
Equity markets are well regulated and there are regulations guiding the PMS as well. Along with other norms like minimum net worth requirement of the PMS provider, norms in terms of investment restrictions as per Securities and Exchange Board of India (SEBI), the PMS has got another regulation. One has to have a minimum portfolio size of Rs. 50 lakh. The rationale behind the same is, PMS, unlike mutual funds, are more complicated and riskier products, meant for investors with higher risk taking capacity. Thus, to avoid retail investors with limited understanding of volatility and risk entering this product, it is considered prudent to set the threshold limit at Rs. 50 lakh. Some portfolio managers may set a higher threshold as well. In simple terms the minimum investment limit restricts a lot of investors from going for PMS.
Compare this to as low as Rs. 500 in cases of mutual funds. Just imagine with just Rs. 500 investment one can get the services of the best of the fund manager from the industry. So if the selection of a mutual fund scheme is correctly done – it acts like a PMS only.
Cost element – controlling the controllable
While generating returns or maximising the returns is a basic premise of investment, cost of generating those returns is also very important. In our opinion, when the market becomes volatile and uncertain, it is difficult to control the portfolio. Cost is a controllable factor from our end. Let’s see how PMS and Mutual funds are based on cost parameters.
PMS providers usually charge between 2-3 per cent of the portfolio as annual fees. Generally, it is a function of the portfolio size – larger the portfolio, lesser the costs. Apart from this, there are also incentive-based charges that add to overall costs. For instance, the portfolio manager might charge 10-15 per cent of profits made in excess of Rs. 50 lakh. Or there are agreements where the incentives might be linked to ‘excess’ returns over a pre-agreed threshold.
In case of mutual funds, as per SEBI regulations, equity funds are permitted to charge a maximum of 2.25 per cent every year as annual expenses (all-inclusive) while it is 2 per cent for debt funds. If one considers all the above costs of PMS, mutual funds score better over PMS.
Performance track record
This leads us to the important factor called – profit generation. With higher risk the returns are expected to be higher in PMS. But the way it is applicable upwards is applicable for downwards move as well. Further, it is difficult to access the performance of the PMS based on the data in open domain. With data available for a limited period of time it is difficult to judge on the return parameter. In case of mutual funds – transparency is the key factor as data is available in open domain and can be tracked easily on user-friendly platforms. There is a possibility that the performance shared by PMS portfolio managers might not be the aggregate returns of all their investors and perhaps only that of its ‘model’ portfolio. While there would be PMS with a superior track record, it is important to do the necessary due diligence before investing.
Tax implication - who wants to get into it?
While generating returns is fine, it eventually leads to taxation complexity. In other words, selling an equity-oriented fund after a year attracts long-term capital gains tax of 10 per cent for its investor. However, its fund manager can sell and buy stocks many times over without any tax implication for the unit holder or investor. However, for a PMS, any sale or purchase of stocks in the portfolio attracts taxes on investors. The reason being, PMS invested assets are directly owned by them. So, if one is not capable of tackling the tax complexity issue PMS is not meant for such investors. Though the taxation process has become simpler – not many would want to get into the act of taxation complexities.
Fund managers flexibility on investment calls
Mutual fund as an asset class was created keeping the retail investors in mind. Hence, as expected, the mutual fund regulations have a lot of checks in place to protect the portfolios of retail investors. For instance, a single stock cannot be more than 10 per cent of an equity fund portfolio, sector and industry restrictions, etc. However, a PMS portfolio manager can create a concentrated portfolio by investing disproportionate amounts in favour of compelling opportunities based on their own research capabilities. In some cases the portfolio manager can get 100 per cent cash, if they feel the market is overheated and weak.
It is true that PMS gives the flexibility to portfolio managers in investing and also an opportunity for investors to benefit from tailor-made investment advice, it is also fraught with risk. What if investment is tilted towards one stock and the research call ends up being a wrong one. While flexibility comes as an advantage for risk seekers, for retail investors the regulated aspect works in favour.
Conclusion: Considering all the above parameters it comes out well that – PMS is not meant for all. If one has a higher risk appetite and funds available to meet the minimum portfolio criteria – PMS is not a bad choice. However, for the one having limited access to capital and still wishing for a professional management, mutual funds are the best way of investment.
Pro Tip: Basic premise of investing is returns. However, controlling the controllable parameters is what helps in wealth creation in long term.